The Appen Ltd (ASX: APX) share price has struggled on all fronts of late. Not only has it underperformed the S&P/ASX 200 Index (ASX: XJO) in recent weeks, but it's also been subject to the rotation away from tech shares into cyclicals, and delivered an earnings downgrade.
Could the recent weakness in the Appen share price be a buying opportunity? Here's what Citigroup Inc (NYSE: C) is thinking.
What's been impacting the Appen share price?
Appen previously advised the market back in April that the pandemic may dampen its 2020 performance. This was expected to play out through a slowdown in digital ad spending, a reduction in IT/digital spending, the reduction or cancellation of services from Appen's smallest customers, interruptions to global hardware supply chains, and suspension of face-to-face projects such as audio data collection.
The business remained resilient throughout the first half of FY20 with strong growth despite a slowdown in new business development and deferred revenues. While third quarter (Q3) revenue came in lower than expected, its major customers released strong Q3 results and online advertising bounced back. This raised the company's optimism for Q4, especially taking into consideration how Q4 revenue has historically averaged 30% of Appen's full year results.
However, after finalising Q4 performance, the pandemic has clearly disrupted and reshaped the priorities and activities of Appen's customers and the traditional ramp up in Q4 has not occurred.
The company now expects FY20 underlying earnings before interest, taxes, depreciation and amortisation (EBTIDA) to be in the range of $106 million to $109 million compared to the $125 million to $130 million outlined in its half year results.
Appen cites that its major clients are reprioritising resources towards new product areas that enhance their long-term resilience and value which is currently impacting work volumes on some large mature projects.
The company reiterates that the long-term trends for its business are positive with spending on artificial intelligence (AI) growing rapidly at 28% annually and the expectation that AI adoption should accelerate in a post-pandemic environment.
Broker update
Citi reacted negatively to Appen's profit guidance by lowering its price target from $45.00 to $32.60 but retains its buy rating. The broker notes that the company is in a strong position to take advantage of the expected increase in expenditure on AI and earnings growth could return to circa 20% if pandemic conditions in the United States ease. This price target represents a 30% upside to Monday's closing Appen share price of $25.25. However, it makes a number of assumptions including the US flattening its COVID curve.
