Zalaris — Tenth consecutive quarter of revenue growth

Zalaris (OSE: ZAL)

Last close As at 23/08/2024

NOK71.60

−0.20 (−0.28%)

Market capitalisation

NOK1,585m

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Research: TMT

Zalaris — Tenth consecutive quarter of revenue growth

Zalaris delivered a tenth consecutive quarter of year-on-year revenue growth in Q224 to another record of NOK323m. The company continued to win new business as well as renegotiating contracts with existing customers to bring them onto the PeopleHub platform. Low churn also contributed to a net retention rate within Managed Services of 106%. Adjusted EBIT margins improved as the first Asia-Pacific contribution and cost efficiencies offset lower year-on-year margins in both Managed Services and Professional Services. The robust contract momentum has led us to upgrade our FY24 revenue estimates by 2.4% to NOK1,307m, with an improved adjusted EBIT margin of 11.2%. Management noted that the strategic review is in progress following an initial planning period.

Written by

Milo Bussell

Analyst, Consumer and TMT

TMT

Zalaris

Tenth consecutive quarter of revenue growth

H124 results

Software and comp services

23 August 2024

Price

NOK71.6

Market cap

NOK1,599m

Net debt (including lease liabilities and continuing operations) at 30 June 2024

NOK343.3m

Shares in issue

21.7m

Free float

65.6%

Code

ZAL

Primary exchange

Oslo Børs

Secondary exchange

N/A

Share price performance

%

1m

3m

12m

Abs

(5.0)

(7.0)

62.7

Rel (local)

(2.9)

(6.3)

46.7

52-week high/low

NOK79.2

NOK37.4

Business description

Zalaris is a leading provider of comprehensive human capital management and payroll solutions. The company works with organisations globally to deliver solutions covering over 150 countries and the payroll and HR needs of over 1.5 million employees.

Next events

Q324 results

24 October 2024

Analysts

Milo Bussell

+44 (0)20 3077 5700

Dan Ridsdale

+44 (0)20 3077 5700

Zalaris is a research client of Edison Investment Research Limited

Zalaris delivered a tenth consecutive quarter of year-on-year revenue growth in Q224 to another record of NOK323m. The company continued to win new business as well as renegotiating contracts with existing customers to bring them onto the PeopleHub platform. Low churn also contributed to a net retention rate within Managed Services of 106%. Adjusted EBIT margins improved as the first Asia-Pacific contribution and cost efficiencies offset lower year-on-year margins in both Managed Services and Professional Services. The robust contract momentum has led us to upgrade our FY24 revenue estimates by 2.4% to NOK1,307m, with an improved adjusted EBIT margin of 11.2%. Management noted that the strategic review is in progress following an initial planning period.

Year end

Revenue (NOKm)

PBT*
(NOKm)

EPS*
(NOK)

DPS
(NOK)

P/E
(x)

Yield
(%)

12/22

892.7

6.1

0.07

0.50

N/A

0.7

12/23

1,131.2

21.5

1.49

0.00

48.0

N/A

12/24e

1,306.5

111.5

4.11

0.91

17.4

1.3

12/25e

1,435.5

141.5

5.27

1.11

13.6

1.6

Note: *PBT and EPS are normalised, excluding amortisation of acquired intangibles, exceptional items and share-based payments.

Momentum continuing

Zalaris reported another record level of revenue in Q224 at NOK323.2m (Q223: NOK280.5m), up 15.2% y-o-y. Contract momentum continued as Zalaris both won new clients and upsold existing clients, with the net client retention for Managed Services at 106% in the quarter. Group adjusted EBIT margins were up to 8.8% (Q223: 7.2%), although within this both the Managed Services and Professional Services businesses delivered lower margins. This was offset by the first positive contribution from Asia-Pacific (APAC), as well as continued efficiency gains from the Zalaris 4.0 strategy, with a reduction in overheads as a percentage of revenue. Free cash flow improved as a percentage of revenue to 6.6% (Q223: 3.0%), resulting in a lower net debt position (excluding lease liabilities) of NOK286.5m (Q124: NOK297.9m).

