PSI — Update 22 November 2015

PSI Software (PSAN)

Last close As at 27/03/2024

11.96

0.00 (0.00%)

Market capitalisation

188m

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Research: TMT

PSI — Update 22 November 2015

PSI

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Written by

TMT

PSI

Near- and longer-term prospects solidifying

Eigenkapitalforum

Software & comp services

20 November 2015

Price

€13.4

Market cap

€209m

Net cash (€m) at September 30 2015, excluding €46.7 pension provision.

23.7

Shares in issue

15.6m

Free float

76%

Code

PSAN

Primary exchange

Frankfurt

Secondary exchange

Munich

Share price performance

%

1m

3m

12m

Abs

6.9

12.8

20.9

Rel (local)

(2.0)

8.7

3.3

52-week high/low

€13.8

€10.3

Business description

PSI develops and integrates software control systems: (1) solutions for electricity, gas, oil and water; (2) software for production planning, control and logistics; and (3) solutions for monitoring and operating critical transport, public safety, environmental and disaster prevention.

Next events

Eigenkapitalforum

23-24 November 2015

Full-year results

March 2016

Analyst

Dan Ridsdale

+44 (0)20 3077 5729

PSI is a research client of Edison Investment Research Limited

PSI has delivered a solid recovery in order intake and margins in 2015 to date and management expects double-digit growth in orders and revenues into early 2016. While we are mindful of the economic risks and exposure to the cyclical investment cycle in Electrical Energy, our confidence that PSI can sustain its growth and margin expansion trend is improving.

Year end

Revenue (€m)

PBT*
(€m)

EPS*
(c)

DPS
(c)

P/E
(x)

Yield
(%)

12/14

175.4

5.9

27.50

0.0

48.7

0.0

12/15e

179.7

9.6

50.57

15.0

26.5

1.1

12/16e

188.4

13.5

70.96

20.0

18.9

1.5

12/17e

196.6

15.7

82.16

25.0

16.3

1.9

Note: *PBT and EPS exclude acquired intangible amortisation, but not exceptional items or share-based payments.

So far, generally encouraging FY15

So far in FY15, PSI’s performance has been generally encouraging, with order intake for Q1-Q3 growing by 12% to $149m and sales by 7.4% to €137m, driven mainly by demand in Western markets, particularly in Energy and Production Management. EBIT margins for the first nine months expanded from 3.4% in FY14 to 5.3% in FY15, reflecting the lingering impact of cost overruns in Logistics, which suppressed the prior year and operationally geared margin expansion in Energy Management. The outlook also looks encouraging, with management reconfirming its full-year €11m EBIT target (we estimate €11.1m), while order intake and revenues are expected to grow at a double-digit rate into the early part of 2016.

Improved confidence in a sustained improvement

While we are mindful of the uncertain global economic situation and the potential for a cyclical reduction in demand from the German electricity segment, our confidence that PSI can sustain its growth and margin expansion trajectory is improving. In particular, the ThyssenKrupp strategic partnership, a healthy product launch pipeline including new product launches in Automotive & Industrial, Logistics and Energy Trading and follow-on orders in Mining should support growth from a broad base of end markets. The company’s key initiatives to migrate all products to a single software platform and shift to a software-vendor versus software-implementation model will take time, but if successful, should support progressive margin expansion and robust earnings growth over a number of years.

Valuation: Upside from continuation of current trends

PSI’s P/E rating, while not particularly compelling, is not out of kilter with its broader group and its EV/Sales ratio at 1.0x is substantially lower than its peers. This highlights the potential upside if PSI can expand its margins closer to 15%+ levels enjoyed by established industrial software vendor peers. We believe that the current share price factors in the expectation that EBIT margins can be expanded to 10% (vs 6.1% forecast for FY15) in the medium term. However, with good execution, we believe that 15% remains a valid target on a four- to five-year view, and that if achieved, would justify a share price in excess of €20.

Investment summary

Control software for critical infrastructure

PSI (Gesellschaft Fuer Produkte und Systeme der Informationstechnologie) develops, sells and integrates software for controlling complex systems, networks and infrastructures. Its systems are crucial components within these systems, enabling them to run efficiently, improving flexibility and avoiding failure. The company has three key divisions: Energy Management – the company’s systems are used to ensure a stable and dependable supply of electricity, gas, oil, heat or water; Production Management – solutions for optimising metal processing, automotive production, mechanical engineering and mining processes; and Infrastructure Management – highly resilient control systems for managing and monitoring road, rail and other public transport systems. The company transacts business across the globe, with Germany accounting for circa 51% of sales as a result of a strong domestic position in Electrical and Multi-Utility Energy, Logistics and Automotive & Industrial divisions. Two key initiatives are being implemented to add resilience to earnings and put the business back on a margin expansion trajectory. Firstly, the shift towards a product-led vs project-based model should reduce exposure to cost overruns and improve the working capital profile. Secondly, the progressive migration of customers and products onto a unified technology platform should help improve development and implementation efficiency and reduce overheads.

