IBM - Gitlab: Upgrade To Hold More Balanced Risk-Reward Now

2023-12-05 13:37:35 ET

Summary

• We are upgrading GitLab Inc. to a hold.
• Q3 2023 earnings and outlook lead us to believe the stock provides a more balanced risk-reward profile now.
• We think the stock remains too expensive, with no near-term catalyst driving outperformance for 1H24.
• Management guided comfortably higher than consensus for next quarter at $158M versus consensus at $150.2M; we think the expectation of recovery is now factored into the stock.
• We think GitLab Inc. stock will be more of an in-line performer in 1H24.

We're upgrading GitLab Inc. (GTLB) to hold after a long, bearish stance. Their third quarter 2023 results and outlook lead us to believe that GTLB provides a more balanced risk-reward profile as IT spending stabilizes and the enterprise optimization cycle completes. Still, we're more cautious about the company sustaining better-than-expected top-line growth, as we see no near-term catalyst driving outperformance.

We understand investors' heightened confidence in the stock after 3Q23 results , but we now think the expectation of recovery has been priced into the stock at current levels. GTLB soared +18% in extended trading post-earnings yesterday and is up +10% today since market open. Management reported revenue up 32% Y/Y this quarter to $149.7M, ahead of consensus of 141.5M, and guided higher than consensus to the range of $157M and $158M compared to a consensus of $150.2M.

GTLB stock's underperformance has moderated in 2H23, aside from today's run-up; over the past three months, the stock is up 8%, outperforming the S&P 500 (SP500) by 6%. We now expect GTLB to be an in-line performer into the next quarter. While we see a balanced risk-reward profile for the stock as IT spending recovers in 2024, we think the stock is too expensive and has already priced in the recovery that we don't think will sustain.

The following graph outlines the stock's performance compared to the S&P 500 over the past three months.

Our neutral sentiment on GitLab Inc. stock is based on our belief that the stock doesn't provide attractive entry points at current levels, mainly due to its post-earnings run-up and high valuation. We don't think GTLB will have the kind of growth rate in 2024 that would justify the higher multiple, particularly as the competitive landscape expands. GTLB competes in a heavily contested SCM and application development tools market. Large incumbents such as Microsoft ( MSFT ), Atlassian ( TEAM ), IBM ( IBM ), and GIT own significant chunks of the market. We believe the heightened competition shows the market opportunity for developer tools software is growing, with an estimated CAGR of 17.47% between 2023-2027. We think the market opportunity is wide enough to encompass multiple players, but we don't see a competitive advantage for GTLB in 1H24.

It's essential for investors to factor in the competitive landscape, especially the presence of strong competitors like GitHub. GitHub, a key player in the Cloud-hosted Git solution market, has been setting industry standards and growing under Microsoft's ownership since 2018, placing pressure on GTLB. We recommend investors revisit the stock closer to mid-2024 once the balanced risk-reward has turned favorable.

Valuation

GitLab Inc. stock remains expensive; we don't see attractive entry points at current levels. The stock is trading at 10.2x EV/C2024 Sales versus the peer group average of 8.8x. We think the stock is too expensive for the company's lack of near-term catalyst, and believe the valuation is factoring in future earnings. We would recommend investors stay on the sidelines for the near term.

The following chart outlines GTLB's valuation against the peer group average.

Word on Wall Street

Wall Street doesn't share our neutral sentiment. Of the 23 analysts covering the stock , 16 are buy-rated on GTLB, and seven are hold-rated. We think Wall Street is more bullish on the stock due to exposure to A.I. tailwinds and an expected rebound in IT spending next year. We're constructive on GTLB's position in the market, but don't see the stock materially outperforming in 1H24.

The median and mean price targets for GTLB both stand at $64, when compared to the current trading price of $53, the price targets indicate an upside potential of 21%. We think GTLB is better positioned in the longer run once macro headwinds ease. Still, we don't recommend investors to start a position. We expect better opportunities to arise in 1H24.

The following charts outline GitLab's sell-side ratings and price targets.

What to do with the stock

We're upgrading GitLab Inc. shares to a hold. Our upgrade is driven by our belief that the company now provides a more balanced risk-reward profile, but won't outperform materially in the near term. We think macro weakness may spill into 1H24 and cause longer deal cycles. We also think GitLab Inc. stock is too expensive and has already priced in the expectation of recovery. We recommend investors stay on the side for now.

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