DT - Dynatrace: Empowering Intelligent Monitoring Cheaply Priced

2023-06-27 12:48:12 ET

Summary

• Dynatrace, Inc. offers intelligent monitoring and analytics, empowering businesses to optimize application performance and identify performance issues.
• Dynatrace is poised for strong growth in the low 20s% CAGR.
• Despite some minor concerns such as slowing customer growth rates, Dynatrace has a compelling opportunity to cross-sell its different product solutions.
• With a stable revenue growth rate and a reasonable free cash flow profile, Dynatrace's valuation at 47x forward free cash flows is an attractive entry point.
• I'm bullish on Dynatrace stock.

Investment Thesis

Dynatrace, Inc. ( DT ) is a monitoring and analytics platform. I make the case that Dynatrace is likely to grow at least in the low 20s% CAGR for the foreseeable future and that paying 47x forward free cash flows is not expensive given its secular tailwinds to its back.

I also note some minor blemishes that readers should think about, such as its slowing customer growth rates and the potential compression in its free cash flow margin for the year ahead.

Why Dynatrace? Why Now?

Dynatrace provides observability and application performance management. At its core, Dynatrace offers intelligent monitoring capabilities, with analytics to identify performance issues and optimize application performance.

If readers know Datadog, Inc. ( DDOG ), Dynatrace is like that, but Dynatrace focuses slightly more on automatic monitoring. Datadog, on the other hand, offers a more flexible and customizable approach to monitoring with extensive dashboarding capabilities. Furthermore, Datadog has a slightly broader number of products, while Dynatrace is more focused on application-level performance.

The one blemish to the bull case is that Dynatrace's customer adoption curve of 9% y/y as of fiscal Q4 2023 isn't that strong. What's more, this customer adoption slowed down from the prior year, when the total number of customers grew by 14% y/y.

For their part, Dynatrace is able to point to the fact that 65% of its new customers landed with three or more modules, up from approximately 50% in the prior year.

Meaning that the customers that do embrace Dynatrace are more than willing to be cross-sold into its different product solutions.

What's more, with time, the cloud-based workload market for observability and security continues to grow, as more and more enterprises find that on-premise solutions may not provide all the tools they require. To highlight Dynatrace's opportunity here's a quote from its recent earnings call :

We believe the estimated $50 billion market for observability and application security is at an inflection point.

The complexity of modern technology ecosystems is forcing companies to move from in-house or open-source dashboards to much more sophisticated observability solutions that deliver vastly improved insights and automation.

Essentially, this highlights the overall secular tailwinds that this business is able to grow into. With that in mind, let's now discuss its financials.

Revenue Growth Rates Remain Very Stable

Dynatrace's guidance above is likely to leave itself some margin of safety. After all, note below that looking back over the previous 12 quarters, Dynatrace has not missed any quarterly revenue estimate.

Meaning that you can practically assume that Dynatrace is going to deliver at least around the low 20s% CAGR in fiscal 2024, a figure that's mostly consistent with the prior year.

In other words, this business has a compelling tailwind of a secular growth market, and it doesn't require much heroics to deliver +20% CAGR for a prolonged period of time.

With that framework in mind, let's discuss its free cash flows and valuation.

Free Cash Flow Profile is Enticing

Dynatrace finished fiscal 2023 with free cash flow margins of 29%. However, this included a one-off tax refund. Without this refund, Dynatrace's free cash flow margin would have been around 26%. Furthermore, looking to the year ahead, Dynatrace's free cash flow margin is expected to compress to about 22%.

I don't believe this is a massive thesis breaker since the business isn't still being operated toward free cash flow maximization.

That being said, it is important to note that free cash flows for this upcoming year are not likely to be quite as strong as the prior year.

On the other hand, management is likely to be guiding somewhat conservatively, so that Dynatrace's full-year fiscal 2024 free cash flow may ultimately end up around 25%. Consequently, it's possible that Dynatrace's free cash flow does not end up being so different in the upcoming year compared with the prior year.

Altogether, this leaves the stock priced at about 47x forward free cash flows. And I have to say, as far as SaaS businesses, with secular tailwinds, that are still growing at more than 20%, paying 47x forward free cash flows is really not that expensive.

Even without relying on any multiple expansions, if Dynatrace simply grows in intrinsic value by around 20% CAGR, that would make this investment a compelling opportunity over the next twelve months.

The Bottom Line

Dynatrace is a monitoring and analytics platform poised for strong growth in the low 20s% CAGR, backed by secular tailwinds.

Despite slower customer growth and potential free cash flow margin compression, the stock's valuation at 47x forward free cash flows is justified.

The market for observability and application security is expanding, benefiting Dynatrace. Stable revenue growth rates and a reasonable free cash flow profile further support its investment potential.

I believe that over the next twelve months, investors will look back to $50 per share as a cheap entry point for Dynatrace, Inc.

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