IQV - Veeva Systems: Attractively Valued FCF Star

2023-12-04 10:00:00 ET

Summary

• Veeva provides cloud solutions for the life sciences industry, with a focus on streamlining product development and market entry processes.
• The company has shown exceptional financial performance, with strong revenue growth and operating leverage.
• Veeva's balance sheet is strong, with no debt and a large net cash position, and the company has a sound capital allocation policy.
• My valuation analysis suggests VEEV stock is attractively valued.

Investment thesis

Veeva Systems ( VEEV ) has demonstrated staggering financial performance over the last decade, with a 30% revenue CAGR and strong improvement in profitability metrics. About 80% of sales generated from highly profitable subscription businesses and solid operating leverage suggest the company has a wide moat. The company's significant operating leverage translates into strong free cash flow, contributing to a fortress-like balance sheet with minimal debt and a substantial net cash position of $3.8 billion. This makes the company strategically positioned to continue investing heavily in growth and innovation. My valuation analysis suggests the stock is attractively valued. All in all, I assign VEEV a "Strong Buy" rating.

Company information

Veeva provides cloud solutions for the global life sciences industry. The company's offerings span cloud software, data, and business consulting, aiming at streamlining life sciences companies' process of developing and bringing products to the market.

The company's fiscal year ends on January 31 with a sole operating segment. According to the latest 10-K report , Veeva generates 80% of the total sales from subscription services.

Financials

Veeva has consistently delivered exceptional financial performance throughout the past decade. Revenue compounded at 30% CAGR over the last ten years, which is massive. Apart from stellar revenue growth, Veeva demonstrated strong operating leverage. As the business scaled up, the operating margin expanded from 18.6% in FY 2013 to 27.3% in FY 2022. The FY 2023 operating margin demonstrated softness, but this was due to the harsh macro environment. Veeva's wide above 70% gross margin makes the company well-positioned to reinvest heavily in innovation. The R&D to revenue ratio was consistently above 20% in recent years, which indicates the management's strong commitment to building sustainable competitive advantages.

Having substantial operating leverage makes Veeva the free cash flow [FCF] machine even if the stock-based compensation [SBC] is deducted. That is why Veeva's balance sheet is a fortress with almost no debt and a vast $3.8 billion net cash position. Liquidity metrics are also sky-high. Veeva does not pay dividends, and stock buybacks do not look substantial relative to the company's market cap. Given the company's strong ability to innovate and fuel revenue growth, the current capital allocation policy looks sound.

The latest quarterly earnings were released on August 30, when the company topped consensus estimates. The operating margin shrank YoY by 130 basis points, but this was due to the increased R&D spending, which is an investment in the long-term prospects. The SG&A to revenue ratio decreased by 50 basis points, meaning the company continues to demonstrate economies of scale.

The upcoming quarter's earnings release is scheduled for December 6. Quarterly revenue is expected by consensus at $616 million, which indicates a solid 11.5% YoY growth. The adjusted EPS is expected to improve notably on a YoY basis as well, from $1.13 to $1.29. The massive bullish sign is that there were 22 EPS upgrades during the last 90 days.

Another sign that adds a lot of optimism to me before earnings is the company's strong track record of delivering positive earnings surprises. Apart from indicating high-quality planning from the management, this also highlights the company's resilience and capability to perform better than anticipated consistently.

Veeva's stellar profitability suggests solid operating leverage and extensive pricing power. According to the 10-K report, Veeva's primary direct competitor is IQVIA Holdings ( IQV ). This company operates on a larger scale, as its annual revenue is around $15 billion. Despite operating at multiple times larger scale, IQV's profitability metrics are mostly far lower than Veeva's. This is a clear indication that Veeva's offerings are much more appealing, which enables the company to charge premium fees compared to its primary competitor. The recent news regarding the expanded partnership with one of the largest global life sciences companies, Bayer ( BAYRY ), underscores the superiority of Veeva's offerings.

The fact that Veeva's gross margin is two times higher than IQV's means the company can allocate a larger portion of sales to marketing and R&D, and the net income per employee figure says that is all. Veeva looks much more efficient than its competitor, which is a strong competitive advantage to ensure superior profit margins for longer.

Valuation

VEEV rallied by 9% year-to-date, notably underperforming the broader U.S. stock market. The stock has the lowest possible "F" valuation grade from Seeking Alpha Quant . This is because VEEV's valuation ratios are far higher than the sector median across the board. On the other hand, it is crucial to emphasize that VEEV demonstrates unmatched profitability and strong revenue growth compared to peers. Therefore, comparing current valuation multiples with Veeva's historical averages would be more proper. From this point of view, the stock looks attractively valued.

Now, I want to proceed with the discounted cash flow [DCF] valuation approach. I use a low 9% WACC, given Veeva's wide FCF margins and strong balance sheet. Consensus revenue estimates are available up to FY 2032, projecting double-digit CAGR, which I consider fair enough. For FY 2033 and years beyond, I estimate a 10% revenue CAGR. I use a 19% TTM FCF ex-SBC margin and expect 50 basis points yearly expansion.

According to my DCF simulation, the business's fair value is almost $29 billion, which is modestly higher than the current market cap. I think that given Veeva's stellar performance, the stock deserves a substantial premium to the fair value, and that is the reason why I believe the stock is very attractively valued at current levels.

Risks to consider

Investors should be aware of the substantial concentration risks Veeva is facing. According to the 10-K report, two customers account for almost a quarter of the total revenue. If either of Veeva's largest customers faces financial difficulties, it will highly likely adversely affect the company's earnings. With changes in these customers' technology preferences, Veeva could face a sharp decline in revenue, potentially leading to financial instability and a negative impact on shareholder value.

As a cloud-based service, Veeva faces significant cybersecurity risks. Operating in the cloud involves storing and managing vast amounts of sensitive data belonging to life sciences companies. The increasing sophistication of cyber threats poses a constant challenge to the security of cloud-based platforms.

Bottom line

To conclude, Veeva Systems is a "Strong Buy". The company has a rich history of delivering stellar financial performance, and recent developments suggest the company will be able to sustain stellar profitability for longer. The valuation looks very attractive, far outweighing all the potential risks and uncertainties.

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