Financials: Scope for sustained strong EPS growth

The company’s recent trading and outlook suggests the business is now set on a recovery path, following a difficult period in 2013 and early 2014, where a weak domestic energy market and cost overruns severely compressed margins. Order intake over the nine months to September 2015 grew by 12% to €149m and sales by 7.4% to €137m, driven mainly by demand in Western markets, particularly in Energy and Production management. EBIT grew by 66% y-o-y to €7.3m due to recovery from the negative impact of cost overruns in early 2014 and operationally geared growth, although weak conditions in South-East Asia were a supressing factor. Our estimates have not changed materially other than a reduction in the dividend (20c to 15c for FY15, 30c to 20c for FY16) to reflect management’s 30% payout-ratio guidance. While we are mindful of the uncertain economic and geopolitical environment, and of the potential for German electrical grid investment to soften following the tariff setting year, we see good potential for PSI’s growth and margin expansion trajectory to continue. The strategic partnership with ThyssenKrupp should support growth in PSI metals, while new product releases in Automotive & Industry, Logistics and Energy Trading and a follow on order in Mining should support growth across a broad base of divisions. Reflecting the progressive impact of the software platform consolidation and shift to a product-led software model, we forecast EBIT margins expanding from 4.1% in FY14 to 8.5% in FY17. This drives a 44% EPS CAGR over this period. Looking longer term, we believe that the initiatives could drive margin expansion to the mid-teens level on a four- to-five year view versus 6.1% forecast for FY16.

Valuation: Upside from continued growth and margin expansion

Despite the recent recovery, PSI’s share price remains rated at recovery multiples, with a low EV/Sales (1.0x) but relatively high P/E (18.9x), although the latter is not out of kilter with the company’s broader peer group. On a fundamental basis, our DCF scenario analysis suggests that the current share price factors in low single-digit organic growth, with margins expanding to 10% by 2020. Expansion of operating margins to 15% would justify a share price above €20. We believe that evidence that the current growth and margin expansion trajectory is set to continue is likely to be the key catalyst for upside. In particular, management is guiding to a 10%+ growth in revenue and order intake into early FY16, which if sustained could drive upside to our estimates and potentially a moderate upwards rerating of the P/E as well.

Mission critical infrastructure control software

PSI’s software solutions control, monitor and optimise complex, mission critical infrastructure for utility companies, industrial manufacturers and processors and the transport industry.

Control software is an essential component in the operation of advanced industrial or logistics processes enabling operators to improve operational efficiency, reduce the risk of potentially catastrophic failure, deploy infrastructure more efficiently, adapt to change or improve flexibility and reduce environmental impact.

The range of functionality covered by the company’s solutions varies by vertical market, but includes front-end user interfaces for control and monitoring, process-specific control algorithms, fault analysis and handling, simulation, reporting, maintenance, trading software and workforce management.

Exhibit 1: Electrical energy control room

Exhibit 2: Other product screen shots

Source: PSI

Source: PSI

Exhibit 1: Electrical energy control room

Source: PSI

Exhibit 2: Other product screen shots

Source: PSI

Understanding the balance of the business

Multiple segments, each with their own dynamics

The company segments its business into three divisions: Energy Management, Production Management and Infrastructure Management, each addressing a broader collection of end markets. However, to better understand the dynamics of the business, it is important to note that each of these three divisions is made up of a number of more focused businesses, each offering optimised solutions and expertise to address more specific industry verticals, as shown in Exhibit 3. Consequently, each reporting segment consists of a number of businesses with differing maturities and margin profiles and each is exposed to different end-market and competitive dynamics. Looking at the business from this perspective, the five largest businesses in terms of revenue contribution are PSI Metals (25%), Electricity and Multi-Utility (19%), PSI Automotive & Industry (16%), Gas and Oil (13%) and PSI Incontrol (10%) (percentages are estimated on trading for the nine months to September).

Geographically, the company operates on a global basis, with just over half of revenues generated from Germany. Again, the profile differs very much by division, with the Electricity and Multi-Utility, PSI Penta and PSI Traffic divisions being largely domestic, whereas Metals and Gas and Oil are both international although the latter has significant exposure to Russia. PSI Incontrol operates in South-East Asia.

Exhibit 3: Revenue split by segment and by division (FY14)

Source: Company data, Edison Investment Research

Structural transformation initiatives

Consolidating to a uniform software platform

From its foundation in Berlin, in 1969, PSI was built up through organic development supplemented by a number of acquisitions, and as a result the company currently works with around 25 different specialist software platforms, each developed for specific vertical markets of applications. The requirement to enhance, maintain and support all of these platforms clearly results in very significant inefficiencies, suppressing margins and impairing competitiveness.

Exhibit 4: New platform architecture

Industry solutions: Contains industry-specific or customer-specific functions and algorithms and interfaces to existing enterprise software or machinery.

Application layer: Provides ready to use applications for solving operational tasks. Includes algorithms for optimisation, production control and logistics.

Framework layer: Provides the basic interfaces and tools to enable rapid, cost-effective application development.

Infrastructure layer: Contains the key elements common to all components and services. Key elements include the operating system, databases and networks.

Source: PSI, Edison Investment Research

The company introduced a new platform in July 2010, based on the Eclipse Java based architecture and has invested well over €10m in the development to-date. The group is now around a third of the way through a programme to progressively migrate its operations onto this architecture, which should ultimately improve the efficiency of R&D and support and enhance competitiveness. It is also a key enabler of the company’s strategic transition from its previous position as an IT solutions provider to a more product-driven software licensing model.

The key benefits of this migration to the company’s margin profile are as follows:

reduced replication of work, through the use of a common platform. For example if an infrastructure software provider changes an interface, the modification can be implemented just once across all applications rather than once for each legacy platform;

efficiency gains through using a more modern, user-friendly platform;

access to a larger pool of developers, enabling reduced dependence on (typically expensive) niche skillsets and increased ease of near shoring or offshoring; and

more flexibility in being able to reallocate staff across applications according to the balance of demand.

Ultimately, the potential for this platform consolidation to proportionately reduce R&D costs and raise margins could be significant. In the transition period however, margins are being compressed by an element of double costs being incurred, as the company still supports a number of disparate legacy solutions, while it further develops the platform.

The migration process is also very much a long-term project, with the divisional schedule based on both commercial need and degree of complexity. Consequently the release of efficiency benefits will be very progressive.