German EBIT improvement plan

Management has laid out a strategic plan to address the lower-margin German business, expecting to gain incremental margin improvements through synergies, renegotiating contracts with existing customers, implementing Zalaris 4.0 and reducing the number of external consultants in Professional Services. Overall, management is targeting a NOK40m improvement in EBIT across the next 12–18 months. This provides a boost to management’s FY26 adjusted EBIT target of 12–15%, although there is obviously still execution risk.

Valuation: DCF valuation shows good upside

Zalaris’s share price has performed very well in the year-to-date, up 54%, outperforming its payroll software and IT services peers. Following the changes to our estimates, our DCF-based valuation has increased to NOK91.1 per share (previously NOK88.8/share).

Contract momentum continuing in Q224

Exhibit 1: Quarterly revenue and adjusted EBIT margin progression

Source: Zalaris

Zalaris delivered record quarterly revenue in Q224, successfully continuing its momentum as it delivered a 10th consecutive quarter of year-on-year revenue growth. Revenue increased 15.3% (constant currency) to NOK323.2m (Q223: NOK280.5m) in Q2, as strong progress made in Managed Services (+18.8%) offset a 3.7% year-on-year decline in the Professional Services business. The higher-margin Managed Services business now accounts for 75.0% of group revenue, up from 72.7% in Q223. With a high degree of recurring revenues, continued growth in the Managed Services business will be key to Zalaris achieving management’s mid-term revenue target of NOK1.5bn by FY26.

The Managed Services business recorded a number of new client wins and renewed services with existing customers, upselling existing services and moving clients from legacy technology onto the PeopleHub platform. Within these contract wins and extensions was expanding the scope of service for Telenor to include Finland, c 1,800 employees, and for SAS to include its UK employees. Zalaris has signed two letters of intent with two large customers, one German retailer and another global IT services provider, which together have NOK40m in annual contract value (ACV). As we noted in our initiation report, a key leading indicator for Zalaris is deal newsflow and the extension of existing contracts, and the company is certainly delivering on this. Reflecting this, the net retention revenue in Q224 was 106% as existing clients expand their geographic footprints and employee bases. Zalaris continues to benefit from low churn in the Managed Services business and long-term relationships with its client base, as existing customers accounted for 82% of revenue, up from 78% in Q223.

For the Professional Services business, Q224 was slightly weaker year-on-year, with revenue down 3.7% to NOK69.7m (Q223: NOK72.3m), predominantly owing to lower application maintenance revenue in Poland. There was a significant drop-off in revenues on a quarter-on-quarter basis, which management believes was due to four fewer working days in Q224 versus Q124, as well as a higher amount of annual leave taken in the quarter, resulting in fewer billable hours. The Professional Services business continues to make inroads into German municipal organisations, winning an agreement to implement a new SAP HCM solution for the City of Berlin with a total contract value of NOK170m, as well as winning a contract for application maintenance services for the State of North Rhine Westphalia, which has a contract value of NOK32m over four years.

APAC also delivered good progress in Q224, with revenue growing significantly to NOK10.8m (Q223: NOK4.3m) as it saw significant client wins in the region, including Yancoal, Campari, the Port of Melbourne and Crawford. Within this, 59% of revenue was recurring revenue, with the remaining 41% derived from individual projects. The progress made in APAC highlights Zalaris’s ability to successfully enter greenfield geographies and deliver on multi-country contracts.

