The megatrend of digitalization is being materially accelerated by the global pandemic. One prevailing way to invest in this space is to look for products and services that support customers' digital ventures. Being mindful of the intense competition of the information technology world and for the sake of a longer runway, we tend to prefer small-cap, lesser-known players that concentrate on a niche. Bouvet ASA (OSL:BOUVET) from our last article is one such business.
Today, we a Urbem would like to share with you another company with the same characteristics. Through its expertise in technology and creativity, Japan-based oRo Co. (TSE:3983, Financial) helps its clients with digitalization. The company provides cloud-based enterprise resource planning (referred to as "ERP") software mainly for small- and medium-sized enterprises (referred to as "SME") as well as one-stop outsourcing and consulting services for digital transformation at larger corporates.
oRo was founded by CEO Atsushi Kawata and Senior Managing Director Yasuhisa Hino. The company was named after the Spanish word for "gold" to demonstrate the desire to become No.1 in its space. Per the latest filing, both founders together own nearly 60% of the company.
As of fiscal 2019, the ERP business accounted for approximately 56% of the total sales but just over 93% of the operating profit, reflecting the high-margin nature. Furthermore, according to our calculation based on the company's financial data of the same year, the ERP business earns a 162% return on operating assets compared to a 6.8% return for the consulting business. Fortunately, the ERP business is the primary growth driver for oRo, delivering a rapid but steady year-over-year sales growth (ranging between 18.6% and 23.1%) over the last three years. The total number of active licenses for ZAC, the company's flagship ERP system, has almost tripled between fiscal 2015 and 2019. ZAC targets SMEs and so-called white-collar growth industries (e.g., advertising, information service, consulting and technology), and hence avoids a clash with software giants like Oracle (ORCL, Financial) and SAP (SAP, Financial).
The total ERP market is estimated to grow stably by 4-5% annually. The main driver for the SME segment, in particular, involves the need for improved operational efficiency. The productivity issue among the country's white-collar labor force is a well-recognized one. The government and corporations have been seeking to reform ways of working over recent years. ERP software could offer digital support. At the same time, the management also points to the expanding white-collar economy, which enlarges the total addressable market for its ERP business. Per our calculation based on the company's provided data, ZAC shares less than 1.5% of the market. Meanwhile, the management implied that the goal of an over 7% market share should be achievable in the medium term.
The license of ZAC can be sold either through a one-time purchase or on a Software-as-a-Service basis (charging monthly usage fees). Existing customers contribute to the recurring revenue in the form of the subscription fee, maintenance fee, data center usage fee, etc. Thanks to the cloud-based solution, the business is considerably scalable and capital-light, meaning that most of the additional revenue from the growth would fall into shareholders' pockets.
Overall, oRo generates a 16% return on equity and grows its revenue at a double-digit annual rate. The company has no debt and pays a modest dividend (a 13% payout ratio) with most of its free cash accumulated on its balance sheet (a 7.6x current ratio).
Disclosure: The mention of any security in this article does not constitute an investment recommendation. Investors should always conduct careful analysis themselves or consult with their investment advisors before acting in the stock market. We do not own any security mentioned in the article.
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