SAP Earnings Preview: Cloud growth and price fixing probe in focus

SAP is set to report its third-quarter 2024 earnings overnight, with analysts expecting earnings per share (EPS) of €1.31, a 17.1% decline compared to the same quarter last year. Revenue is anticipated to rise by 9.9% year-over-year to €9.26 billion, driven by the company's continued expansion in the cloud space. SAP has surpassed analyst expectations in two of the last four quarters, with an average beat of 4%, making this report closely watched. Key metrics to focus on include cloud revenue growth, especially from the Rise with SAP and Grow with SAP solutions, which have been major contributors to the company's cloud business momentum.

Cloud remains a critical driver for SAP, with its Cloud ERP Suite expected to show robust growth. In Q2, the suite's revenue surged by 33%, and a similar performance is anticipated in Q3. Additionally, the company's increasing focus on artificial intelligence (AI) is noteworthy, particularly its partnership with NVIDIA to integrate AI capabilities into its solutions. Investors will also be keen on SAP's current cloud backlog, a key indicator of future growth, which grew by 28% last quarter. However, challenges remain, including softness in the software license and support business and rising R&D costs, which could weigh on profitability.

Another factor that will capture attention is SAP's acquisition of Israel-based WalkMe Ltd. for $1.5 billion in September 2024. This deal strengthens SAP’s digital adoption capabilities, helping users accelerate their digital transformation processes. The acquisition aligns with SAP's strategy to drive innovation and foster growth in key areas like AI and cloud. Investors will look for insights on how WalkMe's integration is progressing and its potential contributions to SAP's top-line growth in the upcoming quarters.

Despite its strong cloud performance, SAP is facing significant legal headwinds. The company, along with Carahsoft Technology, is under investigation by U.S. officials for allegedly conspiring to fix prices on sales to government agencies. This investigation could pose a legal risk for SAP, as it is a major supplier of technology to the U.S. government. The outcome of this probe could have far-reaching implications, not only for SAP's government business but also for its reputation in the broader enterprise software market.

The price-fixing probe has already impacted investor sentiment, as SAP's shares dropped 4% following the news, although they have still gained 42% year-to-date. The investigation, which covers dealings with nearly 100 government agencies, is a serious concern, and SAP’s full cooperation with the U.S. Department of Justice will be closely monitored. Investors will be looking for any updates or guidance on how SAP plans to address these legal challenges and minimize their impact on the company's operations.

SAP reported strong Q2 earnings, with EPS of €1.10, beating the FactSet consensus of €1.04, and revenues rising 9.7% year-over-year to €8.29 billion, slightly ahead of expectations. The company is in the midst of a major restructuring initiative aimed at focusing on strategic growth areas, particularly in AI, and enhancing operational efficiency. SAP recorded an additional €0.6 billion in restructuring costs during the quarter, bringing the total for the first half of 2024 to €2.9 billion. The program is expected to conclude in early 2025, affecting 9,000 to 10,000 positions, mostly through voluntary leave programs and re-skilling measures.

Looking ahead, SAP reaffirmed its 2024 guidance, projecting cloud revenue to grow 24-27% year-over-year, reaching €17.0-17.3 billion, and total cloud and software revenue of €29.0-29.5 billion, an 8-10% increase. Operating profit is expected to rise 17-21%, reaching €7.6-7.9 billion. However, free cash flow is expected to drop to around €3.5 billion, down from €5.09 billion in 2023, as SAP continues to reinvest in its strategic priorities, including AI and cloud technologies.

Overall, while SAP's cloud and AI-driven growth provide a positive outlook, the Q3 report will need to balance these achievements with the potential downside from legal issues and macroeconomic headwinds. Investors will also be closely watching SAP’s guidance for the remainder of 2024, especially regarding cloud revenue targets, free cash flow projections, and the impact of restructuring efforts aimed at boosting efficiency and scalability in the long term.