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Great Business But Approach With Caution

- By New Moon

Manhattan Associates (MANH) develops, sells, deploys, services and maintains software solutions designed to manage supply chains, inventory and omnichannel operations for retailers, wholesalers, manufacturers, logistics providers and other organizations. In particular, its software helps to manage:

  • Supply chain - Manage distribution and optimize transportation costs throughout customers' entire commercial network.
  • Omnichannel - Provide solutions that manage inventory availability across all channels and locations and empower store associates to satisfy the demands of the walk-in shopper and the online customer.
  • Inventory - Provide distributors of any finished goods the ability to forecast demand, determine when, where and how much inventory is needed and translate this into a profitable inventory buying plan.

Manhattan Associates' customers include many of the world's premiere and most profitable brands. But the top five customers only accounted for about 10% of total revenue in 2016. The company proudly stated on its Web site: "Forty percent of retailers in the U.S. use Manhattan Associates software," "One out of four retail sales fueled by Manhattan solutions," "Forty percent of the top 20 retailers (by revenue) use our Transportation Management System," "Sixteen of the top 20 apparel retailers use our software solutions," "Forty percent-plus of all U.S. domestic grocery products consumed in the U.S. are transported with our TMS."

Manhattan Associates competes with the big (such as Oracle [ORCL] and SAP [SAP]) and the small. But it has the best reputation in what it does.

The following table has its revenue breakdown. The company does have some currency exposure, but U.S. retail is still the driving factor of growth and profitability.

Manhattan Associates was founded in 1990 in Manhattan Beach, California. Blackrock, Vanguard, Brown Capital and Eaton Vance are the largest shareholders, owning 9.9%, 8.5%, 5.9% and 5.2% of the company.

CEO Eddie Capel joined Manhattan Associates in 2000 and was its chief operating officer before becoming CEO in January 2013.

Financial profile

From 1998 to 2016, Manhattan Associates grew its revenue almost 20 times and earnings almost 15 times. The earnings growth lagged revenue growth significantly until 2010 but has taken off since then.

It has had significant margin expansion since 2010.

It delivered strong ROIC throughout its history (as expected for a capital light software business) with dramatic improvement since 2010.

Its spare cash was almost all used in share buybacks.

As a result, share base shrank almost 50% from the peak in 2004.

Thoughts on stock

Manhattan Associates is a high quality business with a wide moat under a strong management.

The supply chain, omnichannel and inventory management system are crucial for the retailers in terms of efficiency and future growth. But spending on information and communication technology equipment and software (ICTS) accounts for less than 1% of retailers' revenue and less than 10% of the spending budget. Unfortunately we could not find more updated data than the data shown below. But the message remains the same. Conceptually, it is hard for customers to switch to another vendor.


Manhattan Associates is the best doing what it does and has the leading market position in this crucial part of retailers' operations yet only a small part of their spending budget. As a result, ROIC is high. Margins are high.

The current CEO took over in January 2013. Comparing the margin and ROIC performance under the tenure of his predecessor from 2004 to 2012, the company had the same revenue growth (and growth opportunity) but dramatically better bottom-line performance.

In the CEO's first letter in the company's annual report, he pointed out the dramatic change in commerce space, the opportunities for Manhattan Associates and margin expansion opportunity. "While overall (the market) will continue to grow 5% to 6% in 2013, our plans are to grow at about twice that rate while generating earnings growth through operating margin expansion." And he delivered for the next four years.

But Manhattan Associates' stock is likely to rerate significantly only after retailers stabilized from what currently looks like a permanent decline unless the company shows it can defy gravity.

Manhattan Associates' stock has been weak since 2016 because its customers, primarily retailers, were weak. Same-store sales went negative. 2017 is a record-breaking year for store closings, even worse than 2008 (chart below).


It is hard to make money when your customers are in trouble. And we may not have seen the end of weakness. As the CEO commented in the first-quarter earnings conference call, U.S. retail footage per capital is 5x to 6x of elsewhere in the world. According to the census bureau data, even after so many years of relentless growth, e-commerce still only accounts for about 7% of total retail trade.

In addition, Amazon (AMZN) does not seem to care about profitability at all. Therefore it seems that there is still plenty of room for brick-and-mortar retailers to fall. Manhattan Associates cut revenue guidance in October 2016 for the first time since 2013. Then it downgraded revenue growth guidance of 2017 from a range of 3% to 5% to a range of 0% to 3% after the first quarter. This could be just the beginning of a string of weak quarters as a result of refrained spending from its troubled customers.

Manhattan Associates' stock price is positively correlated with retail stock performance. The correlation between Manhattan Associates and SPDR S&P Retail (XRT) is 0.51.

The stock is still expensive given the uncertain outlook. The target price is $38 at 20x 2017 earnings.

The price-earnings (P/E) ratio has come down significantly to below average. But its traditional customers are experiencing unprecedented challenges. Management guided 0% to 3% revenue growth and 1% to 3% non-GAAP earnings growth in 2017. Therefore 20x P/E or $38 looks like a good starting point to consider for a good business with a wide moat and strong management. But this is a moving target. The earnings and guidance need to be closely watched. The stock has very high volatility around earning releases in either direction.

We hope earnings will not decline materially from there. On one hand, there are a lot of opportunities for Manhattan Associates . The CEO wrote in the 2016 annual report: "Our growth has come not only from geographic expansion and entry into new market sectors, but also from the ongoing retail paradigm shift, in which virtually every finished goods company is fast becoming a retailer."

At the same time, the traditional customers of Manhattan Associates are facing unprecedented structural challenges. We cannot see clearly the path from now to the bright future; 24x P/E does not provide us enough margin of safety. We don't know whether this is still a cyclical business. In the 2001 to 2003 recession, Manhattan Associates enjoyed very good growth in both revenue and operating income. But the company was very small. In 2009, revenue declined 27% and operating income declined 19%. Although the 2009 cycle is probably once in a lifetime, the magnitude of revenue decline deserves caution.

Disclosure: We do not own Manhattan Associates shares.

This article first appeared on GuruFocus.