2023-06-03 03:07:18 ET
Summary
- The Q4 results were in-line, with deceleration in important metrics like revenue growth but strength in deferred revenue additions.
- The results are better than they appear with significant headwinds that will turn to tailwinds in the coming quarters.
- The stock is trading at a very reasonable price for an attractive software asset that could be a target of a larger company.
Elastic ( ESTC ) has seen a number of challenges over the past several years which have put a damper on its performance. During the pandemic period, it was one of the stronger performers among mid cap software. However, it has been decimated since the start of 2022 with softening growth results leading to a huge revision in the stock. However, many of the issues are temporary such as foreign exchange and cloud consumption headwinds. Once these issues abate, Elastic will be able to sustain a higher multiple giving good upside potential for those willing to wait. As it stands now, consumption0based software is seeing significant weakness as customers are optimizing spend to save money. Also, small businesses are pulling back and not adding new tools as they tighten their belts. Valuation for EST stock has come back to a reasonable level at 6.8x trailing sales making it intriguing to buy at $70. The company has also recently made a push towards improving profitability metrics and reducing the less effective marketing spend. These efficiencies are essential in this environment and shows management's commitment to the most effective use of shareholder funds. Let's dive into the Q4 results for its fiscal year 2023 which were reported on June 1st.
Solid revenue growth powered by Elastic Cloud
In 2023 the company continued to push hard with its cloud based solution, much like MongoDB (MDB) has over the past several years. Elastic Cloud revenue was $112 million in Q4 2023 or a 28% growth rate . Total revenue growth was $280.0 million for a 17% growth rate over the prior year Q4. Notably the company faced a headwind to revenue growth with FX factored in - giving a normalized growth rate of a solid 19%. While the US dollar continues to strengthen short term, longer term reversion to the mean for the dollar against other currencies is likely. Net expansion of 117% is solid, but customer growth has slowed significantly in the past year as ESTC only added 300 customers in the quarter. That net expansion rate is also rolling 12 months and will continue to decrease in the coming few quarters to the lower 110s. That said the biggest headwinds are mostly among the small and medium businesses, with large enterprises still moving workloads to Elastic. 42% of the company's revenue is outside the United States which is higher than many of the other publicly traded software peers. This may be hurting them now as companies in Europe pull back on spending.
As the company continues to scale the consumption cloud business, the deferred revenue and remaining performance obligations continue to shrink in importance. This is because ESTC has a significant portion of monthly pay as you use data contracts which aren't in RPO or deferred revenue. However in Q4, RPO increased 19.5% from $932.3 million to $1.103 Billion which is ahead of revenue growth for the quarter. You can see the same in deferred revenue as it increased 21% to $563 million. These metrics are most useful in looking at their enterprise customers. Bookings outgrowing revenue in the quarter shows that large enterprises are still planning on long term Elastic deployments and signing long term 6 figure or greater deals. The 16% guided revenue growth for the coming fiscal year should be more than attainable, with longer term growth of 20% more normal going forward once macroeconomic issues subside. Companies are just continuing to take a careful posture for 2023 which is likely to stay the same going forward. The company will continue to have operating losses into Fiscal 2025, but positively they have a cash hoard of $915 million to make acquisitions or buy back shares if they stay inexpensive.
As you can see below the company is a far cry from its peak over 20x trailing sales, selling now in the 5-7 range. This is below where some recent peers have been bought, even though ESTC has had higher CAGR and better technology. On the positive side, operating margin has improved for two quarters now to -14.4% in Q4 from -25% two quarters ago. They are aiming for slightly improved margins in the coming 12 months as well, with operating margin 1-2 higher than Q4 expected. While this focus on cost cutting has helped with profitability it has temporarily slowed the growth which you can see below flattening out in the past year. This is due to focusing on getting the most value out of their dollar and aiming at profitability.
Q4 Fiscal Presentation (Elastic IR)
Elastic is focusing on selling and improving its new Elasticsearch relevance engine ((ESRE)) to become part of the AI stack. This allows companies to implement hybrid search and integrate with large language models. 20% of enterprises are already taking advantage of machine learning through Elastic among their cloud customers. While this isn't a major needle mover yet, longer term management sees this driving significantly increased consumption. The company is also strengthening its relationship with Amazon Web Services and is adding more security capabilities like cloud posture management/container protection. These security offerings for ESTC are a small piece of the overall pie but it increases the value offered which should help land bigger AWS contracts in the future. They also show Amazon (AMZN) is seeing value in improving Elastic for AWS and helping ESTC to market to its large customer base. Large language models are quickly becoming a focus for large enterprises, with customers looking to optimize co-pilots with their vast business data. If they succeed in this new area the company will find itself an acquisition target, with several software companies around the $6.7 Billion market cap level being taken private already. That is another reason to own the stock, but never buy shares purely for a takeout rumor due to the unlikely nature of such things.
Elastic - Solid buy at $70
Elastic is a buy on both long term secular trends of enterprise search and AI, plus an intriguing valuation. Many of Elastic's peers trade at 50 to 100% higher valuation as the company has had missteps in the past year. However, this has made them intriguing both as a takeout candidate and as a turnaround. Management has done a good job executing on cost reductions in the past few quarters, giving good visibility to GAAP profitability in 2 years. This combined with a large market of $88 Billion long term means the shares have significant potential to outperform as cloud consumption patterns improve. I have been adding to my position in the $60 range and the stock has recent broken out above its 200 day moving average - a bullish signal. Investors would be wise to take a look at ESTC for the software and high growth portions of their portfolio for 2023 and beyond.
For further details see:
Elastic: Stock To Rebound From 2023 Trough