New ERP customers and development efficiency drive earnings upgrades for OBIC, but the valuation has largely priced in its growth advantage

Overview

This report updates earnings forecasts based on OBIC's 1Q3/27 results, focusing on growth in new ERP customers among large enterprises and manufacturers, the flow-through from the SI business to cloud and maintenance services, and improvements in project efficiency and margins from the training center and AI development. Goldman Sachs raised its earnings forecasts and target price but believes these advantages are largely reflected in the valuation, and therefore maintains its Neutral rating.

Core views

Based on 1Q3/27 (April to June) results, Goldman Sachs raised its FY3/27E, FY3/28E, and FY3/29E operating profit forecasts by 2%, 3%, and 4%, respectively, from ￥99.3 billion, ￥108.8 billion, and ￥118.0 billion to ￥101.3 billion, ￥112.2 billion, and ￥122.3 billion. The revisions reflect faster-than-expected acquisition of new ERP customers and improved development-project productivity. Corresponding annual revenue forecasts are ￥151.9 billion, ￥166.7 billion, and ￥180.4 billion; basic EPS forecasts are ￥200.0, ￥225.0, and ￥248.4; and dividend forecasts are ￥100, ￥115, and ￥130. Goldman Sachs expects FY3/27E operating profit to reach ￥101.3 billion, an increase of approximately 14% or ￥12.5 billion year over year, above company guidance of ￥98.0 billion and exceeding ￥100 billion for the first time. By business, SI operating profit is expected to grow 12% year over year, an increase of ￥3.9 billion, mainly driven by ERP projects for large enterprise groups and manufacturers; SS operating profit is expected to grow 16%, an increase of ￥8.35 billion, mainly due to expanding cloud infrastructure and maintenance revenue from new ERP customers. The report also forecasts 2Q operating profit of ￥25.3 billion, up 14% year over year, with SI and SS business profits growing 13% and 16%, respectively, broadly maintaining the strong quarterly trend seen in 1Q. New customer acquisition is the primary source of growth. Manufacturing inquiries are particularly strong from the chemical and machinery industries, where customers have significant demand to upgrade legacy systems. New customer acquisition is also progressing in the retail and services sectors, supported by OBIC's track record of serving large customers. Large enterprise groups remain the principal growth driver, while the small and medium-sized enterprise market, previously underpenetrated because of personnel shortages, is also showing signs of recovery as labor productivity improves. Some manufacturing and wholesale customers became cautious in April and May because of developments in the Middle East, but ultimately did not reduce investment, and the report states that overall capital-expenditure appetite is currently improving. Revenue related to new customers accounted for more than 70% of 1Q SI business sales, including 15% from cross-selling to new departments of existing customers and approximately 55% from entirely new customers, with the proportion of entirely new customers gradually increasing. Goldman Sachs believes OBIC is gaining market share from overseas vendors through relatively low pricing and an integrated service model in which the same company provides software, infrastructure, and follow-up support. Because these differentiating factors are sustainable, the report expects this trend to continue in the near term. Improving project productivity is the second major theme supporting earnings growth and margin expansion. Improvements are especially evident because of experience accumulated from large projects. The company uses its training center to improve customers' proficiency with OBIC ERP, shortening implementation support during the final stage of system delivery, including operational guidance and data migration. Efficiency gains from AI-driven development are also beginning to emerge in the development process, particularly in connecting data from external systems with OBIC systems. Given the current penetration of AI development, Goldman Sachs expects further room for productivity improvement. It forecasts the EBIT margin to rise from 65.7% in FY3/26 to 66.7% in FY3/27E, 67.3% in FY3/28E, and 67.8% in FY3/29E. The growth driver for the cloud and maintenance business is shifting from migration of existing customers to contributions from new ERP customers. At the end of 1Q3/27, the cloud-service adoption rate by number of client companies was 91%, up 2 percentage points quarter over quarter. Because some customers will continue to use on-premises deployments, the report estimates a theoretical ceiling of approximately 95%, indicating that cloud migration among existing customers is approaching its later stages. However, almost all new SI customers are likely to adopt the company's cloud infrastructure, and increases in new ERP customers will continue to translate into cloud and maintenance revenue for the SS business. Goldman Sachs therefore continues to expect strong SS business growth. OBIC is Japan's largest provider of core ERP software for small and medium-sized enterprises and has also expanded its business with large enterprise groups in recent years. Goldman Sachs attributes its high profitability and stable growth to its 100% direct-sales structure, transition to cloud products, tighter order management, and balanced engineer utilization. The company achieved an operating margin of 65.7% in FY3/26 and recorded operating profit growth for the 32nd consecutive fiscal year. These characteristics support a valuation premium to the industry, but also underpin the Neutral view: the report believes OBIC's earnings stability, margins, and faster growth than competitors are largely reflected in the share price. Goldman Sachs raised its DCF-derived 12-month target price from ￥4,500 to ￥4,800, representing potential upside of 4.2% from the current price of ￥4,606. The target price corresponds to an FY3/28E P/E of approximately 21x, above the industry average of 18.0x. Goldman Sachs believes this premium is justified by OBIC's industry-leading earnings stability and profitability, but is insufficient to support a more positive rating. The report states that further rerating would require greater margin improvement from AI development, higher unit pricing driven by additional AI functionality, and stronger shareholder returns utilizing the company's ample cash.