However, we believe that the recent strategic deal with ThyssenKrupp for PSI Metals, which is now largely based on the new platform, does give investors an indication of the type of commercial benefits which will be made possible. As part of the deal, PSI become the standard software provider for ThyssenKrupp’s European steel business, and over a period of years all of ThyssenKrupp’s 15-20 European plants, (which currently use a variety of different solutions) will migrate to the PSI platform. We highly doubt that such a deal would be possible using a legacy solution.

Shift towards a more product-based model

Historically, PSI operated a solutions-based model, whereby the licensing component of a customer engagement was relatively low, with revenues weighted towards the implementation project, which involved customising and then integrating the solution, often on a fixed-price basis. Facilitated by the move towards a standard software platform, the company is now shifting its model, whereby the licensing component (for a more modern, flexible product) will be higher, while the implementation work will be carried out on a time and materials basis, and should proportionately reduce with the improved configurability of the new platform. The standardisation of the platform should also support growth in maintenance and upgrade revenues, through enhancing the company’s ability to sell standard software upgrades and security patches, often bundled into a full upgrade and maintenance contract. Historically, the typical value of a standard maintenance contract was 15-16% of sales, whereas under the new model a full upgrade and maintenance contract may be worth as much as 20-25% of the initial licence fee.

Exhibit 5: Revenue progression by type (strategic growth areas in green)

Source: PSI, Edison Investment Research

Improving margins and earnings predictability

Ultimately, this shift in the model should help drive up margins and improve earnings predictability. The shift should drive growth in licensing (high margin but volatile) and maintenance and upgrade revenue (high margin and recurring), while software development and integration revenues are likely to decline, although the shift towards time and materials contracts should reduce exposure to cost overruns. Hardware revenues, a significant proportion of which are generated by Incontrol, are unpredictable and low margin. The shift will also suppress growth in the order book in the near term as multi-year fixed price implementation projects, (where the whole value would be recognised in the order book) give way to time and materials, upgrade and maintenance revenues, which enter the order book more progressively.

Building on strengths, potential rationalisation of non-core

The company has also taken further steps over the course of the past year to consolidate the business, building on its key strengths in vertical markets, where the company has a strong competitive position, while rationalising weaker operations.

The acquisition of Broner, a direct competitor to PSI metals in Q414, showed PSI’s ambition to build upon its core strengths, consolidating the market to improve pricing power and grow the company’s customer and geographic footprint. Equally, the headcount at PSI Incontrol has been reduced by 40 to adjust to the difficult economic environment in South-East Asia.

Dynamics by segment and division

Production Management (c 48% of sales)

The production segment consists of two of PSI’s larger businesses, PSI Metals and PSI Automotive & Industry (previously called Penta), with two smaller divisions, Logistics and PSI Mining. In the nine months to September, revenues grew by 8% to €65.6m with EBIT increasing 167% to €4.5m. While the Q414 Broner acquisition will have accounted for the bulk of this increase, we see good scope for robust organic growth going forward, driven by the ThyssenKrupp deal in Metals, new product launches in Automotive & Industrial and Logistics and follow-up orders from initial trials in mining.

PSI Metals – ThyssenKrupp, aluminium could offset the weak steel market

Challenging conditions faced by the global steel industry over the past year have had an impact on what had previously been one PSI’s strongest performing divisions. However, the deal with ThyssenKrupp should provide support for the steel business for a number of years, while investment in the aluminium production industry also provides growth opportunities. The contribution from Broner is difficult to gauge, as other than certain key modules, the Broner products are being phased out to be replaced by the PSI ones. We have yet to see any evidence that Broner is helping drive new business wins in geographies where PSI was historically weak, such as the UK, India and Brazil, but given the industry’s long sales cycles and conditions in the global steel industry this is not surprising, although the consolidation of a competitor may have simplified the bidding process for the ThyssenKrupp deal.

PSI Automotive & Industry – new platform to capitalise on Industry 4.0 opportunities

PSI Automotive & Industry (previously PSI Penta) stands somewhat apart from the rest of the group in that it supplies enterprise resource planning (ERP) and manufacturing execution systems (MES) rather than control software. Operating primarily in Germany, the division supplies into two key verticals: the automotive manufacturing supply chain; and German Mittelstand manufacturers. The economics of this business are hampered by the fragmentation of the customer base (over 400 customers) and competition with SAP. However, a major new product update, due for launch in H116, which will bring the solution onto PSI’s core platform, should both enhance competitiveness and replacement sales, although the knock-on effect from the Volkswagen scandal clearly adds an element of risk.

The longer term and more significant growth opportunity within this vertical will come from PSI’s ability to capitalise on the anticipated upheaval in manufacturing processes and supply chains brought about by the implementation of Industry 4.0 or smart factory concepts. The basic principal of Industry 4.0 is that by connecting machines, work pieces and systems, businesses are creating intelligent networks along the entire value chain that can control each other autonomously. While the pace of change and therefore the extent of the revenue opportunity for PSI is difficult to estimate, management reports a rapid acceleration in interest from customers. The company has also been a prominent evangelist of Industry 4.0’s potential and has been involved in multiple research projects regarding its implementation in practice.

Exhibit 6: The four industrial revolutions

Source: PSI

Mining – trials expected to yield follow-on projects

PSI Mining is an early-stage business, which has been implementing control room software at two lead customers, both in China. The company is now in discussions with one of these customers for a follow-up order, which should be more profitable than the initial trial implementation, as well as adding further referencability to PSI’s solutions in this field .The overall market opportunity looks significant. PSI’s solutions help improve efficiency, so we see ample opportunity for the division to grow from its small base, despite the weak commodities market.