Zalaris grew adjusted EBIT in the quarter by 40.4% y-o-y to NOK28.4m (Q223: NOK20.2m), at an improved margin of 8.8% (Q223: 7.2%), benefiting from APAC contributing its first quarter of profitability and EBIT improvements as Zalaris continues to shift the proportion of its service delivery locations from onshore to nearshore and offshore locations. Reflecting this shift in the personnel cost base, despite Zalaris increasing its headcount by 78 full-time employees year-on-year, personnel costs as a percentage of revenue have fallen to 53.3% in Q224 (Q223: 55.1%). Managed Services grew adjusted EBIT by 12.3% to NOK33.4m, although at a lower margin of 13.8% (Q223: 14.6%). Profitability in the Professional Services was affected by the rehiring of a SuccessFactor team of seven employees who had left the firm 18 months prior. This team was not fully utilised through May and June and, consequently, adjusted EBIT fell 27.2% to NOK2.4m (Q223: NOK3.2m). Management noted that this SuccessFactor team is now fully utilised, and the segment should benefit from the additional revenue it should generate going forward.

Operating cash flow improved in Q224 with a positive inflow of NOK18.4m (Q223: NOK3.3m), owing to the improved profitability and more favourable working capital in the quarter. Net debt (excluding leases) reduced to NOK286.5m (Q124: NOK297.9m) due to a slightly higher cash balance and lower bank debt, owing to favourable foreign exchange movements given Zalaris’s euro-denominated bond loan.

Exhibit 2: Q224 and H124 results summary

NOKm

Q123

Q223

H123

Q124

Q224

H224

Revenue

260.8

280.5

541.3

318.3

323.2

641.7

Y-o-y growth (%)

22%

15%

19%

Adjusted EBITDA

29.6

34.6

64.2

50.9

45.0

96.3

Y-o-y growth (%)

72%

30%

50%

Adjusted EBIT

18.5

20.2

38.7

34.8

28.4

63.2

Y-o-y growth (%)

88%

40%

63%

Operating cash flow

(4.1)

3.3

(0.8)

7.2

18.4

25.7

Investing cash flow

(4.8)

(4.7)

(9.5)

35.4

(6.8)

28.7

Financing cash flow

36.1

(7.3)

28.8

(16.9)

(8.5)

(25.4)

Net change in cash

27.1

(8.6)

18.5

25.7

3.2

28.9

Net debt

332.9

356.3

356.3

297.9

286.5

286.5

Y-o-y growth (%)

-10%

-20%

-20%

Net debt/adjusted EBITDA (LTM)

3.3

3.0

1.7

1.6

Source: Zalaris

German EBIT improvement programme finalised

During Q224, management finalised its EBIT improvement programme, targeting NOK30m of improvements by Q225 and NOK40m of improvements within 24 months. Zalaris’s German business has historically been a drag to group margins as it relied on onshore service centre locations, with the FY23 EBIT margin just 1.7% compared to the group level of 8.5%. However, management has defined its improvement programme to target adjusted EBIT within Germany of NOK61.0m in the medium term, equivalent to a margin of 13.9%.

Within Germany, management expects the improvements to come from:

Synergies from German ba.se, which was originally acquired in 2021. The company has been renamed Zalaris Retail Solutions and has been integrated into the group’s German Managed Services business from Q324. The synergies borne from this are expected to add 1.6% to the margin.

Management expects 4.1% of incremental margin to be derived from negotiating new terms with existing customers, through upselling or moving customers off legacy systems and onto its PeopleHub platform.

The Zalaris 4.0 strategy, which includes the rightsizing of the cost base towards nearshore and offshore service location centres, as well as leveraging the existing workforce. As at end Q224, nearshore locations within Germany increased by 4% from end FY23, while the use of offshore locations increased by 2%. Zalaris 4.0 is expected to run to Q125 and is anticipated to add 2.6% of incremental margin.

Reducing the number of external consultants within Professional Services. For Germany, this is down from 30% at end FY23 to c 15% of hours. This is expected to add 2.9% of margin over 24 months.

Following the sale of the Leipzig office in Q124, the German margin is lowered by 0.5% due to rental costs. Adding these improvements to the FY23 German EBIT of NOK6.7m, Zalaris estimates a pro forma FY23 adjusted EBIT of NOK48.4m, equivalent to a margin of 12.4%.

