3 reasons to be bullish on Appen shares

The Appen Ltd (ASX: APX) share price hit an all-time of high of $24.53 in Monday trade before retreating to close up 2.34% to $24.05. The Appen share price is up 87% in 2019 on the back of a rebound in global equity markets and last week’s release of its FY18 earnings report where it once again beat guidance.

Appen is a global leader in developing high-quality human annotated datasets. These datasets are then used in the burgeoning fields of machine learning and artificial intelligence (AI).

Following last week’s earnings report, there are a number of reasons for growth investors to be bullish on Appen’s future prospects.

Strong top-line growth and margin expansion

In FY18, Appen reported revenue growth of 119% to $364.3 million with underlying earnings before interest, tax, depreciation and amortisation (EBITDA) up 153% to $71.3 million. Pleasingly, underlying EBITDA margins rose 270 basis points from 16.9% to 19.6%.

The company’s 2017 acquisition of Leapforce was a major catalyst in driving revenue growth of 148% in its Content Relevance segment which represents around 86% of total revenue. Content Relevance continues to benefit from existing and new customer investments in AI.

Moreover, margins in Content Relevance expanded from 17.6% to 23.9%. Management attributed this expansion to Leapforce, organic growth and economies of scale.

FY19 growth

Appen’s management expects underlying EBITDA for the year ending December 31, 2019, to be in the range of $85 million to $90 million at an AUD/USD exchange rate of 74 cents. This would represent year on year growth of around 23% at the midpoint. The company has a history of being conservative when announcing guidance. For FY18, Appen had initially guided for EBITDA to be between $50 million and $55 million at an AUD/USD exchange rate of 80 cents.

Appen upgraded guidance on multiple occasions in 2018 and eventually surpassed its own guidance by 36% at the midpoint. It would not surprise me if the company managed to exceed guidance once again in FY19.

Industry tailwinds

The AI market is continuing to expand with market research predicting the total AI market to reach between $169 billion and $191 billion by 2025. The Data labelling market, which Appen operates in, is predicted to be up to 10% of AI investment reaching around $17 billion to $19 billion in size by 2025.

Appen noted in its investor presentation that one-third of AI applications require frequent, monthly data updates with one-quarter of those requiring weekly updates.

Foolish takeaway

Appen remains one of the more intriguing growth stocks on the Australian market alongside Afterpay Touch Group Ltd (ASX: APT) and WiseTech Global Ltd (ASX: WTC). These 3 companies have managed to deliver significant shareholder returns compared to the broader market over the last 12 months.

Appen’s share price has rallied 28% subsequent to last week’s release of its earnings. At current prices, Appen is trading for around 44 times the consensus FY19 earnings per share estimate of 54.30 cents. In my view, the valuation is starting to look a little stretched from a near-term perspective. However, the company’s long-term fundamental thesis remains intact, and any material correction as we saw in Q4 2018 would present a buying opportunity for investors.

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Motley Fool contributor Tim Katavic owns shares of Appen Ltd. The Motley Fool Australia owns shares of AFTERPAY T FPO, Appen Ltd, and WiseTech Global. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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