Logistics – from recovery to growth

The logistics division is now well placed to grow again following the costly project overruns, which significantly hurt group earnings in 2013 and ran into H114. The launch of a new warehouse management system has been successfully deployed at lead customers and a broader sales and marketing campaign is set to commence in H116, once the consolidation of the product into the group platform is fully complete.

Energy Management (36% of sales)

The Energy Management segment comprises three divisions: Electricity and Multi-Utility, Gas and Oil, and Energy Trade and Sales. Overall revenues for the segment grew 7% to €49.1m year-on-year in the nine months to September 15, compared to €31.8m in H1. While nine months EBIT increased by 29% to €3.5m, reflecting both operational gearing and lower development costs. We believe that a requirement for increasingly complex control solutions and new product launches to meet this demand should create a robust demand environment for this segment over the medium term, although we need to be mindful of a potential near-term moderation in demand in electrical energy related to the German electricity tariff setting and investment cycle.

Electricity and Multi Utility – balance of cyclical and structural demand

The German electrical energy business was, as expected, a key driver of growth for the segment and the group as a whole. This is in part cyclical, with demand being buoyed by investment ahead of the German tariff-setting ‘photo year’ (the five year cycle when feed-in tariffs are decided) in FY16. (Around two-thirds of the division’s revenues come from the domestic market.) More structurally, the shift towards decentralised energy supply, more volatile renewable energies and intelligent grids should drive demand for complex control software and PSI has invested in solutions to meet these requirements. The use of more sophisticated control software can for example help reduce the overall investment required in the distribution network to adapt to the changing energy supply dynamics. The shift to a decentralised supply should also reduce the exposure to the centralised tariff setting cycle. For example, the company started a pilot project for a “multi-client capability control system for municipal utility co-operations” in Q215.

Enabled by the new software, the company is also looking to structure its deals towards a more recurring maintenance/update-weighted format. Looking further out, the cyclicality of the sector could be further reduced if German government plans to exclude software investment from the tariff-setting cycle are ratified.

The balance between cyclical and structural demand within Electrical Energy is difficult to gauge at this stage. However, while it is prudent to assume some degree of drop-off in 2016/17 following the tariff setting cycle, the overall demand environment looks set to remain substantially stronger than the 2012/13 period, when the German government’s policy to eliminate nuclear power generation and to migrate from conventional to renewable energy sources starved PSI’s core customer base of cash.

Gas and Oil – demand holding up, despite Russian exposure

The company’s Gas and Oil business supplies control software primarily for gas distribution grids (mainly domestic) and pipelines (mainly overseas). Given the overseas businesses exposure to Russia and the weak oil price, demand appears to have held up surprisingly well, although the company is expanding its position in the Scandinavian market, which should help diversify exposure.

Energy Trading – growth potential from new product introductions

This is a small division, which supplies software for enterprises working in the liberalised energy market to allow them to manage all sales- and trade-related processes. This is another division where the development of new products and reimplementation of existing products on the group platform should support growth prospects. For example the division has won further contracts this year for its gas and electricity solutions, which are both on the new platform. A trial project to implement the first virtual power plant for decentrally-generated energies and industrial energies also commenced in Q315.

Infrastructure management

Infrastructure is PSI’s smallest division covering three relatively small business, none of which we would consider core. Sales grew 6% to €21.9m in the nine months to September but EBIT of -€20k (versus a €900k profit last year) was affected by continued weakness in South-East Asia and restructuring costs.

PSI Incontrol – differs from the rest of the group, in that it was PSI’s implementation partner in South-East Asia, which the company acquired in 2009. As such, its revenues are more project than product based and it also has a more significant hardware component to its revenue mix than the rest of the group. The weak economic and turbulent geopolitical environment in South-East Asia has afffected progress, prompting the company to reduce headcount this year by 40.

PSI Transcom – provides software for controlling public transport infrastructure: metro, buses, trams, regional trains, etc, and also has a depot management system in German-speaking countries. Despite operating in a competitive market, particularly for public transport infrastructure systems, where the company competes with INIT and IVU Traffic Technologies, divisional sales and earnings have grown this year. However, given the relative lack of scale, the division’s long-term fit with the rest of PSI’s business looks unclear.

PSI Poland – is a small division in terms of revenue contribution, providing PSI’s solutions into the Polish market. However, is also an important R&D centre for the group, with over 200 software developers, leading the development of the group platform.

Sensitivities

Electrical energy cyclicality – as discussed earlier in this report, trading in the Electrical and Multi Utility division is currently being boosted by the investment ahead of Germany’s five year cycle for setting energy distribution tariffs. While we do see structural demand as being stronger than it was following the last cycle, it is difficult to estimate the extent to which demand is likely to drop off.

Fragmentation of the business – while the breadth of PSI’s industry and geographical footprint helps diversify risk, some operations are sub-scale. In addition, as we saw with logistics in 2013/14, execution issues even in a relatively small business can have a negative impact on profitability. The shift towards a more product-led model should reduce the risk of this happening again.

Low margins, operational gearing – while margins are low, relatively small variations in operational performance have a large percentage impact on earnings. Equally, the scope to expand margins is central to the long-term investment case. Executing this transition is not a trivial task and will take time.

Geopolitical/economic risk – PSI has a diverse geographical footprint and investment in mission critical infrastructure can be negatively affected by geopolitical or economic instability. The impact is also difficult to predict. Whereas the company’s operations in Thailand have been significantly scaled back as a result of the political instability, demand from the Russian Gas and Oil market has held up relatively well.

Strategic attractiveness – PSI is often mentioned as a potential takeover target, and compared to its largest competitors (ABB and Siemens) PSI is a small company with limited resources. The current situation, with the share price still relatively depressed and benefits from initiatives such as the move to a single product platform and product-based model yet to be reflected in any meaningful way, could attract attention. However, we believe that management is not seeking such a scenario. We also note that RWE (a German utility) owns approximately 18% of PSI’s shares, with employees and management owning 25%. Together these represent a reasonable blocking holding.