Analysis framework

The report first revises its SI and SS business forecasts based on 1Q3/27 results, then explains the forecast changes through customer industry and scale, the composition of new customers, cloud adoption rates, and project productivity. It subsequently aggregates growth by business into revenue, margin, and EPS forecasts. For valuation, it uses a ten-year DCF model to derive a 12-month target price and compares the FY3/28E P/E implied by the target price with the industry average to assess whether the earnings advantages are already priced in by the market.

Methodology notes

• Valuation MethodDCF Discounted Cash Flow

  Ten-year DCF target-price model

  Goldman Sachs discounts forecast cash flows to present value using a model extending through FY3/36E, with an 8.0% WACC and a 0% terminal growth rate. Because OBIC has recorded operating profit growth for 32 consecutive fiscal years, the report considers its earnings stability suitable for using DCF to determine the 12-month target price.

• Valuation MethodPE/PEG valuation

  Comparison of target-price-implied P/E with the industry average

  The report compares the approximately 21x FY3/28E P/E implied by the target price with the industry average of 18.0x to evaluate the valuation premium embedded in the DCF result and assess whether OBIC's earnings stability and high margins are already reflected in the share price.

• (Out-of-Vocabulary Method)

  Separate earnings forecasts for the SI and SS businesses

  The report separately forecasts growth in the ERP development business and the cloud and maintenance business, then aggregates company profit based on the conversion of new ERP customers to cloud services, thereby explaining how new customer acquisition, project efficiency, and cloud adoption affect overall performance.

Asset mapping & comparison

Structured mapping from thesis to named assets (strengths, weaknesses, peers, risks).

• OBIC (4684.T)

  A Japanese provider of ERP development and cloud and maintenance services, benefiting from new customer acquisition among large enterprises and manufacturers, cloud-service synergies, and improved project productivity.

  Strengths

  100% direct sales, integrated software and infrastructure support, relatively low pricing, operating profit growth for 32 consecutive fiscal years, a 65.7% FY3/26 operating margin, and expanding market share among large enterprises.

  Weaknesses

  Cloud migration among existing customers is approaching its later stages, the valuation is above the industry average, and the advantages in earnings stability and profit growth are largely reflected in the share price.

  Comparison

  The target price corresponds to an FY3/28E P/E of approximately 21x, above the industry average of 18.0x; the report believes the premium reflects industry-leading earnings stability and profitability.

  Risks

  IT investment by small and medium-sized enterprises is sensitive to economic conditions; the share of demand from large enterprises could be higher than expected; large projects could unexpectedly become loss-making.

Key data

• 12-month target price￥4,800Raised from ￥4,500
• Current share price￥4,606Pricing basis stated in the report
• Upside to target4.2%Target price relative to the current share price
• FY3/27E operating profit￥101.3 billionUp approximately 14% or ￥12.5 billion year over year, above company guidance of ￥98.0 billion, and raised 2% from the previous forecast
• FY3/28E operating profit￥112.2 billionPreviously forecast at ￥108.8 billion, raised by 3%
• FY3/29E operating profit￥122.3 billionPreviously forecast at ￥118.0 billion, raised by 4%
• FY3/27E to FY3/29E revenue￥151.9 billion, ￥166.7 billion, ￥180.4 billionCorresponding revenue growth of 12.3%, 9.7%, and 8.2%
• FY3/27E to FY3/29E basic EPS￥200.0, ￥225.0, ￥248.4Corresponding growth of 16.6%, 12.5%, and 10.4%
• 2Q3/27E operating profit￥25.3 billionExpected to grow 14% year over year
• FY3/27E profit growth by businessSI +12%; SS +16%Expected year-over-year increases of ￥3.9 billion and ￥8.35 billion, respectively
• Share of 1Q SI business revenue related to new customersMore than 70%New departments of existing customers accounted for 15%, while entirely new customers accounted for approximately 55%
• Cloud adoption rate at the end of 1Q3/2791%Calculated by number of client companies, up 2 percentage points quarter over quarter; theoretical ceiling of approximately 95%
• EBIT margin forecasts66.7%, 67.3%, 67.8%Corresponding to FY3/27E, FY3/28E, and FY3/29E, respectively; FY3/26 was 65.7%
• FY3/28E P/E implied by the target priceApproximately 21xIndustry average is 18.0x
• Key DCF assumptionsWACC 8.0%; terminal growth rate 0%Ten-year model extending through FY3/36E
• Record of consecutive operating profit growth32 fiscal yearsAs of FY3/26
• Market capitalization and enterprise value￥2.0 trillion/$12.6 billion; ￥1.8 trillion/$11.3 billionKey data stated on the report's cover page

Impact & implications

The report believes growth in new ERP customers, conversion of SI customers to cloud services, and AI-driven improvements in development efficiency could enable OBIC to exceed ￥100 billion in operating profit for the first time in FY3/27E and support continued margin expansion. However, earnings stability and the growth advantage over peers already support a clear valuation premium; further rerating would require stronger improvements in efficiency, pricing, or shareholder returns.

Risks

• IT investment trends among medium-sized and small and medium-sized enterprises are relatively sensitive to business conditions.
• A higher-than-expected share of demand from large enterprise groups could cause deviations in the business mix and forecasts.
• Projects could unexpectedly become loss-making, particularly projects for large enterprise groups.

What to watch

• Whether new ERP customer acquisition among large enterprise groups, manufacturers, and small and medium-sized enterprises can continue.
• Whether AI-driven development and efficiency gains from the training center can continue to shorten implementation cycles and expand margins.
• Whether the SS business can sustain double-digit growth as new SI customers adopt cloud infrastructure.
• Whether additional AI functionality can support higher unit pricing.
• Whether the company uses its ample cash to strengthen shareholder returns.