SEMR - Semrush Holdings Q2: Strong Execution On Display Supports My Buy Rating

2023-08-14 12:03:13 ET

Summary

• Semrush Holdings, Inc. Q2 2023 revenue met expectations, with positive non-GAAP EBIT, demonstrating strong execution and resilience.
• Customer base expansion, positive net dollar retention, and increased ARR indicate growth potential.
• I believe Semrush Holdings' valuation should not be at such a big discount to peers.

Summary

Following my coverage on Semrush Holdings, Inc. ( SEMR ), I recommended a buy rating due to my expectation that growth should continue to recover to previous levels (pre 2H22), given that management has now focused its investments to increase its up- and cross-sell capabilities. This post is to provide an update on my thoughts on the business and stock. I reiterate my buy rating for SEMR, as I expect management to continue executing strongly. Growth should reaccelerate back to historical levels when the economy eventually turns for the better.

Investment thesis

The $74.7 million in revenue reported by SEMR for 2Q23 was in line with expectations, while the unexpected positive non-GAAP EBIT caught the market by surprise (consensus expected negative). Overall, I was pleased with the results, and they demonstrate that management is able to execute effectively despite the state of the economy. Looking at the key metric in this result, SEMR increased its customer base by 14.3% compared to 2Q22 and by 4% sequentially from 1Q23, reaching a total of 104k.

Although this is a slowdown from 1Q23's 14.9% and 5.3% growth, the fact that growth remains in a similar range is impressive. The slowdown in net dollar retention (NDR), which came in at 112% (a 400bps slowdown from 1Q23's 116%), is one metric that bears would focus on. Since it is driven by macro pressures that are not unique to SEMR, I don't think it's a big deal.

The tone of the Q2 earnings call from management also suggests things are leveling off or getting better.

“So NRR, of course, is a function of both your ability to retain in an upsell and cross-sell within your base. For us, we're actually seeing really good, strong demand.”

“So next year, again, not guiding anything, but directionally, I would like to see more growth driven by user base growth, and then the remaining growth driven by expansion and up-sell, cross-selling to user base.”

A positive increase in ARR was ultimately driven by healthy customer additions and a positive NDR. SEMR's ARR grew by $9.4 million, or 18.6% annually, in 2Q23, bringing the total to $302.4 million. Assuming the macro environment stabilizes, I anticipate growth to maintain its current pace for the foreseeable future, if not pick up speed.

One early indicator that I used to gauge future growth potential was the number of free active users on the platform. The number of free active users on the platform grew by 66K sequentially to 951K, a 35% year-over-year increase. While these are not paid users yet, they represent a pool of customers that SEMR has direct access to convert. These free users would learn the positive benefits of using SEMR (if it works for them), thereby representing future opportunities for SEMR to upsell or cross-sell as well.

In terms of innovation, SEMR is not far behind, either. The progress being made with AI, according to management, is very promising, especially in terms of actual usage. 700k people have used SEMR's generative AI tools so far. After promoting its Writing Assistant product and a generative AI tool that helps customers respond to reviews, the company saw a 42% increase in the number of posted replies within weeks of the tool's launch. I still have a lot of faith in generative AI, and I think SEMR is in a great spot to capitalize on this trend thanks to the availability of several AI tools.

I continue to be optimistic about SEMR's long-term prospects and believe the stock benefits from secular tailwinds as more and more businesses realize the value of Semrush's online visibility and competitive intelligence tools, despite the drag from the macro, which is still present.

Valuation

I believe the fair value for SEMR based on my model is $24.25. My model assumptions are that growth will be in line with management's FY23 guidance, followed by a recovery to a historical growth rate of 25–30% when the economy eventually turns for the better (I expect FY24 onwards). This is pretty much in line with my previous model assumptions. I also reiterate my assumption that SEMR multiples will recover to around 5x forward revenue. The reason is that SEMR has historically traded in line with peers before 2H22 (likely due to rates and backward macro sentiment), and given my expectations that things will return to normal, I believe SEMR's valuation should not be at such a big discount to peers. However, I acknowledge that investors are likely to pay more attention to profits now, and as such, it should trade at a minor discount to peers that are profitable in this case.

Peers include Trade Desk, DoubleVerify, and Amplitude. The median forward revenue multiple peers are trading at is 7.9x, the expected 1Y growth rate is 25%, and EBITDA margins are 13% for Trade Desk and 22% for DoubleVerify.

Conclusion

In conclusion, Semrush Holdings, Inc. continues to exhibit strong execution, validating my buy recommendation. Despite economic challenges, SEMR's adept management showcased by robust 2Q23 results, including unexpected positive non-GAAP EBIT, underscores its resilience. Notably, customer base expansion, positive NDR, and increased ARR highlight its growth potential. Valuation-wise, my model indicates a fair value of $24.25, reflecting a return to historical growth rates and improved multiples.

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