Financials

Recent trading – encouraging trading and outlook

Results for the nine months to October growing were generally encouraging, with order intake growing by 12% to $149m, sales by 7.4% to €137m and EBIT by 66% to €7.3m, driven mainly by demand in Western markets, particularly in Energy and Production Management. EBIT margins for the first nine months expanded from 3.4% in FY14 to 5.3% in FY15, reflecting the lingering impact of cost overruns in Logistics which suppressed the prior year and operationally geared margin expansion in Energy Management, boosted by robust demand from the German electricity market.

The company’s outlook statement was also encouraging, with management reconfirming its full year €11m EBIT target (we estimate €11.1m), while order intake and revenues are expected to grow at a double-digit rate into the early part of 2016.

Estimates

At group level, our estimates have not changed materially for FY15 and FY16, although we have adjusted the divisional breakdown, moderating the sales performance for Production Management in FY15 but assuming a robust recovery in growth in FY16 driven by the ThyssenKrupp deal and opportunities in Automotive & Industrial, Logistics and Mining. We have also reduced our dividend forecasts from 20c to 15c for FY15 and from 30c to 20c for FY16 to reflect management’s 30% payout-ratio guidance. Our FY17 estimates are new.

Conservative growth forecasts

At the group level, we believe our revenue growth forecasts are conservatively set at a mid-single digit level for both FY16 and FY17. While management’s expectation is of both order book and revenues growing at a double-digit rate in the early part of FY16, our prudent stance stems from the uncertain global economic and geopolitical climate and that investment from the German electricity sector may drop off following the tariff-setting year.

Exhibit 7: Estimate changes

€m

2013

2014

2015e

2015e

2016e

2016e

2017

Actual

Actual

Old

New

Change

Old

New

Change

New

Energy Management

Revenue

61.0

64.1

66.7

66.1

(1%)

66.7

67.4

1%

68.7

Growth

-2%

5%

3%

2%

2%

EBITDA

2.2

5.5

6.3

7.1

12%

7.3

7.6

4%

8.2

EBITDA margin

4%

9%

10%

11%

11%

11%

12%

Production Management

Revenue

84.1

79.6

86.6

81.8

(6%)

90.9

89.2

(2%)

95.4

Growth

-6%

-5%

3%

9%

7%

EBITDA

2.9

3.8

5.9

8.4

43%

7.7

10.3

33%

11.5

EBITDA margin

3%

5%

7%

10%

9%

12%

12%

Infrastructure Management

Revenue

31.3

31.6

31.6

31.8

0%

33.2

31.8

(4%)

32.4

Growth

-6%

-5%

11%

3%

13%

9%

7%

EBITDA

4.0

2.9

3.5

1.0

(73%)

4.3

2.2

(48%)

2.6

EBITDA margin

13%

9%

11%

3%

13%

7%

8%

Group

Total sales

176.3

175.4

185.0

179.7

(3%)

190.9

188.4

(1%)

196.6

EBITDA

8.0

11.1

14.5

15.3

5%

18.2

18.9

4%

21.0

Operating profit (reported)

4.2

7.2

11.0

10.9

(0%)

14.6

14.5

(0%)

16.7

Margin

2.4%

4.1%

5.9%

6.1%

7.7%

7.7%

8.5%

Profit before tax (FRS 3)

3.1

5.7

9.4

9.4

(0%)

13.4

13.3

(1%)

15.5

EPS - normalised and fully diluted (c)

10.6

27.5

50.7

50.6

(0%)

71.3

71.0

(1%)

82.2

EPS – FRS 3 (c)

2.4

26.2

49.4

49.3

(0%)

70.0

69.7

(1%)

80.9

Dividend (c)

0.0

0.0

20.0

15.0

(25%)

30.0

20.0

(33%)

25.0

Net debt (cash)

(14.9)

(24.0)

(28.3)

(27.8)

(2%)

(34.3)

(34.3)

(0%)

(41.8)

Source: Company Data, Edison Investment Research

Margin expansion driving strong EPS growth, scope for this to continue

Reflecting the progressive impact of the software platform consolidation and shift to a product-led software model, we forecast EBIT margins expanding from 4.1% in FY14 to 8.5% in FY17. This drives a 44% EPS CAGR over this period (or 27% from 2015 to 2017).

Looking longer term, we believe that these initiatives could drive margin expansion to the mid-teens, on a three- to five-year view.

Looking at PSI’s peer group in Exhibit 8, successful companies with pure software models and a (more or less) consolidated software platform can generate operating margins well north of 20%. Achieving such margins would take time and/or more aggressive restructuring, but is not outside the realms of possibility.

Balance sheet and cash flow

The company had cash of €29.4m at end Q314 with financial liabilities of €5.8m, which was broadly unchanged year-on-year and a €46.7m pension provision.

The business does have a considerable amount of cash tied up in working capital (average 36% of sales over the past two years), mainly in receivables and accrued income, although this appears relatively stable. There should be room to reduce these levels as the company migrates to a software-vendor model, with a typically shorter payment cycle versus the project-based model, where significant capital can be tied up in projects. Expanding margins should also help cash conversion. Consequently, we expect positive free cash generation over our forecast period. Having not paid a dividend in FY13 and FY14, the board has communicated its intention to reinstate a dividend with a payout ratio of around 30% this year. Our forecasts for FY16 and FY17 are also based on a 30% payout ratio.

