GLOB - Globant Q2 Results: Growth Improving But Valuation Remains Demanding

2023-08-22 08:30:42 ET

Summary

• Globant's Q2 revenue reached its highest level ever, with year-over-year growth of 15.9% and quarter-over-quarter growth of 5.3%.
• The company is focusing on AI solutions, particularly in the areas of augmented knowledge and conversational AI.
• While growth is improving, it is still far from previous historic levels, and Globant's international expansion may face challenges.
• GLOB stock's valuation remains quite demanding, despite the benefits of AI growth. We are maintaining our previous 'hold' rating.

Despite the share price being at relatively similar levels compared to when we last covered Globant (GLOB) in February, things looks somewhat different from a fundamental perspective. Back then we pointed out that the company's Q4 results were clearly showing a growth deceleration, even if it looked to be caused by macro-economic conditions. Things got worse than we expected, but the good news is that they are now turning positive. Growth is finally re-accelerating, but the company is still delivering growth that is far from what investors had gotten used to in the past. We believe this is the result of a combination of things, including getting to the point of saturation in some markets, having picked the "low hanging fruit" in relation to international expansion and now having to focus in more complex or more difficult markets; and economic conditions that remain far from ideal. While we continue to believe that Globant is well-positioned to capture growth in AI, its valuation remains demanding.

Still, even if the valuation is high, we would argue that it is much more reasonable compared to many other "AI" stocks. It remains an interesting prospect, and a name worth following, for those interested in the AI technology space. Globant remains optimistic about the growth of its addressable market, which is estimated to reach up to $8.9 trillion by 2030 according to the Digital Transformation Market Forecast 2023-2030 released by Fortune Business Insights this year.

Something we appreciate with Globant is that it both uses AI to improve the efficiency of its internal processes, as well as sell AI solutions to customers. It has said that with the release of ChatGPT a lot of companies rushed to start new initiatives and proofs-of-concepts that could be applied to achieve specific KPIs and expand their businesses. Now many of these are becoming real-life solutions that are ready to be scaled. Globant has explained that most use cases they see fall into two categories. Augmented knowledge, which gives skilled professionals such as those in law or finance the ability to access and interpret large amounts of data quickly. The second field is what they call 'Converse AI', which allows an end user to interact with a transactional system in a conversational way. These include reservation systems, and in general customer assistance systems. Globant has a page dedicated to showcase some interesting AI use cases here .

It has also been publishing some reports on how AI will impact industries and how organizations can harness its power to improve their operations. One example that caught our eye is stadiums and event venues, which can use digitization to both lower operating costs and increase revenues, while apparently also improving the customer's experience.

Globant Q2 2023 Results

In the second quarter revenue was $497 million, which is the highest the company has ever delivered. This revenue represented ~15.9% year over year growth, and ~5.3% quarter over quarter growth. While this is very decent growth given the less than ideal economic conditions, it is far from what investors had grown accustomed too. Investors should also consider that inorganic contributions accounted for ~6% of y/y growth in Q2.

Adjusted gross profit increased to ~$190 million, which represents ~13.5% year over year growth. The company is experiencing marginal cost headwinds due to some currency appreciation in most LatAm countries, negatively affecting margin improvement plans. Its adjusted operating margin for the quarter was 15%. changes in the foreign exchange market have impacted.

Adjusted net income also grew to $58.9 million, representing an ~11.8% adjusted net income margin. All of these translated to an adjusted diluted EPS for the quarter of $1.36, representing an ~11.5% year over year increase. These are good results, but not the extraordinary performance the company used to deliver.

There are positive signs, however, that things are further improving. The company reported that bookings in the first half 2023 were over 40% larger than those in the second half of 2022. Its net promoter score ("NPS") also improved in the quarter to 83, its best ever. The average NPS for the trailing twelve months has now increased from 79 to 81.

The balance sheet remains strong, positioning the company well to continue its bolt-on acquisition strategy that has worked so well in the past. At the end of the quarter cash, cash equivalents, and short-term investments were $270.8 million. The company recently expanded its revolving credit facility to $725 million from $350 million, and at the end of the quarter it remained fully undrawn.

Given these positive signs, the company increased guidance for the year, implying strong sequential growth in Q3 and Q4. The company is guiding Q3 revenues of at least $545 million, representing ~18.8% year over year growth, and a 9.5% sequential increase. If contribution from the Pentalog acquisition is excluded, quarter over quarter growth is expected to be lower at roughly 6%.

Growth

Globant has had a very successful growth strategy, which combined two key elements. One was expanding its share of wallet with its most important customers, increasing the average spending on Globant's services. The second key strategy was international expansion, by either acquiring smaller rivals in new markets and then growing them, or by starting operations in these new regions from scratch. While this worked wonderfully for the company, it is starting to hit some limits, as its key customers are becoming more reluctant to increase spending even further, and the easier markets have been for the most part already tackled. Still, it will continue further expanding, for example, it recently started operations in Portugal. It also continues its M&A strategy, as seen with the acquisition of Pentalog which added ~1,300 employees in France, Romania, Moldova, Mexico, Vietnam, and the US. This acquisition particularly strengthened Globant's presence in Europe.

