Digital Workforce Q2'24: Improved growth prospects

This report is a summary translation of the report “Parempi kasvunäkymä” published on 8/26/2024 at 7:45 am EEST.

We raise our price target to EUR 4.7 (was EUR 4.0) and reiterate our Buy recommendation on the back of revised forecasts and improved growth prospects. Digital Workforce performed better than expected in Q2, with a significant acceleration in growth driven by strategically important Continuous Services. In addition, comments on sales and growth for the rest of the year were cautiously positive. At the same time, however, the company has invested more than expected in growth, and we believe the near-term outlook remains a cautious balancing act between scaling growth and investments. We expect the company to outperform the market over the next few years but miss target and historical levels. In addition, we expect growth to be well scaled to profitability in the coming years. Relative to the company's earnings growth prospects, the valuation picture (2024e EV/S 1.2x, SOTP EUR 4.6) supports a positive view on the stock. 

Revenue growth accelerated significantly in Q2, exceeding our expectations

Digital Workforce's revenue increased by 14% to 7.0 MEUR, beating our forecast of just over 6.5 MEUR for Q2. By business lines, revenue of Continuous Services increased by 16% to 4.3 MEUR (forecast: 4.0 MEUR), while revenue Professional Services increased by 11% to 2.6 MEUR (forecast: 2.5 MEUR). As a result, both business segments landed above our forecasts. As we understand it, growth continued to be driven by healthcare in Finland, in line with the industry focus, and by the North American market, which is the geographic focus of the growth market.

Growth did not quite translate into profitability as expected, as the company invested more than expected

Digital Workforce's sales margin was 2.6 MEUR or 38% of revenue in Q2. Sales margin-% improved significantly from 33% in the same period last year and also from 36% in Q1'24. However, other operating expenses and fixed personnel costs increased by 0.5 MEUR compared to Q1'24. The company has added new high-profile individuals to the management team, increased salaries and paid bonuses that were not paid in the comparison period. This translates into an average wage bill increase of ~6% in Q2 (-2% in 2023). Other operating expenses increased due to several large sales and marketing events. In turn, profitability was supported by growth in higher-margin Continuous Services, the closure of the Danish and Norwegian offices at the end of last year and administrative efficiency measures.

Guidance reiterated as expected; revenue and profit expected to grow in 2024

Digital Workforce commented that its early year successes with both new sales and existing customers provide a good platform for continued profitable growth for the remainder of the year. The company estimates that full-year revenue in 2024 will be higher and adjusted EBITDA will be positive and improve compared to 2023. We have slightly increased our revenue forecasts based on good growth and sales comments from Continuous Services. We have also slightly revised our expectations for investments and revenue structure, leading to a slight increase in next year's profit forecast. We expect that the company’s revenue will grow by 10% and EBITDA will be 1.2 MEUR or 5% of revenue in 2024 (2023 adj. EBITDA 0.2 MEUR). We expect the company to grow to 35 MEUR by 2026 (12% y/y growth) with an EBITDA% of 11%, which is below the company’s growth target (50 MEUR) but above its profitability target (above 10%).

Valuation remains attractive thanks to improved growth prospects

In terms of the investment profile, Digital Workforce is a turnaround company that is still in its early stages, although the turnaround made good progress in H1, which has slightly lowered the risk level. Based on our forecasts and the valuation multiples that we accept for the company for the next few years, the sum of the parts, scenario analysis and the DCF, we estimate that the fair value range of Digital Workforce’s share is EUR 3.8-5.2 per share (previously EUR 3.2-4.7). In the current environment of heightened market uncertainty, while the company's strategy is still in its early stages, our range is low if the company proceeds in line with our forecasts for the next 3-5 years.