Valuation: Margin expansion should drive upside

Typical recovery multiples

Despite the recent share price recovery, PSI remains rated at typical recovery multiples, with a low EV/Sales ratio but a relatively high P/E, although the P/E is actually not out of line with the broader peer group. However, PSI’s margins are substantially below the majority of its peers, which reflects the fragmentation of the current product set and project-based business model.

While the very high margins enjoyed by the likes of AVEVA and Dassault are likely to be out of reach, with some rationalisation, broader rollout of the Eclipse 4 software platform and a successful shift to a standard software model, we believe that expansion to the mid-teens level should be achievable with a five-year view. This would open up the potential for sustained double-digit earnings growth, which we do not believe is priced in.

Exhibit 8: Peer valuation comparison

 

 

 

Market

EV/Sales (x)

P/E (x)

EBIT margin (%)

 

Currency

Share price

cap

Current

Next

Current

Next

Current

Next

PSI

EUR

13.5

212

1.0

0.9

26.7

19.0

6.1

7.7

Local peers

 

 

 

 

 

 

 

 

 

Init Innovation in Traffic Systems

EUR

18.0

181

1.7

1.6

18.1

14.8

13.8

16.0

IVU Traffic Technologies

EUR

4.5

80

1.3

1.2

16.8

15.1

9.8

10.4

Nemetschek

EUR

41.2

1,585

5.7

5.1

36.8

32.7

18.7

20.2

International industrial software

 

 

 

 

 

 

 

 

 

ANSYS

USD

90.6

8,061

7.7

7.1

26.7

24.5

47.1

47.9

Autodesk

USD

62.0

14,020

5.0

5.8

92.6

-95.6

9.5

-6.7

AVEVA Group*

GBP

2039.0

1,304

6.0

5.7

29.1

27.1

24.6

26.7

Constellation Software Inc/Canada

CAD

554.6

11,752

5.0

4.2

24.9

21.1

14.1

14.9

Dassault Systemes

EUR

74.3

19,065

6.4

6.0

33.7

29.9

29.9

30.7

Emerson Electric

USD

48.8

32,068

1.7

1.7

15.8

14.4

15.2

16.2

Source: Company data, Edison Investment Research, Bloomberg consensus. Note: *In a reverse takeover with Schneider Electric. Prices at 17 November 2015.

DCF: Operating margin expansion beyond 10% should generate upside

A discounted cash flow analysis suggests that the current valuation is pricing in a low single-digit growth with operating margins expanding – and plateauing – at 10%. In Exhibit 9, we show a DCF sensitivity analysis assuming that the company reaches different operating margins by the year 2020 and differing organic growth rates between now and 2020. The analysis suggests that a share price of €20+ should be justifiable assuming growth rates above 4% and if operating margins can be expanded to 14% and €15+ if margins reach 12%. It is worth noting that the DCF-derived valuation is much less sensitive to variations in growth rate than margins.

Exhibit 9: DCF sensitivity analysis to growth and EBIT margin expansion

EBIT margin attained by 2020e

Organic growth rate to 2020e

8%

10%

12%

14%

16%

0%

8.9

12.0

15.1

18.2

21.2

2%

9.2

12.5

15.9

19.2

22.5

4%

9.5

13.1

16.7

20.3

23.9

6%

9.8

13.7

17.5

21.4

25.3

8%

10.1

14.3

18.5

22.6

26.8

10%

10.5

15.0

19.4

23.9

28.4

Source: Edison Investment Research

Exhibit 10: Financial summary

€m

2013

2014

2015e

2016e

2017e

Year end 31 December

IAS

IAS

IAS

IAS

IAS

PROFIT & LOSS

Revenue

 

 

176.3

175.4

179.7

188.4

196.6

Cost of Sales

(34.8)

(33.3)

(34.1)

(35.8)

(37.4)

Gross Profit

141.5

142.1

145.6

152.6

159.3

EBITDA

 

 

8.0

11.1

15.3

18.9

21.0

Operating Profit (before aqu'd int amortisation.)

4.4

7.4

11.1

14.7

16.9

Amortization of acquired intangibles

(.2)

(.2)

(.2)

(.2)

(.2)

Operating Profit

4.2

7.2

10.9

14.5

16.7

IFRS 2 charges

-

-

-

-

-

Net Interest

(1.6)

(1.5)

(1.6)

(1.2)

(1.2)

Profit Before Tax (norm)

 

 

3.3

5.9

9.6

13.5

15.7

Profit Before Tax (FRS 3)

 

 

3.1

5.7

9.4

13.3

15.5

Tax

(2.7)

(1.6)

(1.7)

(2.4)

(2.8)

Profit After Tax (norm)

1.7

4.3

7.9

11.1

12.9

Profit After Tax (FRS 3)

0.4

4.1

7.7

10.9

12.7

Average Number of Shares Outstanding (m)

15.7

15.7

15.7

15.7

15.7

EPS - normalised (c)

 

 

10.6

27.5

50.6

71.0

82.2

EPS - normalised fully diluted (c)

 

 

10.6

27.5

50.6

71.0

82.2

EPS - FRS 3 (c)

 

 

2.4

26.2

49.3

69.7

80.9

Dividend per share (c)

0.0

0.0

15.0

20.0

25.0

Gross Margin (%)

80%

81%

81%

81%

81%

EBITDA Margin (%)

4.5%

6.3%

8.5%

10.0%

10.7%

Operating Margin (before GW and except.) (%)

2.4%

4.1%

6.1%

7.7%

8.5%

BALANCE SHEET

Fixed Assets

 

 

69.3

80.5

79.7

79.1

78.7

Intangible Assets

49.1

61.7

60.4

59.2

57.9

Tangible Assets

13.8

12.9

13.5

14.2

15.0

Goodwill

0.0

0.0

0.0

0.0

0.0

Other

6.4

5.8

5.8

5.8

5.8

Current Assets

 

