2023-05-14 23:43:13 ET
Summary
- PagerDuty has continued to grow briskly while having turned the corner on profitability in its latest earnings report; it is also cash flow positive.
- The firm is now estimating 8-9% operating margins for the current year.
- Given the significant momentum this business has with its product offering and client base, I am inclined to the upside and think it will achieve these projections.
- At current growth rates and levels of profitability expansion, PD stock appears relatively cheap as far as growth stocks are concerned.
- This yields a buy rating for what is a good growth stock.
Overview
I previously covered PagerDuty ( PD ) and expressed a bullish outlook due to the company's robust rate of growth and increasing levels of cash flow generation. Since then the stock has appreciated 24% while garnering increasingly positive sentiment from Wall Street. Expectations are notably high heading into the company's next earnings call, which is slated to occur in two weeks' time. This article will review how PagerDuty has progressed, model future results, and determine whether it's still a good buy.
Financials
PagerDuty's latest quarter (fiscal Q4 ending Jan 2023) was a strong showing and indicated that the company is continuing to grow apace while exceeding its own projections. Financial highlights from the earnings release included 29% YoY revenue growth and non-GAAP profitability at a 1% operating margin. The company also achieved over $400M in annual recurring revenue, indicating strong growth in its subscription business.
Business highlights include PagerDuty having cumulatively signed up 68 of the Fortune 100 companies as customers while also posting a 120% Dollar-based net retention figure. This is an excellent showing as it demonstrates continued growth amongst new customers while also expanding revenues 20% beyond what its current customer base has been paying.
The quarterly results, particularly around operating margin and bottom line expansion, fanned significant consensus optimism and yielded a new quarterly EPS estimate of $0.09, up from $0.02 the day prior to the earnings release.
Revenue growth estimates have been more muted for the quarter ahead.
Evidently estimates are now materially higher for PagerDuty's profitability in its upcoming report as well as thereafter. This makes sense as the company achieved its best-yet bottom line metrics in its most recent quarter while also elevating guidance going forward. PagerDuty generated a 6% non-GAAP operating margin while also forecasting a 8-9% non-GAAP operating margin for the current fiscal year.
Extrapolating these numbers shows how things could get interesting for PagerDuty when we consider its cash flow picture. Since the firm generated a 4.58% cash operating margin for the prior year, we can assume that it will generate proportionally this level of cash for its operating income going forward. We will also assume a constant 2.5% yearly growth in operating margin that caps out at 20%.
This yields a cash operating margin of 18.35% by 2029. Note that this would still be less than sector comparison Salesforce, which has a cash operating margin of 22.6%. As such I consider this estimate to be relatively conservative.
Fiscal Year Ending | Jan-23 | Jan-24 | Jan-25 | Jan-26 | Jan-27 | Jan-28 | Jan-29 | Jan-30 |
Revenue | $370.80 | $448.53 | $547.75 | $680.52 | $843.84 | $1,046.37 | $1,297.50 | $1,608.89 |
non-GAAP Operating Income | $22.25 | $38.13 | $60.25 | $91.87 | $135.02 | $193.58 | $259.50 | $321.78 |
non-GAAP Operating Margin | 6.0% | 8.5% | 11.0% | 13.5% | 16.0% | 18.5% | 20.0% | 20.0% |
Operating Cash Flow | $18.00 | $34.97 | $55.27 | $84.27 | $123.85 | $177.57 | $238.04 | $295.17 |
Operating Cash Margin | 4.58% | 7.80% | 10.09% | 12.38% | 14.68% | 16.97% | 18.35% | 18.35% |
non-GAAP EPS | $0.08 | $0.46 | $0.65 | $0.94 | $1.32 | $1.71 | $2.05 | $2.46 |
Price/Sales Ratio At Current Price | 7.36 | 6.09 | 4.98 | 4.01 | 3.24 | 2.61 | 2.10 | 1.70 |
Price/Earnings Ratio At Current Price | 361.63 | 62.89 | 44.51 | 30.78 | 21.98 | 16.91 | 14.09 | 11.74 |
Price/Op. Cash Flow At Current Price | 151.67 | 78.06 | 49.39 | 32.39 | 22.04 | 15.37 | 11.47 | 9.25 |
Implied Share Price (FWD Sector Median) | $15.97 | $23.47 | $33.65 | $45.10 | $55.93 | |||
Current Share Price | $28.93 | $28.93 | $28.93 | $28.93 | $28.93 | $28.93 | $28.93 | $28.93 |
Current Market Capitalization | $2.730 B | $2.730 B | $2.730 B | $2.730 B | $2.730 B | $2.730 B | $2.730 B | $2.730 B |
Source: Excel, Seeking Alpha
At current growth rates PagerDuty would hit price/sales FWD sector parity (2.53) in 2029, and price/earnings FWD sector parity (19.32) in 2028. For operating cash flow, this would also occur in 2028.
Since growth stocks are often priced out a decade or more, this 5-6 year runway to sector parity actually appears relatively cheap. The market has not priced in a full decade of growth for PagerDuty. Modeling out the fair price on the basis of operating cash flow, we can see that the stock would have a fair price of $55.93 in 2030 if it were to trade at sector median multiples. By late 2027 it would be intrinsically undervalued at its projected cash flows and sector median multiples.
Given the early stages of the margin expansion story here, this is not guaranteed. The latest report, however, and management's forward-looking confidence, make me optimistic; I think PagerDuty can readily continue to expand its bottom line and operating cash flow in line with the projections I have detailed above.
There has also been commentary that PagerDuty could actually exceed these operating margins significantly. Since it is a software business experiencing organic growth and per-customer revenue acceleration, I don't see this as out of the question. This would come down to how aggressive management continues to be around managing the firm's cost structure. This more aggressive growth picture would yield estimates far in advance of the ones that I outlined above.
Risk
The risk here is PagerDuty experiencing a slowdown in growth or failing to achieve what are now optimistic projections. This could result in a sell-off and a new set of trading multiples at lower growth projections. Since this stock is trading like a growth stock and is priced into the future, this is a possible outcome.
Worth noting here, however, is that the stock does not appear to have become particularly expensive in response to its latest results. PagerDuty has not maintained the price appreciation that it saw in the wake of its latest earnings report and is actually trailing the NASDAQ Composite YTD. The market does not appear as optimistic about its prospects as may be warranted; this should change as the company generates 1-2 additional quarters of provably growing margins and cash flows.
Conclusion
PagerDuty is at an interesting inflection point in which it is continuing to briskly grow its top line while also generating traction on its bottom line. While already cash-flow positive as of last quarter, this company could become much more interesting as operating cash margins improve. Furthermore, it doesn't seem that the market has priced this in just yet - even as earnings consensus has accelerated materially.
The trajectory for this stock will be determined in its next earnings report. If it can continue matching consensus and its own guidance, it should appreciate due to the attractive economics of its business. Given its trajectory across fundamentals as well as its business/customer metrics at present, I am inclined to think this will occur; PagerDuty is still a buy.
For further details see:
PagerDuty: Fast Growth With Bottom Line Expansion