Management expects in the medium term that new signed contracts will add 1.5% of incremental margin to get the medium-term target of 13.9%, resulting in a total adjusted EBIT of NOK61.0m.

Changes to estimates

We have upgraded our revenue forecasts for the second consecutive quarter, reflecting the strong contract momentum and the weighting towards the second half that Zalaris has historically reported. Management’s commentary in relation to robust levels of demand and a strong new contract pipeline underpin this upgrade. We now expect revenue growth of 15.5% for FY24 to NOK1,306.5m (previously NOK1,275.4m), driven by an improved Managed Services performance, while we anticipate Professional Services returning to a higher level of growth in H224 as the new SuccessFactor team build up to full utilisation. The higher level of Managed Services revenue, combined with the higher-than-expected share-based payments expense to date, has nudged the adjusted EBIT margin up to 11.2% (previously 10.9%).

Consequently, our FY25 revenue estimates have also edged up to NOK1,435.3m (previously NOK1,410.1m), as we maintain the growth rate in Managed Services but slightly reduce our Professional Services growth expectations. This, along with a higher share-based payment expense, brings the adjusted EBIT margin to 11.8% (previously 11.3%).

The changes to our estimates result in an improved net debt (excluding leases) to adjusted EBITDA leverage position in both years: 0.9x in FY24 (previously 1.1x) and 0.6x in FY25 (previously 0.8x).

Exhibit 3: Summary forecast changes

NOKm

FY24e

FY24e

FY25e

FY25e

Old

New

Change

Old

New

Change

Revenues

1,275.4

1,306.5

2.4%

1,410.1

1,435.3

1.8%

Adjusted EBIT

138.6

145.7

9.9%

159.7

169.5

6.1%

Adjusted EBIT margin

10.9%

11.2%

0.8ppt

11.3%

11.8%

0.5ppt

Reported operating profit

137.1

136.0

4.0%

147.7

151.9

2.8%

Reported operating margin

10.7%

10.4%

0.2%

10.5%

10.6%

0.1%

Normalised PBT

104.3

111.5

13.1%

131.7

141.5

7.4%

Normalised basic EPS (NOK)

3.86

4.11

12.5%

4.98

5.27

5.8%

Normalised diluted EPS (NOK)

3.86

4.11

12.5%

4.98

5.27

5.8%

Net debt/adjusted EBITDA (x)

1.1

0.9

0.8

0.6

Source: Edison Investment Research

DCF-based valuation of NOK91.1 per share

Our 10-year DCF uses a weighted average cost of capital (WACC) of 8%, reflecting a cost of equity of 9.7% (Norwegian base rate of 4.5%, beta of 1.14 (source: LSEG Data & Analytics) and an equity risk premium of 4.6% (source: Damodaran)) and an after-tax cost of debt of 4.1%. Following the changes to our revenue growth estimates and subsequent improvements at the EBIT level, our valuation has increased from NOK88.8 per share to NOK91.1 per share. Our assumptions of a 4% revenue CAGR in the medium term and a 12% EBIT margin from FY26 are relatively conservative when compared to the EBIT margin range of 12–15% guided by management.

Our valuation indicates 27% upside to Zalaris’s current share price of NOK71.6. We believe the strong contract momentum and potential EBIT margin improvement are not fully reflected in the current share price.

Exhibit 4: DCF sensitivity (NOK per share)

Terminal growth rate

0%

1%

2%

3%

4%

WACC

10.0%

56.6

60.0

64.2

69.7

76.9

9.5%

60.7

64.6

69.6

76.1

85.0

9.0%

65.2

69.8

75.8

83.7

94.8

8.5%

70.2

75.7

82.8

92.6

106.7

8.0%

75.9

82.4

91.1

103.3

121.5

7.5%

82.4

90.2

100.9

116.3

140.6

7.0%

89.8

99.3

112.6

132.6

166.0

6.5%

98.3

110.0

127.0

153.6

201.6

6.0%

108.3

122.9

144.9

181.6

254.8

5.5%

120.1

138.7

168.0

220.7

343.6

Source: Edison Investment Research

Exhibit 5: Financial summary

NOK'm

2021

2022

2023

2024e

2025e

Year end 31 December

IFRS

IFRS

IFRS

IFRS

IFRS

INCOME STATEMENT

Revenue

 