 

108.8

111.8

122.0

131.5

141.0

Stocks

3.9

3.5

5.0

5.0

5.0

Receivables

77.8

73.6

78.6

82.4

86.0

Cash

21.8

29.3

33.1

39.6

47.0

Other

5.3

5.4

5.4

5.4

5.4

Current Liabilities

 

 

(64.8)

(75.7)

(76.7)

(78.7)

(80.7)

Trade & Tax Payable

(35.5)

(41.1)

(42.1)

(44.2)

(46.1)

Short term borrowings

(3.5)

(5.1)

(5.1)

(5.1)

(5.1)

Other creditors

(25.7)

(29.5)

(29.5)

(29.5)

(29.5)

Long Term Liabilities

 

 

(45.9)

(48.2)

(48.2)

(48.2)

(48.2)

Long term borrowings

(3.4)

(.2)

(.2)

(.2)

(.2)

Pension provision & other long term liabilities

(42.6)

(48.0)

(48.0)

(48.0)

(48.0)

Net Assets

 

 

67.4

68.3

76.8

84.5

93.2

CASH FLOW

Operating Cash Flow

 

 

1.8

27.4

9.1

14.8

17.1

Net Interest

(.2)

(.2)

(.2)

0.2

0.2

Tax

(1.6)

(1.3)

(1.7)

(2.4)

(2.8)

Capex

(5.0)

(3.0)

(3.6)

(3.8)

(3.9)

Acquisitions/disposals

1.0

(11.5)

0.0

0.0

0.0

Financing

(.6)

(.5)

0.0

0.0

0.0

Dividends

(4.7)

(1.2)

0.0

(2.4)

(3.1)

Net Cash Flow

(8.6)

9.7

3.7

6.5

7.5

Opening net debt/(cash)

 

 

(24.0)

(14.9)

(24.0)

(27.8)

(34.3)

HP finance leases initiated

0.0

0.0

0.0

0.0

0.0

Other

(.5)

(.5)

0.0

0.0

0.0

Closing net debt/(cash)

 

 

(14.9)

(24.0)

(27.8)

(34.3)

(41.8)

Source: PSI accounts, Edison Investment Research

Source: Contact detail Contact details

Revenue by geography

PSI AG Headquarter
Dircksenstrase 42-44
Berlin 10178
Germany
+49 302801-0
www.psi.de

Source: Contact detail Contact details

PSI AG Headquarter
Dircksenstrase 42-44
Berlin 10178
Germany
+49 302801-0
www.psi.de

Revenue by geography

Management team

CEO: Dr Harald Schrimpf

CFO: Harald Fuchs

Dr-Ing Harald Schrimpf became a member of PSI's executive board in July 2002. Since 1995, the graduate electrical engineer has held different management positions at DaimlerChrylser, EADS and Volkswagen subsidiary gedas, with responsibility for major IT projects.

Harald Fuchs, as the head of finances and controlling, has been active in the Electrical Energy business unit of PSI since 2011. Prior to that he held a number of senior commercial positions in RWE, Continental and Alpine Energy Group within Germany, the US and Austria. He studied business management in Germany, the UK and US.

Chairman of the supervisory board: Prof Dr-Ing Rolf Windmöller

Professor Dr-Ing Windmöller is retiring from the supervisory board in December 2015 for health reasons. A replacement is being sought.

Management team

CEO: Dr Harald Schrimpf

Dr-Ing Harald Schrimpf became a member of PSI's executive board in July 2002. Since 1995, the graduate electrical engineer has held different management positions at DaimlerChrylser, EADS and Volkswagen subsidiary gedas, with responsibility for major IT projects.

CFO: Harald Fuchs

Harald Fuchs, as the head of finances and controlling, has been active in the Electrical Energy business unit of PSI since 2011. Prior to that he held a number of senior commercial positions in RWE, Continental and Alpine Energy Group within Germany, the US and Austria. He studied business management in Germany, the UK and US.

Chairman of the supervisory board: Prof Dr-Ing Rolf Windmöller

Professor Dr-Ing Windmöller is retiring from the supervisory board in December 2015 for health reasons. A replacement is being sought.

Principal shareholders

(%)

RWE Deutschland

17.8

Harvinder Singh

8.1

Employee consortium

9.4

Investmentaktiengesellschaft für langfristige Investoren TGV

5.4

Sterling Strategic Value

5.0

Baden-Württembergische Versorgungsanstalt für Ärzte, Zahnärzte und Tierärzte

5.0

Companies named in this report

Ansys Inc ANSS US, Autodesk ADSK US, AVEVA Group plc, AVV LN, Constellation Software Inc CSU CN, Dassault Systemes DSY FP, Emerson Electric EMR US, Init Innovation in Traffic Systems IXX GR, IVU Traffic Technologies IVU GY, Nemetschek NEM GY

Edison, the investment intelligence firm, is the future of investor interaction with corporates. Our team of over 100 analysts and investment professionals work with leading companies, fund managers and investment banks worldwide to support their capital markets activity. We provide services to more than 400 retained corporate and investor clients from our offices in London, New York, Frankfurt, Sydney and Wellington. Edison is authorised and regulated by the Financial Conduct Authority (www.fsa.gov.uk/register/firmBasicDetails.do?sid=181584). Edison Investment Research (NZ) Limited (Edison NZ) is the New Zealand subsidiary of Edison. Edison NZ is registered on the New Zealand Financial Service Providers Register (FSP number 247505) and is registered to provide wholesale and/or generic financial adviser services only. Edison Investment Research Inc (Edison US) is the US subsidiary of Edison and is regulated by the Securities and Exchange Commission. Edison Investment Research Limited (Edison Aus) [46085869] is the Australian subsidiary of Edison and is not regulated by the Australian Securities and Investment Commission. Edison Germany is a branch entity of Edison Investment Research Limited [4794244]. www.edisongroup.com

