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My up close and personal view on ELMO Software (ELO)

Reporting season gives us a chance to assess companies that we might hold or want to hold or even are thinking about selling. Here’s a company I hold that I want to do an objective test on and it’s called ELMO Software (ELO).

Back on June 1, I suggested that there were four tech-related stocks [1] that had potential over time. The goal was to think about tech stocks that one day might have the success of the WAAAX stocks of recent years. These of course are Wisetech, Afterpay, Appen, Altium and Xero. The acronym I came up with was ZEET.

The four companies were Zip.co, ELMO, EML and Tyro.

This is how they’ve performed since June 1:

ELMO Software (ELO)

As you can see, the company (like all the others) has rebounded out of the March 23 low and has reached higher levels, close to the pre-Coronavirus highs. However, it has struggled a bit since then.

Being payments businesses, both Tyro and EML have been negatively affected by the Victoria lockdown and how it has slowed down the Australian economy getting back to normal.

Similarly, ELMO, which is a cloud-based HR, payroll and rostering software business has seen the normal business environment challenged. It’s reasonable to think that natural or organic business growth has been hurt by these abnormal, pandemic-infected times.

Last week I interviewed the CEO of ELMO, Danny Lessem, and you can see that interview here. [2]

This is how Motley Fool saw the result:For the 12 months ended 30 June 2020, ELMO‘s strong form continued and it has delivered further strong growth in annualised recurring revenue (ARR), statutory revenue, cash receipts, and customer numbers.

“The company reported ARR of $55.1 million and statutory revenue of $50.1 million for FY 2020. This represents a 19.7% and 25% increase, respectively, over the prior corresponding period. Also growing strongly were its cash receipts. They came in at $57.5 million for the year, up 27.6% on FY 2019’s result.”

The first person to alert me to the potential of ELMO was Medallion Financial Group’s Michael Wayne. I checked out his latest take on the company in light of its report. “The market didn’t seem to like the recent results too much, despite the fact they were basically pre-guided and in-line with expectations,” he said. “Guidance had already been re-instated to between $55m and $57m, while EBITDA guidance had been upgraded to between negative $2.5m and negative $4.5m.

“Over all, we thought they were completely fine, considering the environment.”

Michael objectively looked at the pros and cons for ELMO. I’ve listed them below.

The negatives:

“In an unprecedented environment where businesses are doing everything to cut non-essential costs retracements in those key metrics weren’t entirely unexpected,” Michael pointed out.

The positives:

“From speaking with management, the indication has been that the business has experienced a slight deferral in purchasing decisions by many prospects,” Michael reported.

“However, broadly speaking the sense is that the COVID-19 has helped to accelerate businesses migrating to the cloud. This has helped to partially offset some weakness as businesses with old school legacy payroll systems have been forced to modernise to facilitate staff working from home.

“In the view of management, Elmo’s competitive position is likely to been enhanced due to this pandemic. Many competitors are smaller companies led by Venture capital (VC) and private equity (PE) which are now starved of cash.”

As ELMO is still quite small, it isn’t well covered by analysts but Morgan Stanley has a price target of $9 and on the current share price of $5.89, that would be a huge 52% potential gain!

But can we expect that any time soon? I got my charts guy, Michael Gable of Fairmont Equities to run his eye over the chart for ELO.

This is what he said: “ELO’s chart is telling us that we can probably pick it up at cheaper levels. It has been drifting back since early May. Although there might be some support nearby at $5.50, the severity of the fall in the last few days, coupled with the high volumes, is telling me that it might even head lower than $5.50 during the next several weeks. Having said that, the March lows near $4 look very unlikely to be threatened.”

That covers the possible short-term view. But what potentially lies ahead?

As a shareholder, I’m currently keeping the faith but not expecting anything spectacular in the short term. Why?

Try these points:

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.