Devil In The Detail: Appen Limited (ASX: APX) Share Price Flat After Maintaining Guidance

Appen Limited (ASX: APX) has been a focus for me during the pandemic because it has large customers are that are unlikely to be forced to cut spending, due to their intense profitability and strong balance sheets. So it was no real surprise that the company decided to restate its FY 2020 guidance of full year underlying EBITDA of $125m to $130m.

This result would represent an increase of around 25% on FY 2019 (Appen’s financial year ends in December).

At the current price of $23.97 Appen has a market capitalisation of about $2.9 billion, and an enterprise value of about $2.8 billion if we take its claim of “$100m in cash resources” at face value. That means it is trading on an EV/ Underlying EBITDA of about 22.4 based on the low end of guidance. If it can add another $25m of Underlying EBITDA for three years in a row, then at the end of FY 2022 it would have an underlying EBITDA of $175 m and would be trading on about 16 times underlying EBITDA.

In such a scenario its profit might be around $70m for the full year, putting it on a price to earnings ratio (for a bullish FY 2022) of 40.

So back of the napkin, at current prices, I need to take a fairly optimistic view of the next few years and then still be willing to pay a fairly optimistic multiple of estimated FY 2022 earnings to like the current price.

Now, I bought shares in Appen Limited (ASX: APX) during March, topping up at $19.05 and $17.14, because I thought it would cruise through the pandemic easily. However, there was one aspect of today’s update that makes me a bit nervous about FY 2020 and FY 2021.

Will Appen Limited Be Negatively Impacted By Falling Ad Spending?

That is the bit where Appen says:

“Considerations that may dampen 2020 performance are: a slowdown in digital ad spending, a reduction in IT/digital spending, reduction or cancellation of services from Appen’s smallest customers, interruptions to global hardware supply chains and suspension of face-to-face projects such as audio data collection.” [my emphasis]

You see, as one twitter wag alluded to, there is an 100% chance that there will be a slowdown in digital ad spending. That takes about 5 seconds to work out. Just look at this headline from Wall St Journal.

While Appen still looks like a cruiser within my framework for assessing pandemic opportunities, I may have slightly underestimated how impervious it would be to short and medium term set backs.

As a result, I have reduced my holding by 20% after this announcement. I will likely look to accumulate again if it drops to lower prices again. I am still a happy long term holder of Appen shares, but a little more cautious than before.

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