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Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

245 Park Avenue, 39th Floor

10167, New York

US

Sydney +61 (0)2 9258 1161

Level 25, Aurora Place

88 Phillip St, Sydney

NSW 2000, Australia

Wellington +64 (0)48 948 555

Level 15, 171 Featherston St

Wellington 6011

New Zealand

Edison, the investment intelligence firm, is the future of investor interaction with corporates. Our team of over 100 analysts and investment professionals work with leading companies, fund managers and investment banks worldwide to support their capital markets activity. We provide services to more than 400 retained corporate and investor clients from our offices in London, New York, Frankfurt, Sydney and Wellington. Edison is authorised and regulated by the Financial Conduct Authority (www.fsa.gov.uk/register/firmBasicDetails.do?sid=181584). Edison Investment Research (NZ) Limited (Edison NZ) is the New Zealand subsidiary of Edison. Edison NZ is registered on the New Zealand Financial Service Providers Register (FSP number 247505) and is registered to provide wholesale and/or generic financial adviser services only. Edison Investment Research Inc (Edison US) is the US subsidiary of Edison and is regulated by the Securities and Exchange Commission. Edison Investment Research Limited (Edison Aus) [46085869] is the Australian subsidiary of Edison and is not regulated by the Australian Securities and Investment Commission. Edison Germany is a branch entity of Edison Investment Research Limited [4794244]. www.edisongroup.com

DISCLAIMER
Copyright 2015 Edison Investment Research Limited. All rights reserved. This report has been commissioned by PSI and prepared and issued by Edison for publication globally. All information used in the publication of this report has been compiled from publicly available sources that are believed to be reliable, however we do not guarantee the accuracy or completeness of this report. Opinions contained in this report represent those of the research department of Edison at the time of publication. The securities described in the Investment Research may not be eligible for sale in all jurisdictions or to certain categories of investors. This research is issued in Australia by Edison Aus and any access to it, is intended only for "wholesale clients" within the meaning of the Australian Corporations Act. The Investment Research is distributed in the United States by Edison US to major US institutional investors only. Edison US is registered as an investment adviser with the Securities and Exchange Commission. Edison US relies upon the "publishers' exclusion" from the definition of investment adviser under Section 202(a)(11) of the Investment Advisers Act of 1940 and corresponding state securities laws. As such, Edison does not offer or provide personalised advice. We publish information about companies in which we believe our readers may be interested and this information reflects our sincere opinions. The information that we provide or that is derived from our website is not intended to be, and should not be construed in any manner whatsoever as, personalised advice. Also, our website and the information provided by us should not be construed by any subscriber or prospective subscriber as Edison’s solicitation to effect, or attempt to effect, any transaction in a security. The research in this document is intended for New Zealand resident professional financial advisers or brokers (for use in their roles as financial advisers or brokers) and habitual investors who are “wholesale clients” for the purpose of the Financial Advisers Act 2008 (FAA) (as described in sections 5(c) (1)(a), (b) and (c) of the FAA). This is not a solicitation or inducement to buy, sell, subscribe, or underwrite any securities mentioned or in the topic of this document. This document is provided for information purposes only and should not be construed as an offer or solicitation for investment in any securities mentioned or in the topic of this document. A marketing communication under FCA Rules, this document has not been prepared in accordance with the legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research.
Edison has a restrictive policy relating to personal dealing. Edison Group does not conduct any investment business and, accordingly, does not itself hold any positions in the securities mentioned in this report. However, the respective directors, officers, employees and contractors of Edison may have a position in any or related securities mentioned in this report. Edison or its affiliates may perform services or solicit business from any of the companies mentioned in this report. The value of securities mentioned in this report can fall as well as rise and are subject to large and sudden swings. In addition it may be difficult or not possible to buy, sell or obtain accurate information about the value of securities mentioned in this report. Past performance is not necessarily a guide to future performance. Forward-looking information or statements in this report contain information that is based on assumptions, forecasts of future results, estimates of amounts not yet determinable, and therefore involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of their subject matter to be materially different from current expectations. For the purpose of the FAA, the content of this report is of a general nature, is intended as a source of general information only and is not intended to constitute a recommendation or opinion in relation to acquiring or disposing (including refraining from acquiring or disposing) of securities. The distribution of this document is not a “personalised service” and, to the extent that it contains any financial advice, is intended only as a “class service” provided by Edison within the meaning of the FAA (ie without taking into account the particular financial situation or goals of any person). As such, it should not be relied upon in making an investment decision. To the maximum extent permitted by law, Edison, its affiliates and contractors, and their respective directors, officers and employees will not be liable for any loss or damage arising as a result of reliance being placed on any of the information contained in this report and do not guarantee the returns on investments in the products discussed in this publication. FTSE International Limited (“FTSE”) © FTSE 2015. “FTSE®” is a trade mark of the London Stock Exchange Group companies and is used by FTSE International Limited under license. All rights in the FTSE indices and/or FTSE ratings vest in FTSE and/or its licensors. Neither FTSE nor its licensors accept any liability for any errors or omissions in the FTSE indices and/or FTSE ratings or underlying data. No further distribution of FTSE Data is permitted without FTSE’s express written consent.

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

245 Park Avenue, 39th Floor

10167, New York

US

Sydney +61 (0)2 9258 1161

Level 25, Aurora Place

88 Phillip St, Sydney

NSW 2000, Australia

Wellington +64 (0)48 948 555

Level 15, 171 Featherston St

Wellington 6011

New Zealand

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