TEAM - GitLab Earnings: A Bright Future Amid Revenue Challenges

2023-09-06 06:10:26 ET

Summary

• GitLab delivered a solid fiscal Q2 2024 earnings report, with an upward revision of revenue targets.
• GitLab emphasized its focus on security and software delivery, benefiting from vendor consolidation.
• Revenue growth rates are decelerating, but the profitability profile is set to improve with positive cash flows and determination for profitable growth.

Investment Thesis

GitLab ( GTLB ) delivers an overall solid fiscal Q2 2024 earnings report. There are some blemishes to this report, for instance, in my earnings preview analysis written a few days before this earnings result I stated that I believed that GitLab would upwards revise its revenue targets to around $565 million.

And yes, GitLab did upwards revise its revenue targets, but the figure that GitLab upwards revised to was just $557 million in revenues. And therein lies one pesky detail overshadowing GitLab's story. It's difficult to get a sense of what its revenue growth rates will stabilize at, something we'll discuss soon in more detail.

That being said, I argue that paying approximately 14x this year's revenues for GitLab already prices in that consideration.

Hence, here's why I'm bullish on GitLab.

GitLab's Near-Term Prospects

GitLab is a virtual toolbox for software development teams, helping them work together more efficiently. It simplifies tasks like managing code, tracking changes, and automating the process of turning code into working software. Essentially, it's a one-stop shop that streamlines the entire software development process, making teamwork smoother and software delivery faster.

In my previous analysis, I made the case that GitLab would use the earnings call to discuss its AI innovation. And while that did make an appearance, it didn't make the bulk of its prepared remarks. Instead, GitLab emphasized its mission focus on security together with shipping software faster, here's a quote from the earnings call ,

Using GitLab, Navy Black Pearls' teams have designed and created custom operational software environments within days rather than months. Many of our customers have complex security compliance and regulatory requirements. We address these needs with GitLab Dedicated

GitLab went on to discuss how it's benefiting from customers' desire for vendor consolidation and how GitLab is taking market share from some of its peers in software development and collaboration, in this case, Atlassian ( TEAM ), see below.

GitLab integrates all aspects of software development into the same platform. Customers can improve their productivity and efficiency across the entire life cycle. This includes enterprise agile planning and value stream management. In Q2, we expanded business with a multinational financial services company. The customer wanted to drive greater efficiency by integrating an enterprise agile planning solution with the rest of their software development practices. They moved thousands of business users from Jira to GitLab.

When the earnings call did eventually, and inevitably, turn to AI, it was more along the lines of how AI wasn't going to hinder its prospects to build and ship code by infringing on IP.

Furthermore, in the Q&A section of the call, the topic of how coding was only a small part of what developers do was discussed, approximately 25% of their time, and how AI could eventually be used by GitLab for "life cycle" features of what DevOps do.

In sum, the message that came out of GitLab was the acknowledgment that AI could eventually be a bigger part of what GitLab does, but for now, there are more pressing prospects for GitLab to go after. With this framework in mind, let's discuss GitLab's financials.

Revenue Growth Rates Impress, With a But

There's no question that GitLab is decelerating its revenue growth rates. This means that even though GitLab delivered close to an 8% top-line beat, the graphic above continues to overshadow its long-term narrative.

Put another way, although investors are pleased to see GitLab exceeding consensus estimates, the fact remains that GitLab's revenue growth rates are slowing down.

Naturally, and uncomfortably, this forces an important and yet unavoidable question. At what rate will GitLab end up stabilizing its growth rates? Indeed, the drop from fiscal Q4 2023 when GitLab was growing at 58% CAGR into fiscal Q1 2024 when GitLab was growing at 45% is quite significant .

And then, the drop from fiscal Q1 2024 into fiscal Q2 2024 is also large. And then, looking ahead to fiscal Q3, even if we presume that GitLab's revenue growth rates are conservative by around 8%, this would still mean that fiscal Q3 2024 would arrive at 33% CAGR, which would be yet a further drop.

So, again, with this context in mind, I'll ask the question, where do GitLab's growth rates stabilize at? And is this question all that important at this stage?

Profitability Profile Set to Improve

GitLab's cash flows improved substantially from negative $36 million in last year's fiscal Q2 to positive $27 million in this most recent quarter.

What's more, looking out to next year, GitLab reiterates that it will be delivering breakeven free cash flow.

Therefore, we are once again reminded that GitLab is determined to deliver profitable growth. So then, the only question we have to truly ascertain is what sort of growth rates make sense? And whether that uncertainty is already priced in?

GitLab is priced at around 14x this year's sales. That's not the cheapest stock out there. But it's far from the most expensive either. It's very much a middle-of-the-pack range. This is ever-so-slightly more expensive than Atlassian, but Atlassian isn't delivering anywhere near these revenue growth rates.

The Bottom Line

I have some minor doubts about GitLab's recent earnings report for fiscal Q2 2024. While there were positive aspects, such as the upward revision of revenue targets, it fell short of my initial expectations. The question of where GitLab's revenue growth rates will stabilize is concerning, given the recent declines.

However, despite these uncertainties, I'm inclined to be bullish on GitLab. Its role as a streamlined software development toolbox and its focus on security and market consolidation are promising signs. The company's improved cash flows and determination to deliver profitable growth make me believe that GitLab's current valuation, at around 14x this year's sales, is reasonable.

So, despite the uncertainties, there are strong reasons to be confident in GitLab's prospects.

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