2024-01-04 07:11:09 ET
Summary
- Gartner's stock price has risen by 26% since receiving a 'Strong Buy' rating, outperforming the S&P 500.
- The company reported strong Q3 results with revenue growth of 4.9% and a 6.2% increase in adjusted EPS.
- IT's robust recurring business model and strong contract value growth indicate promising future expansion.
Since I initiated coverage with a 'Strong Buy' rating, Gartner's ( IT ) stock price has risen by 26%, compared to the 9% return of the S&P 500. I emphasized their robust recurring business model. On November 3, 2023, they reported a strong Q3 result with a 4.9% revenue growth and a 6.2% increase in adjusted EPS. Taking into account the valuation, I am downgrading the stock to a 'Buy' with a fair value of $460 per share.
Quarterly Review
During Q3 FY23 , revenue grew by 4.9% in constant currency, driven by robust growth in research and consulting, although this was offset by weak conference sales. The adjusted EPS also saw a significant increase of 6.2%. Most importantly, the contract value of global technology and global business exhibited strong growth at 6.5% and 14%, respectively.
On the balance sheet, they hold $1.2 billion in cash and carry $2.5 billion in debts, resulting in a notably low net debt leverage. Their balance sheet remains robust.
They generated $331 million in cash from operations, representing a 5% increase compared to the previous year. The high free cash flow margin is attributed to the acceleration in contract value growth. During the quarter, they repurchased $209 million of stock, and the Board expanded the authorization by $500 million. Over the past two years combined, Gartner has allocated $2.7 billion towards share repurchases, suggesting a likely continuation of this trend in the near future.
Year-to-date, they have achieved $4.32 billion in revenue, $674 million in net profits, and generated $856 million in free cash flow. These year-to-date results set the stage for their full-year growth.
The company raised guidance for both top-line and bottom-line performance for the full year. Given their strong growth in the past three quarters, no surprises are expected in their Q4 results. The market's attention is likely to focus on their FY24 guidance during the upcoming earnings call.
FY24 Preview
For FY24, I anticipate the issuance of a robust topline and bottom-line guidance for several reasons. Firstly, their contract value growth serves as a promising indicator for their near-future expansion. The chart below illustrates their constant currency contract value growth, with both technology and global business exhibiting commendable momentum in recent quarters. This sustained contract growth is expected to be a significant driver for their FY24 revenue expansion.
Secondly, Gartner anticipates a return to normalcy in sales to technology vendors over the next 12 to 18 months. I concur with their management's assessment. In 2023, many technology companies were implementing layoffs and budget cuts as precautionary measures against a potential economic downturn. If the Fed initiates rate cuts in 2024, these technology companies are more likely to revert to a normalized spending pattern.
Lastly, Gartner made significant additions over the past two years. Historically, it takes 1-2 years for sales personnel to mature and reach peak productivity. Consequently, in 2024, their sales team is expected to mature and contribute significantly to the company's profitability. This emphasis on the maturity of their sales force was highlighted during the earnings call, and I believe it will serve as a growth catalyst for the company in FY24.
Pricing Increase Remains the Same
During the earnings call, they expressed the expectation that their price increases would remain consistent in FY24, and there was no significant customer pushback due to these increases. Given that their average client spending is approximately $250,000 per year, they believe that a 4-5% price increase does not impose a substantial burden on their customers.
Even in the event of future decreases in inflation, it is anticipated that Gartner can continue with their annual price increases. Their subscription services, although representing a relatively small amount, are deemed mission-critical for enterprises, particularly in the technology sector. These customers rely on Gartner's industry insight reports for presentations, roadshows, and various reports presented to shareholders and boards. In summary, Gartner appears to possess strong pricing power over their customers.
Valuation
I adjusted FY23's assumptions to incorporate 8% revenue growth and 10.5% operating profit growth, aligning with their latest guidance. These adjustments take into account changes in revenue growth, capital expenditures, and other variables while maintaining the integrity of the remaining assumptions in the model. According to my calculations, the current operating margin assumptions are slightly higher than the figures in my previous financial model. This results in a higher FCF margin and final DCF valuation.
The model maintains a terminal growth rate of 4%, a discount rate of 10%, and a tax rate of 22%. Based on these parameters, the fair value is estimated to be $460 per share in the model. While acknowledging that their stock P/E multiple is currently higher than historical levels, and the equity value is trading at 29x of forward free cash flow, it's worth noting that Gartner's sustained double-digit organic revenue growth is quite impressive in the current market environment. The market often tends to assign a premium to stocks with such robust growth characteristics.
Other Risk
As I highlighted in my introductory article , the Conference business exhibited significant volatility in the quarter, experiencing a 26% decline in constant revenue. Fortunately, this business segment constitutes less than 10% of the group's total revenue. Anticipating continued fluctuations in growth for this business segment, I expect it to remain a source of volatility in the future.
Conclusion
I am quite optimistic about their growth prospects for FY24. However, taking into account the valuation, I am downgrading the stock to a 'Buy' rating, establishing a fair value of $460 per share.
For further details see:
Gartner: Impressive Growth And FY24 Preview, Downgrade To 'Buy'