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Elmo Software: Progress And Accounting

Australia | Feb 17 2022

This story features ELMO SOFTWARE LIMITED. For more info SHARE ANALYSIS: ELO

Brokers generally praised signs of operating leverage within Elmo Software’s first half results though one broker questions the accounting treatment employed.

-First half results showed improving operating metrics for Elmo Software
-Breathe continues to be an outstanding acquisition
-The key share price drivers explained
-Wilsons concerns over accounting treatment and cash burn

By Mark Woodruff

Along with many stocks in the technology sector this year, shares of HR software provider Elmo Software ((ELO)) have been in sharp decline this year, falling by over -40%.

The company operates in Australia, New Zealand and the UK and targets customers in the mid-market (more than 50 employees), as well as small and medium-sized enterprises (SMB) with less than 50 employees.

Jarden likes the structurally growing nature of the industry and the company’s exposure to rising operating efficiency requirements. Another tailwind comes from increasing demand for digital workforce management as organisations shift toward greater remote working arrangements.

Following pre-released first half results, Canaccord Genuity believes operating metrics are improving, and investments made over the last 18 months are beginning to bear fruit. Due to the current momentum, Shaw and Partners would not be surprised to see management upgrade guidance in the second half.

The broker highlights top line growth is returning to pre-covid levels, while cost growth is moderating and driving operating leverage.

Annualised recurring revenue (ARR) growth for Elmo Core (mid-market) and Breathe (small business) segments was 34% and 41%, respectively. This growth was driven in-part by 5% and 13% customer growth compared to FY21. According to Canaccord Genuity, Breathe continues to be a standout acquisition.

Wilsons also notes evidence of increased traction for sales from an increase in average modules per customer, and an encouraging rebound by the UK business, Webexpenses, after the removal of some covid restrictions.

However, on a more cautionary note, the broker suggests operating leverage may have been aided by a mix of aggressive accounting treatment (i.e. strong capitalisation) and supplementing payment of headcount costs with share-based payments. Moreover, cash flow breakeven may be too distant to avoid a requirement for additional finance.

The broker, not one of the seven updated daily in the FNArena database, maintains its Underweight rating and slashes its target price to $3.54 from $4.64.

What drives the stock price?

The two key drivers of Elmo Software’s stock price, according to Canaccord Genuity, are the moderation of ARR churn and demonstration of cash operating leverage.

Over the last 12 months the ARR churn for the Elmo Core segment reduced to 10.4% from 11.6% in FY21. The second half is currently running at 9%, aided by an improved operating environment coupled with an investment in customer retention/support initiatives, points out the analyst.

Regarding cash operating leverage, management has repeatedly stated it expects to become free cash flow positive by the fourth quarter of 2023/first half of 2024. As history suggests to the broker, mature SaaS stocks passing through free cash flow breakeven undergo large and positive multiple re-ratings.

Wilsons takes an entirely different tack and suggests a seasonally strong fourth quarter would effectively be a short-term breakeven. By the time of a more formal period of breakeven in FY24, the company could be very low on cash, unless there’s a turnaround on cash burn.


Management reiterated its FY22 guidance for $107-113m in ARR and $1.5-6.5m of earnings (EBITDA). Guidance had been upgraded in early February this year.

Jarden sees operating leverage coming through, as investment as a percentage of revenue has reduced. It’s thought the investment case is being de-risked by a material normalisation of churn and a stabilising free cash outflow.

Given the first half results were largely pre-released, brokers (apart from Wilsons) generally left their respective target prices and ratings unchanged.

Within the FNArena database, Morgan Stanley maintains its Overweight rating and $7.80 target price, which represents 94% upside to the last share price.

For those brokers not updated daily in the FNArena database, both Canaccord Genuity and Shaw and Partners have Buy ratings with price targets of $8.70 and $8.50, respectively. Jarden has an Overweight rating and reduces its target marginally to $6.01 from $6.02.

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