Appen ((APX)) continues to build on its performance record in artificial intelligence (AI) and machine learning while its market is growing rapidly. The industry is highly fragmented, brokers note, and Appen’s early emergence as a leader should place it on a sustainable footing and provide the opportunity for strategic acquisitions.
Wilsons bases its view on a strong track record and high-quality customers, observing Appen accurately analyses increasingly vast quantities of data in a timely manner and at a competitive price, with an ability to adapt. There are two main global operators in this area and a material gap down to the third. The only one with comparable scale and customer base is the unlisted Lionbridge.
The AI market is expected to grow at 36.5% out to 2025, according to various reports, and is likely to hit US$400bn by 2025-26. Appen has reiterated guidance for margins in the high teens in FY20 and Wilsons highlights a dynamic strategy, which supplements organic growth with strategic acquisitions, anticipating FY20 revenue of $707m along with operating earnings (EBITDA) of $131m.
Macquarie retains operating earnings estimates of $136m and forecasts a compound growth rate of of 21.7% over 2019-25. Long-term opportunities are flagged in the Relevance division along with other options in government and autonomous vehicles.
The broker describes Appen as more a services company than a pure technology business. This means operating earnings margins are lower than at software firms such as Xero ((XRO)) and Altium ((ALU)) and, as a result, there is less operating leverage.
High margins and rising competition remain chief concerns, although Credit Suisse acknowledges the outlook for Appen is robust and the prospective market is growing. Back in May, Credit Suisse downgraded to Neutral believing an upgrade to forecasts was required to support the appreciation in the share price, and this could be challenging in the current environment.
Risks
The main risks for the business centre on customer concentration and limited visibility on revenue. Catalysts include the operating leverage that comes from improved execution and automation, underpinned by strong demand from major corporate customers as well as the government sector.
Macquarie understands the long-term viability of human-based data annotation remains a source of concern for investors along with the fact the majority of revenue comes from five of the largest global technology companies.
Appen, with a skew to the big techs and their specific requirements such as search, social media and e-commerce is considered more resilient to technological change. Moreover, in the broker’s assessment, humans are unlikely to be eliminated from the data annotation phase of AI development for quite some time.
Wilsons, not one of the seven stockbrokers monitored daily on the FNArena database, believes the “arms race” in artificial intelligence will continue unabated and Appen will be a net beneficiary. The broker initiates on the stock with an Overweight rating and $42.56 target while Macquarie initiated coverage last month with an Outperform rating and $38.00 target.
FNArena’s database has four Buy ratings and one Hold (Credit Suisse). The consensus target is $32.78, suggesting -10.6% downside to the last share price. Targets range from $30 (Credit Suisse) to $38 (Macquarie).