Globant now has offices in 70 cities in 30 countries, including eight new markets that opened in the past twelve months. We believe Globant is realizing that international expansion is going to get increasingly difficult, and as a result it is now refocusing on its original markets where it started. Globant announced it will be making significant investments in Latin America according to its five-year strategic growth plan.

While we are optimistic that Globant can continue growing at a rapid pace, we think returning ~30% y/y revenue growth will prove very hard. As we've already mentioned, both growing share of wallet and entering new markets is becoming increasingly difficult.

It is therefore not a surprise that a big question on many investor's minds is whether the company can return to 20%+ growth. During the Q&A session of the most recent earnings call an analyst asked if a return to ~20% growth could be accomplished in 2024. CFO Juan Urthiague sounded cautious, and from what he said he appears comfortable guiding to probably reaching double-digit growth next year, but didn't go as far as to say that a return to ~20% revenue growth is likely in 2024.

Yeah. Look, that's what the math -- the math is saying. Of course, it's still early, and we will provide -- we will be providing formal guidance at the beginning of 2024 in February. But you know, clearly, one thing is to get into next year, we are seeing sequential growth and a very different thing is when you are seeing decreases, right? So, we are optimistic about next year. We are optimistic about how deals are shaping up, are getting closed, but, it's I think still early to say, okay, it's going to be [indiscernible] it's going to be 15%, it's going to be 22%, right? When you look at the market and our peers, they seem to be all in the single-digit numbers. I do believe that double-digit is okay, maybe you know, we need to get closer into the end of the year to see if what we are seeing right now is validated in the second half or if there is any change. But you know, so far, it's looking good.

New Products

We have to give the company a lot of credit on the innovation front. It does not stop creating new tools and offerings, many of which make use of AI or machine learning in some way. The following are just a few examples of recent innovations:

• Creation of multi-lingual subtitles that are adapted in near real-time for all live sports matches. The tool also improves metrics availability and data visualization for each team's Head Coach and their team.
• Waasabi, a wallet-as-a-service that has evolved and is now capable of offering organizations a fast track into the digital payments space. The platform's architecture based on APIs sets up a payment aggregation and a digital wallet business in the white label format. It enables organizations to quickly enter the FinTech space without having to develop their own back-end from scratch.
• MAIDA, an AI assistant for IT service management. It optimizes and accelerates IT services by applying AI to streamline ticket management and simultaneously conduct process mining to find bottlenecks. This platform was born out of our work with one of the largest companies in the life sciences sector. The use of this tool resulted in 25% more efficiency in problem-solving, three times faster ticket resolution, and a two-day reduction in ticket management.
• A new AI-based staffing assistant that runs on Slack, and helps project leaders build the best teams in seconds. This new assistant works seamlessly with Globant's performance and career systems, and proposes to each leader suitable candidates within the talent pool that best match each job request.

GLOB Stock Valuation

We will not argue that Globant is cheap or a bargain investment at current prices, but we do believe it deserves a premium valuation given its historic high growth, exposure to AI growth areas, and improving fundamentals. According to Globant's guidance, adjusted diluted EPS for 2023 is expected to be $5.72, assuming 43.4 million average diluted shares for the year. This puts the forward p/e at ~30x, which is close to the analyst average estimate as well. It is important to note that this is a non-GAAP forward p/e ratio, with the GAAP P/E for the trailing twelve months closer to 50x, as can be seen below.

Still, we would argue a forward ~30x p/e is much more reasonable than NVIDIA's ( NVDA ) forward p/e of ~50x. Based on analyst estimates, shares right now trade at ~20x the average EPS estimate for FY2025.

Risks

As a technology company, Globant is exposed to the risk of technology shifts, and the risk that it might invest or bet on the wrong technology. It is also at risk of having some or all of its solutions made obsolete by new products or solutions from the likes of Open AI (creator of ChatGPT), Alphabet ( GOOGL ), Apple ( AAPL ), Microsoft ( MSFT ), Alibaba ( BABA ), Tencent (TCEHY) or other technology giant.

Another important risk for investors is that companies involved or benefiting from AI's growth are currently commanding a valuation premium. Should the AI hype cycle subside, or AI markets prove smaller or slower growth than currently expected, companies such as Globant could see their valuation multiples contract.

Conclusion

Globant's second quarter results were encouraging, and we appreciate that the company has not stopped innovating or looking for growth opportunities. Still, while its growth rate is improving again, it is far from what it used to deliver in the past. We believe the company making new strategic investments in Latin America, is a sign that the easy international expansion phase is over. It will also get increasingly more difficult to expand spending with its top customers. For these reasons we believe the era of 30%+ y/y revenue growth is likely over. Still, we believe the company can grow at a decent double-digit rate. There are signs that in the short to medium term things are improving for the company, and that AI will continue to be an area where companies will continue to invest. Unfortunately, we continue to see shares as fully-valued, and we are therefore maintaining a 'Hold' rating.

For further details see: