Asure Software, Inc. (NASDAQ:ASUR), the human capital management solutions provider including payroll and HR solutions, reported expectedly good growth throughout to Q3/2023, also helping improve the bottom line. The growth has stalled since from Q4/2023 forward, though, posing a threat to investors as growth with the current cost base is critically needed for healthier earnings.

In my previous article published on the 22nd of August in 2023, titled "Asure Software: Waiting For The Operating Leverage", I noted Asure's good long-term growth but also the company's need for continued growth to fuel healthy earnings. Since, as revenues have slowed down for the time being, Asure's stock has lost -33% of its value compared to S&P 500's return of 27%.

Prior ERTC Revenues Create a Growth Hiccup

As told, Asure's revenues grew well until the last quarter of 2023, with the year showing a total revenue growth of 24.3%. The Q4 report changed the direction of revenues, though - Asure reported a revenue decline of -10.3% after prior very strong growth. Going into 2024, Q1 followed with a decline of -4.3%.

The driver behind the declines has been the nearly complete stopping of ERTC revenues that Asure was able to generate well during the Covid pandemic due to temporary tax credit changes - underneath, core revenues are still showing growth with a 15% growth in Q4 excluding ERTC, and a 9% growth in Q1. Organically, core revenues grew by just 3.5% in Q1 due to a strong comparison level.

Asure guides for revenues of $125-129 million in 2024, a growth of 6.7% at the mid-point and around a 27.4% growth when excluding ERTC revenues in 2023 - the underlying growth momentum is continuing well overall, whereas total revenues have shown a hiccup in recent quarters due to the ERTC changes. Over the long term, Asure targets around a 10% organic growth driven by higher bookings than churn, customers' growing staff, and pricing increases. On top, accretive acquisitions are targeted to push growth even further into a total 20% annual growth level.

I believe that investors should be cautiously optimistic about future growth - Asure's pipeline seems solid with a Global Payroll Certification from Workday (WDAY), the joining into SAP PartnerEdge ecosystem, a new 401k product, a new Treasury Compliance service, and a partnership with KBA all being announced in the Q4 report. In Q1, a new tax credit service was announced, and the company's first client through Workday went live, being a team in the MLB.

While the growth momentum has overall been great, the Q1 organic core growth was quite weak. Although unlikely, further regulatory changes regarding taxes and other Asure's solutions may also pose a further threat to growth.

Further growth is still critically needed for healthy earnings - the trailing GAAP operating income stands at -$5.4 million. Incremental revenues should fall quite well into the bottom row. SG&A has also seen an average annual increase of $6.6 million from 2020 to 2023, slowing down the total operating leverage. Incremental need for operating expenses should be low, but still exist as with Asure's estimated 8-12% churn requires a significant sales team to push higher bookings. In Asure's May presentation, the company estimates revenue growth to incrementally add 35% to operating income, meaning that a $100 million increase in sales should add $35 million into operating income.

High Dilution Should Soon Slow Down

Asure has had to dilute shareholders significantly - diluted outstanding shares have increased from 15.5 million in 2019 into a current 23.4 million to finance operations and due to a reasonable amount of stock-based compensation.

Weak cash flows have required Asure to finance operations through equity financing - the company issued stock with proceedings of $46.8 million in 2023, after multiple equity raises in prior years. The company also recently filed a mixed securities shelf worth up to $150 million in April, including common and preferred stock, warrants, rights, units, and debt securities enabling the company to raise further capital in coming years.

With cash flows becoming healthier as earnings grow, the dilution should slow down quite soon. Asure also has $23.2 million in cash after Q1, enabling slight negative cash flows for the short term, making very significant further dilution now more unlikely. Investors should still note the potential, and expect some dilution going forward as well.

Asure's Valuation Has Gotten Slightly Undervalued

I constructed a discounted cash flow [DCF] model to estimate a fair value for the stock. In the model, I estimate continued revenue growth at a gradually slowing total CAGR of 6.8% from 2023 to 2033 organically. Afterwards, I estimate 2.5% perpetual growth.

I estimate incremental revenues to raise EBIT at an incremental rate of 35%, slightly pushed back by cost inflation, into an eventual EBIT margin of 12.0%. I believe that the growth momentum should carry margins into a widely better level, with the estimate being a good base scenario. The company should have quite a good cash flow conversion, as I also previously estimated.

The estimates put Asure's fair value estimate at $9.19, 15% above the stock price at the time of writing but 25% below my previous estimate due to a higher WACC, slightly more conservative margin estimates, and slightly lower revenue estimates, and continued dilution. The investment case is starting to get more attractive as the stock price has fallen, but quite good growth is still priced into Asure's stock.

CAPM

A weighted average cost of capital of 9.15% is used in the DCF model. The used WACC is derived from a capital asset pricing model:

Asure's debt is very unnoticeable, and as such, I estimate no long-term debt as a form of financing. To estimate the cost of equity, I use the 10-year bond yield of 4.28% as the risk-free rate. The equity risk premium of 4.60% is Professor Aswath Damodaran's estimate for the US, updated on the 5th of January. Seeking Alpha now estimates Asure's beta at 0.95. With a liquidity premium of 0.5%, the cost of equity and WACC both stand at 9.15%.

Takeaway

Asure's growth has shown a hiccup in recent quarters as ERTC revenues have vanished. Underlying core revenue growth has still been great overall excluding a weak Q1 growth, as the 2024 guidance expect continued momentum from new partnerships and service offerings. The good growth is still clearly needed to push earnings positive, and as weak cash flows have required dilution-causing equity financing. With great incremental earnings growth prospects, the stock now seems to have a slight undervaluation after the stock price has crashed. Still, I remain with a Hold rating for Asure for the time being, as the risk-to-reward provided by the valuation isn't quite attractive enough yet considering potential dilution.