Here's why the Appen (ASX:APX) share price is sinking

The Appen Ltd (ASX:APX) share price was crunched 9% today as investors sold off after a negative broker report from Macquarie.

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The Appen Ltd (ASX: APX) share price dropped by 9% today after it was on the receiving end of a negative broker report.

Analysts at Macquarie Group Ltd (ASX: MQG) issued a painful downgrade of expectations for Appen this year.

Here's what happened to the Appen share price

Appen shares suffered after Macquarie downgraded the technology business from 'outperform' to 'underperform'.

Macquarie thinks that the FY20 result is now going to be a 'non-event' because of increasing competition and this will cause Appen to lose market share. But the broker doesn't think this competition is a short-term problem – the headwinds could continue for the rest of 2021. It may then lead pricing competition for Appen.

The broker thinks that other brokers could follow suit with downgrades for Appen.

The Australian Financial Review quoted Macquarie analyst talking about how competition could affect things for Appen:

Increased competition has been partially cushioned by greater demand, but supply increase has outstripped demand. Pricing is not yet a lever to differentiate between outsourced solutions, but as competition intensifies in 2021, we see downside risk to street revenue forecasts as this comes into play.

Appen's new share price target and earnings expectations

Macquarie has set a new price target for Appen of $19. That's still a potential downside of around 18% despite already falling 9% today.

The broker is now forecasting that Appen will generate 51 cents of earnings per share (EPS) in its FY20 and 65 cents of EPS in its FY21.

That suggests that the Appen share price is now valued at 45 times FY20's estimated earnings on Macquarie's projections.

What was in the last trading update?

Appen announced a trading update in December 2020.

In that ASX release, the company referenced the fact that on 15 April 2020 it said that the COVID-19 pandemic may dampen 2020 performance through a slowdown in digital ad spending, a reduction in IT/digital spending, a 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.

After completing its November results, Appen said that while the fourth quarter has improved compared to the third quarter, the usual ramp up it normally sees didn't eventuate.

The Appen share price has fallen 23% since this update.

Management said that the pandemic had disrupted and reshaped the priorities of customers, especially in California. Appen said client resources are being put towards new product areas that enhance their long-term resilience and value which is currently impacting work volumes on some large mature projects. At the time, Appen said that was positive for the company.

The company said that the long-term trends for the business remain very positive, with spending on artificial intelligence growing rapidly at 28% per annum.

Appen said that the structural tailwinds, as well as the strength of the existing pipeline, should support a return to strong growth rates in 2021.

In the trading update, Appen said it's expecting underlying earnings before interest, tax, depreciation and amortisation (EBITDA) for FY20 to be in the range of $106 million to $109 million, with second half underlying EBITDA expected to be at least 30% stronger than the first half.

Tristan Harrison has no position in any of the stocks mentioned. The Motley Fool Australia's parent company Motley Fool Holdings Inc. owns shares of Appen Ltd. The Motley Fool Australia owns shares of and has recommended Macquarie Group Limited. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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