NCNO - nCino: Long-Term Story Intact But Near-Term Stock Is Likely Rangebound

2023-09-29 11:41:47 ET

Summary

• nCino's stock is recommended as a hold due to expected rangebound trading until signs of growth acceleration emerge.
• The company provides cloud banking solutions in a growing industry, but recent growth has slowed.
• nCino's focus on R&D and diversification into non-commercial lending products positions it for long-term success, but growth acceleration is needed for stock price growth.

Overview

My recommendation for nCino ( NCNO ) is a hold rating, as I expect the stock to remain rangebound in the near term until NCNO shows signs of growth acceleration. However, it is difficult to predict when growth will accelerate given the current macro-condition, which could further weaken from here.

Business

NCNO provides cloud banking solutions to improve "employee efficiency while enhancing the customer experience for onboarding, loans, and deposits across all lines of business". NCNO competes in an industry that is riding on a strong secular tailwind as more banks seek to digitalize their operations and brand to welcome the new age of banking, in particular, to meet the preferences of the younger generation for convenience. As of 2021, the industry was estimated to be worth $21 billion and is expected to continue compounding at more than 20% for the next few years. Over the years, NCNO has demonstrated itself as a share gainer, as it grew from 40 to 50+% pre-Covid to 34% during FY20 (Covid period).

Recent Results & Updates

In recent quarters, there has been a slowdown in growth. Nevertheless, the company exceeded expectations by reporting higher revenue and profitability in the second quarter of 2024. Additionally, despite a decrease in growth in the US mortgage and enterprise markets, sales for NCNO improved during June and July. Strictly managing costs played a significant role in this improved profitability. I view the second quarter of 2024 as a significant indicator of NCNO's business strength. Despite facing challenges like the regional banking crisis, mortgage market difficulties, and uncertainty regarding interest rates, NCNO's momentum increased in June and July, with customer interactions returning following the liquidity crisis in March. Notably, NCNO continues to gain market share despite these challenging conditions.

We've had nearly or actually over two dozen competitive takeaways in the last year and a half and that's been fueling also our market share growth. Investor Day

While bearish investors are not wrong to focus on near-term challenges, I am encouraged by management to focus on the long term, investing in R&D so that the business's competitive advantage will grow ahead of competitors.

As you heard from Matt, we've seen increased efficiency in our R&D organization from various initiatives, including the positive impact of increasing the frequency of product releases.

We still plan to spend over $100 million in R&D this year, continuing to drive innovation and even further differentiating ourselves from the rest of the market, particularly as others are scaling back investments in light of the more difficult macro environment. Investor day

NCNO's efforts in R&D appear to be paying off, as the company is experiencing growth in areas of product development other than commercial lending. More than half of NCNO's pipeline consists of non-commercial lending products, a fact that was highlighted at the Goldman Sachs Communacopia + Technology Conference as evidence that banks are placing a premium on back and middle office modernization in order to increase financial efficiency. The company's deliberate portfolio diversification, in my opinion, is meeting the needs of banks for a more comprehensive knowledge of their clientele and for the elimination of silos within the financial sector. To give a concrete example of NCNO's success in innovating on the right solutions, on the 2Q24 earnings call, SimpleNexus was highlighted as a product that won 19 new logos during the quarter. Seven of these logos were acquired through cross-selling, and six were taken away from competitors.

Another long-term bullish point for NCNO is that it is still relatively small outside of the US, with only 16% of its FY22 revenue from international sources. However, this 16% was a major improvement from 0.1% in FY18, clearly showing the success that NCNO is seeing internationally. By the end of 2Q24, NCNO had established a presence in 16 different countries and was actively investing in markets outside the United States where it believes its product portfolio can do well. As long as NCNO keeps putting its system integrator partner network to good use, I think we'll see this trend continue. During the Goldman Sachs conference, management mentioned that NCNO has gained trust and recognition by effectively implementing its technology among initial users. They also acknowledged that their achievements in international markets were aided by partnerships with system integrators.

Anyway, while these are positive factors, I believe NCNO needs to show that growth will stop decelerating in the near term and reaccelerate in FY24. Until then, I am afraid the market will continue to see NCNO as a stock that moves along with the interest rate narrative (inverse relationship). As such, I am recommending a hold rating until there is a clear catalyst for the share price to go up.

Valuation and Risk

According to my model, NCNO is valued at $34 in FY24, making it roughly fair value at the current share price of $31. My model is structured to show that the stock is not attractive unless growth accelerates. My expectations for growth to continue decelerating are to reflect market (consensus) expectations.

NCNO is now trading at 7x forward revenue, which I believe to sustain at this level unless growth accelerates, which I lack visibility on at the moment. Compared to peers like Alkami (ALKT) and Q2 Holdings (QTWO), NCNO's expected growth is in between both of them but trades at a premium. I believe the premium is because of its margin profile (better than Alkami) and leverage profile (best among the three of them).

Summary

In conclusion, my recommendation for nCino is a hold rating. While the company's long-term prospects appear promising, the near-term outlook suggests that the stock is likely to remain rangebound until signs of growth acceleration emerge. The current macroeconomic conditions further add uncertainty to the timing of such acceleration. Management's focus on long-term growth through research and development is encouraging, as it positions NCNO for potential competitive advantages. The company's diversification into non-commercial lending products aligns with industry demands for enhanced financial efficiency and customer insights. However, until NCNO demonstrates a clear reversal in growth deceleration and reacceleration in FY24, the stock may continue to be influenced by interest rate dynamics. Therefore, I recommend a hold rating until a compelling catalyst for share price growth emerges.

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