GTLB - GitLab: Valuation And Growth Expectations Are Much Lower Now

2023-04-20 07:39:37 ET

Summary

• GTLB's FY24 revenue growth guidance has been cut to only 26%, a major factor in the drop in share price.
• The price increase is expected to have a minimal impact on FY24 revenue due to timing of renewals and contract duration.
• Despite the weak macro environment, there are still factors that will spur brisk revenue expansion, and the company's focus on profitability is a positive sign.

Investment thesis

When I wrote about GitLab ( GTLB ) last year , I recommended holding the stock because I didn't think it was cheap enough to be attractive. Even though 4Q23 results showed revenue growth of 58% (!) and beat consensus, the stock has fallen by about 30% since then. The disappointing FY24 revenue guidance, in which growth was cut by more than half to only 26%, was a major factor in the massive drop in share price, in my opinion. Despite my previous recommendation to "hold," I continue to be optimistic about the company's prospects. Given the weak macro environment, I believe the slowdown in growth may be an isolated incident. In my opinion, there are still many factors at play that will spur brisk revenue expansion. For instance, I expect price hikes to become more noticeable over the next two years as the premium SKU price increase gradually trickles down to consumers. That said, the timing of renewals will be critical to revenue growth in various time periods, as repeat customers account for 80% of bookings. It's also worth noting that the price increase is responsible for a relatively small share of FY24 revenue growth, as such, it can be inferred that that volume is still growing at a pretty decent pace (absolute terms). In addition, although NER shrank in 4Q and further pullback is anticipated in the guidance, business trends sequentially improved in January, suggesting that things may turn out better than expected. To return to the topic of pricing, I'd like to point out that GitLab's most expensive tier, Ultimate, is significantly more expensive than its Premium SKU, which has recently seen a price increase. As the platform develops and the company assesses the paywall for each feature, this affords GTLB the opportunity to introduce new pricing tiers. Profitability is also a key area of focus, with the non-GAAP operating margin for 4Q23 coming in at -11% compared to -21% forecasted. In addition, this is only going to get better as a result of outperforming on revenue, controlling expenses, and gaining leverage. Overall, I am recommending a buy because revenue expectations have been lowered (20+% vs. 50+%) and the stock is currently trading at a lower valuation.

All about the guidance

The results for GTLB in the fourth quarter of 2023 mainly revolved around their projected revenue growth for the 2024 fiscal year. Unfortunately, this growth is expected to slow down significantly compared to the previous year, and is much lower than what most people were anticipating. Despite the company's recent announcement of a large price increase (which has yet to pass through the P&L). Although 4Q23 revenues came in above expectations, they were a softer beat than expected due to the negative impact of macro headwinds, which intensified in the quarter's final two months. SGTLB also saw a significant drop in its dollar-based net retention rate at the customer level due to seat contractions caused by tech layoffs, smaller deal sizes as businesses focused on buying exactly the number of seats required, and deal push outs. In fact, I think GTLB should brace for the effects of a major recession to last through FY24 and possibly 1FH25, as I do not anticipate a macro recovery this year. The material deceleration in GTLB initial revenue growth guidance is a validating proof that management are worried as well. As I mentioned above regarding the timing of impact from the increased pricing, the impact of the price increase will likely be small in FY24 – which I believe have led to some misalignment of expectation for investors that were hyped up by the price increase, and management initial outlook of over 40% growth provided just 3 months before earnings. Growth weakness aside, I think GTLB profitability is worth mentioned, albeit it is unlikely to shine among the weak guidance. With respect to profitability, GTLB exceeded expectations for 4Q23 – which is definitely something to continue monitoring. Is this improvement in profitability a one-time thing or a structural one.

Price increase

While company leadership has implied that the price hike is factored into projections, they have been less specific about the extent of that inclusion. It is my understanding that there are two main reasons why GTLB thinks the impact will be minimal in FY24. First, bookings will only be affected for ten months due to the price increase, and revenue will be unaffected because most renewals occur in the second half of the year. Second, GTLB contracts have an average duration of 14 months, indicating that not all of the contracts will be due for renewal within the next 10 months. Another reason I believe the price impact will be minimal in FY24 is customer churn, which I expect customers who are up for contract renewal may not do so.

Conclusion

Despite the recent drop in share price following the disappointing FY24 revenue guidance, I remain optimistic about GitLab's prospects. While the weak macro environment may have contributed to the slowdown in growth, I believe there are still many factors at play that will spur revenue expansion. Moreover, the company's focus on profitability is a positive sign, with the non-GAAP operating margin for 4Q23 exceeding expectations. Overall, I recommend buying GTLB stock.

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