775.3

892.7

1,131.2

1,306.5

1,435.3

Costs

(673.3)

(786.6)

(968.6)

(1,084.4)

(1,176.9)

EBITDA

 

101.9

106.2

162.6

222.1

258.3

Normalised operating profit

 

39.8

46.2

95.8

145.7

169.5

Amortisation of acquired intangibles

11.5

11.9

13.7

0.0

0.0

Exceptionals

0.0

1.9

0.0

(7.9)

0.0

Share-based payments

5.7

8.7

11.6

17.6

17.6

Reported operating profit

22.6

23.7

70.5

136.0

151.9

Net Interest

(7.6)

(40.1)

(74.2)

(34.3)

(28.0)

JVS and associates (post tax)

0.0

0.0

0.0

0.0

0.0

Exceptionals

0.0

0.0

0.0

0.0

0.0

Profit Before Tax (norm)

 

32.2

6.1

21.5

111.5

141.5

Profit Before Tax (reported)

 

15.0

(16.4)

(3.7)

101.7

123.8

Reported tax

(2.2)

(6.3)

9.2

(22.4)

(27.2)

Profit After Tax (norm)

30.0

(0.2)

30.7

89.1

114.2

Profit After Tax (reported)

12.8

(22.7)

5.5

79.4

96.6

Minority interests

0.0

1.6

0.8

0.0

0.0

Discontinued operations

0.0

(16.0)

(8.4)

0.0

0.0

Net income (normalised)

30.0

1.4

31.6

89.1

114.2

Net income (reported)

12.8

(37.1)

(2.1)

79.4

96.6

Basic average number of shares outstanding (m)

21

22

21

22

22

EPS - normalised (NOK)

 

1.41

0.07

1.49

4.11

5.27

EPS - normalised fully diluted (NOK)

 

1.32

0.07

1.29

4.11

5.27

EPS - basic reported (NOK)

 

0.60

(1.72)

(0.10)

3.66

4.45

Dividend (NOK)

0.35

0.50

0.00

0.91

1.11

Revenue growth (%)

(-2.2)

15.2

26.7

15.5

9.9

EBITDA Margin (%)

13.2

11.9

14.4

17.0

18.0

Normalised Operating Margin (%)

5.1

5.2

8.5

11.2

11.8

BALANCE SHEET

Fixed Assets

 

394.6

438.6

469.9

427.3

422.5

Intangible Assets

308.0

315.0

327.6

294.7

291.0

Tangible Assets

59.6

81.5

80.0

70.2

69.1

Investments & other

27.0

42.2

62.3

62.3

62.3

Current Assets

 

432.0

467.1

641.6

795.0

914.4

Stocks

94.8

135.4

197.1

236.1

275.0

Debtors

141.4

191.7

262.7

300.5

330.1

Cash & cash equivalents

176.2

91.8

135.7

206.8

253.4

Other

19.6

48.2

46.1

51.6

56.0

Current Liabilities

 

(213.3)

(669.6)

(407.9)

(439.3)

(457.3)

Creditors

(84.7)

(149.2)

(220.7)

(252.1)

(270.1)

Tax and social security

(38.7)

(41.0)

(49.2)

(49.2)

(49.2)

Short term borrowings

(1.4)

(369.7)

(10.8)

(10.8)

(10.8)

Other

(88.6)

(109.8)

(127.3)

(127.3)

(127.3)

Long Term Liabilities

 

(404.3)

(72.6)

(500.6)

(500.6)

(500.6)

Long term borrowings

(374.3)

(43.2)

(468.5)

(468.6)

(468.6)

