2023-07-13 09:45:12 ET
Summary
- I recommend a hold rating for HCP due to significant near-term demand headwinds.
- HCP's weak 1Q subscription growth and a larger-than-expected revenue guidance cut have negatively impacted the company's outlook, attributed to a difficult macro climate and procurement challenges.
- Despite these challenges, HCP has seen net additions of G2K customers and expects positive annual FCF by F25, but uncertainty over the duration of demand headwinds warrants caution.
Summary
This is an update to my previous coverage for HashiCorp ( HCP ). Previously, I recommended a buy rating as HCP remained a top open source infrastructure software vendor at the time, with a positive outlook for 1Q24
For this update, I recommend a hold rating for HCP as I expect it to see significant headwinds to demand in the near-term, which will potentially make the stock a lot more volatile.
Business description
The HCP cloud operating model offers standardized practices for accelerating the rollout of cloud-based software. Its products and services help companies of all sizes and across all industries speed up product development, cut costs, and gain command of intricately designed infrastructure.
Industry
I see the cloud automation market continuing to grow at a rapid clip for the foreseeable future. From a projected $110 billion in 2022, Research and Markets projects that this market will expand to nearly $480 million by the year 2030. More than a factor of four expansion is implied here. The rapid growth of cloud automation is supported by the increasing demand for low-cost data backup, storage, and security across all businesses, as well as the need to manage data generated by the increased use of mobile technologies.
Cisco Systems ( CSCO ), Amazon ( AMZN ), Citrix Systems, IBM ( IBM ), and Hewlett Packard Enterprise ( HPE ) are currently the market leaders. They are all rivals of HCP.
Thesis updates
HCP's weak sequential 1Q subscription growth of 1% and a revenue guidance cut of more than 4% for FY24 have dampened my optimistic outlook on the company. The reduction in guidance was much larger than I had anticipated, even though I agree that the macro environment is not ideal and that businesses are likely to reduce IT budgets. The management blamed the increased difficulty in the procurement process, smaller initial plot sizes, and delayed expansion plans with larger enterprise customers on the current fiscal climate. True enough, the 2 point headwind from a large retail customer optimizing spending with HashiCorp and the 4 point sequential step down in NRR to 127% best underscore this dynamic. Positively, I'd like to highlight HCP's 26 net additions of G2K customers. Despite the more volatile demand, the company is still seeing healthy pipeline generation activity. The fact that HCP expects to have positive annual FCF by F25 and has lowered its FCF margin guidance to -5% in F24 from -10% is also encouraging.
Although I still think HCP has a long growth runway as it becomes the standard for cloud enablement, I am staying on the sidelines due to a lack of information about how long demand headwinds will persist.
Financial analysis
GuruFocus
I anticipate a significant slowdown in revenue growth compared to previous years, as management has publicly stated the business's challenges. However, I would like to point out that I believe the industry will continue to grow rapidly, and HCP will benefit from this. The slowing of growth is most likely a delay rather than a loss of demand.
As revenue is expected to slow, I am less confident that HCP will be able to achieve positive margins anytime soon. Even if it does, it will most likely be due to cost-cutting measures that will not be sustainable in the long run.
GuruFocus
When compared to the industry, HPC growth is still one of the better performing businesses out there, and I expect it to screen well when investors look for growth stocks to invest in once the macro situation improves.
HCP has $1.3 billion in cash and $14.7 million in debt. As a result, the company likely has enough cash on its balance sheet to last through several years of cash burn.
Valuation
Author's model
I expect HCP revenue to grow at a much slower rate than in the past as a result of the near-term headwind from the weak macro environment affecting demand for HCP solutions. I projected 20% growth in FY24 and FY25, followed by a 40% rebound because I believe long-term demand will remain stable. Given my near-term growth outlook for HCP, which is higher than peers’ average, I believe it should trade at least trade at where it is at today – 7x forward revenue. Any further multiples expansion due to the relative growth rate will be additional upside.
Seeking Alpha
Seeking Alpha
Risk
This is happening in real-time today. Enterprise clients, to whom HCP primarily caters, often delay large CAPEX investments during economic downturns in an effort to protect their balance sheets.
Conclusion
I recommend a hold rating for HCP due to significant headwinds in near-term demand. While HCP is a top open-source infrastructure software vendor and operates in a rapidly growing cloud automation market, recent weak subscription growth and a revenue guidance cut have dampened the outlook. The reduction in guidance was larger than expected, attributed to challenges in the procurement process and a difficult fiscal climate. Although HCP has positive aspects such as net additions of G2K customers and expectations of positive annual FCF by F25, the lack of clarity on the duration of demand headwinds warrants caution. All in, I believe a hold rating is prudent until the macro situation improves.
For further details see:
HashiCorp: Hold As Near-Term Demand Faces A Lot Of Headwinds (Rating Downgrade)