Innofactor Q2'24: Innofactor also faces market challenges

Innofactor's Q2 results fell short of expectations as the challenging market also impacted the company's performance. New sales remain challenging, although the order book increased from the previous quarter. In particular, we lowered our earnings forecasts for the coming years due to new sales and the challenge of managing billing rates. We expect that the company will have to issue a profit warning for the current year. With our forecasts (2024e P/E 11x and EV/EBIT 9x), the stock's valuation picture is rather neutral, although there is clear upside in the longer term. We lower Innofactor's target price to EUR 1.20 (was 1.55) reflecting estimate revisions. We also lower our recommendation to Decrease (was Accumulate).

Revenue down slightly and earnings well below our expectations

Q2 revenue declined 1% to 19.9, slightly below our expectations. The company has been able to grow organically and faster than the industry for several quarters, but the difficult market situation inevitably slows down Innofactor as well. Geographically, revenue increased in Finland and Norway, but continued to decline in Sweden and Denmark. Adjusted EBITDA for Q2 decreased by more than 20% to 1.4 MEUR, corresponding to 7% of revenue and below our forecast of 9%. We adjusted for a one-time legal charge of 0.8 MEUR. According to our calculations, the result was limited by lower billing rates (revenue/employee/day adjusted -2% for materials and services).

New sales remained challenging, although order book increased from Q1

New sales remained challenging in Q2, although the order book increased by 2% compared to Q1. The company’s order book decreased by 9% year-on-year to 70 MEUR. Of the solution areas, the other three grew by 4-55%, but Digital Services continued to show a sharp decline (59%), which we believe is due to the current challenging market conditions and is a key concern. It’s therefore important for the company to succeed in new sales in order to return to revenue and earnings growth.

We forecast that the company will have to issue a profit warning

Innofactor reiterated its guidance and expects revenue and adjusted EBITDA to increase from 2022. Given the Q2 earnings miss and new sales challenges, we have lowered our earnings forecasts quite significantly. We forecast Innofactor's revenue to grow by 2% to 82 MEUR in 2024 and EBITDA to decrease to 7.5 MEUR or 9% of revenue (9.1 MEUR or 11.3% in 2023). As a result, our earnings forecast is relatively clearly below the guidance, although this is partly due to one-time factors. We expect revenue to grow organically by 3-4% in the coming years and the EBITDA margin to reach around 11%, driven by billing rates and high-margin SaaS business. The main risks continue to be related to new sales and the resulting increase in billing rates, as well as country-specific challenges in Sweden and Denmark. The company will have its traditional annual strategy process in the summer/early fall and we think it is possible that the Nordic strategy will be refined. We believe it is possible that at least the Danish operations will be managed from Sweden in the future.

Near-term risk levels keeping us cautious, though longer-term potential remains clear

At 2024e EV/EBIT and P/E multiples (9x and 11x), the valuation of the stock is relatively neutral in absolute terms. The multiples are 15% below the company’s Finnish peers, which is a cautiously attractive level. The DCF model shows a much higher level (EUR 1.7/share) and reflects the long-term potential. However, near-term operational uncertainty and the profit warning risk keep us cautious at the moment. On the other hand, the downside is partly limited by the relatively solid and good dividend yield of 7-8%. In addition, the company's SaaS revenue (21 MEUR in 2023) also provides significant support to its valuation. We see risks in the weakening of Finland's strong performance. However, the weakness of Innofactor's Swedish and Danish operations is already slowing down development, and there is clear potential for improvement, which we are not counting on because they have been doing poorly for years.