Other long-term liabilities

(30.0)

(29.3)

(32.1)

(32.1)

(32.1)

Net Assets

 

209.0

163.6

203.0

282.3

378.9

Minority interests

0.0

(1.6)

(2.4)

(2.4)

(2.4)

Shareholders' equity

 

209.0

162.0

200.5

279.9

376.5

CASH FLOW

Op Cash Flow before WC and tax

43.0

(22.2)

(11.7)

120.4

134.9

Working capital

(18.6)

(33.2)

(43.1)

(38.1)

(30.3)

Exceptional & other

(6.2)

28.9

50.1

(7.9)

2.6

Net revenue deferred/(recognised)

19.7

41.3

74.7

26.1

14.4

Tax

(4.8)

(14.4)

(11.5)

(22.4)

(27.2)

Net operating cash flow

 

33.0

0.4

58.6

78.2

94.3

Capex

(20.6)

(27.8)

(33.9)

(22.0)

(20.0)

Acquisitions/disposals

(43.3)

(11.3)

0.0

0.0

0.0

Net interest

(11.9)

20.2

38.5

2.6

2.6

Equity financing

6.3

(17.8)

0.9

0.0

0.0

Dividends

(19.6)

(7.6)

0.0

0.0

0.0

Other

109.7

(38.7)

(20.7)

12.3

(30.4)

Net Cash Flow

53.5

(82.6)

43.3

71.1

46.6

Opening net debt/(cash) including leases

 

275.1

213.9

338.9

362.1

291.0

FX

(2.2)

(0.1)

(0.8)

0.0

0.0

Other non-cash movements

(112.6)

207.8

(19.4)

(142.2)

(93.1)

Closing net debt/(cash) including leases

 

213.9

338.9

362.1

291.0

244.4

Source: Zalaris accounts, Edison Investment Research

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New Zealand

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. 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 (i.e. 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.

United Kingdom

This document is prepared and provided by Edison 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.

This Communication is being distributed in the United Kingdom and is directed only at (i) persons having professional experience in matters relating to investments, i.e. investment professionals within the meaning of Article 19(5) of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005, as amended (the "FPO") (ii) high net-worth companies, unincorporated associations or other bodies within the meaning of Article 49 of the FPO and (iii) persons to whom it is otherwise lawful to distribute it. The investment or investment activity to which this document relates is available only to such persons. It is not intended that this document be distributed or passed on, directly or indirectly, to any other class of persons and in any event and under no circumstances should persons of any other description rely on or act upon the contents of this document.

This Communication is being supplied to you solely for your information and may not be reproduced by, further distributed to or published in whole or in part by, any other person.

United States

Edison 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. This report is a bona fide publication of general and regular circulation offering impersonal investment-related advice, not tailored to a specific investment portfolio or the needs of current and/or prospective subscribers. As such, Edison does not offer or provide personal advice and the research provided is for informational purposes only. No mention of a particular security in this report constitutes a recommendation to buy, sell or hold that or any security, or that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person.

London │ New York │ Frankfurt

20 Red Lion Street

London, WC1R 4PS

United Kingdom

London │ New York │ Frankfurt

20 Red Lion Street

London, WC1R 4PS

United Kingdom

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CoinShares International — Q224 results shaped by two one-time events

CoinShares International (CS) posted a strong adjusted EBITDA in Q224 of £26.6m (vs £11.4m in Q223), which included two one-off factors: the £21.8m full write-down of its holdings in FlowBank and a £28.8m impairment reversal, following the successful sale of CS’s FTX claim. Management highlighted that CS’s operations have not been disrupted in any way by the recent turmoil across financial markets (including the digital assets market). CS recently paid the first two instalments of its £9.3m dividend (£0.13 per share) from FY23 earnings, with the full-year payment now implying a c 2.6% dividend yield. Furthermore, it declared a special dividend of US$31.4m (c £24.3m), representing 86% of the consideration it received for the FTX claim, to be paid in October 2024.

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