2024-01-04 11:59:40 ET
Summary
- Phreesia's revenue in 3Q24 exceeded expectations, driven by growth in subscriptions, network solutions, and payment processing.
- The company's fundamentals remain strong, with a long ARPU expansion runway, indicating continued growth potential.
- Management's focus on profitability and revised EBITDA guidance for FY24 and FY25 has transitioned Phreesia into a profitable-growth company.
Summary
Following my coverage on Phreesia (PHR), which I recommended a buy rating as I believe the valuation was attractive after the big share price dip. I thought that the business fundamentals remained sound, and if management were to hit their FY25 targets, the upside was attractive. While the ride wasn't a smooth one (the stock price dipped further to $12 after my post), the stock did perform very well after that, raising to $22 after the 3Q24 earnings, surpassing my price target of $19.53. This post is to provide an update on my thoughts on the business and stock. I am reiterating my buy rating for PHR as I like the pivot towards profitable growth instead of growth-only. As I mentioned previously, PHR fundamentals remain strong, and with a long ARPU expansion runway, I think PHR can continue to grow for a very long time. Investment thesis.
Investment thesis
PHR performance in 3Q24 did better than expectations, with revenue of $91.6 million, beating consensus estimate of $89.6 million. The 25% y/y growth was driven by 29% growth in subscriptions, 26% growth in network solutions, and 18% growth in payment processing. Profitability also came in better than what the market was expecting. PHR reported EBITDA of -$6.6 million, beating the street estimate by a mile (consensus expected -$13.4 million). Note that this is also a sequential improvement relative to the $11.5 million EBITDA loss in 2Q24.
I am turning more positive toward PHR after reviewing its latest performance. As I expected, the fundamentals remained sound, where revenue continues to grow at a very healthy clip (better than what I expected in my model: 19% growth for FY24), and EBITDA is on track to turn positive. In addition, PHR finally experienced sequential acceleration in net new logo additions, adding 243 new provider clients compared to 136 added in 2Q24, after a period of stabilization. Although PHR did see a 67 client increase from the acquisition of ConnectOnCall , which contributed to the overall increase, the company still managed to add 176 clients organically, which is 29% higher than 2Q24. The end result was that PHR had 3,688 clients on average by the end of 3Q24, an increase of 23.7% year over year. While the strong surge in clients did put pressure on revenue per AHSC (fell 1.1% sequentially), the good news is that subscription ARPU went up sequentially and annually, suggesting that the existing base of clients is willing to pay more for PHR services. The implication is that the new cohorts of subscribers are likely to demonstrate the same ARPU growth motion, which means ARPU still has room to grow. Having said that, management anticipates more sequential growth in subscribers added (guiding to 270 new clients, or 150 if excluding ConnectOnCall), so near-term ARPU might be muted. Keep in mind that, due to the smaller deal size, ConnectOnCall customers are anticipated to initially have lower ARPUs. As such, there is more room for ARPU to expand, extending the growth runway. In the grand scheme of things, the more ARPU is being optically depressed today, the more room there will be for ARPU to grow once subscriber growth slows. This is somewhat similar to a software company selling their subscription product at a cheap price initially to gain a subscriber base, then increasing ARPU overtime as subscribers become "stuck" with the product.
I believe a major catalyst that drove the stock up was that management specifically called out their intention to focus on profitability. By increasing their expectations for adjusted EBITDA in both FY24 and FY25, management demonstrated their heightened focus on profitability. The adjusted EBITDA guidance for FY24 has been revised upwards from a range of -$49 million to -$54 million to a more reasonable -$39 million. This guidance tells a lot as it meant further improvement in EBITDA in the coming quarters, as the raise in guidance was more than the EBITDA beat in 3Q24. In regards to FY25, management has revised their expectations for adjusted EBITDA to be between $10 million and $20 million, which is significantly higher than their previous comments on reaching profitability in FY25. This is also well ahead of consensus expectations (they expected $17.2 million). The truth is, this is going to hurt top-line growth for sure as PHR needs to cut back on growth expenditure, but that is fine because I believe this is what the market wants: profit is more important than growth, as can be seen from the share price reaction. The financial implication here is that PHR is only going to reach its $500 million annualized revenue run-rate at some point in FY25 to FY26. From a narrative perspective, PHR has transitioned from a growth company to a profitable-growth company; the latter is much more favorable in today's investing environment, in my opinion. Consequently, at the midpoint of FY25, revenue was projected to be between $424 million and $434 million, which is still higher than my 15% estimates but lower than the consensus of $446.9 million.
Valuation
Own calculation
My 1-year target price for PHR based on my model is $24.74. With management guiding specifically for FY24 and FY25, I am revising my estimates to meet them. This is a positive revision from my previous estimates for 19% FY24 growth and 15% FY25 growth. The tricky part here is putting a valuation multiple on PHR FY25 revenue. While it is going to turn profitable, the guided EBITDA is not meaningful enough to be used as a valuation metric. As such, I am sticking to my original valuation method of using forward revenue multiples. Now that PHR is going to turn profitable, I believe the valuation multiple will start to see a positive revision, trending towards ~6x forward revenue (similar to where Definitive Healthcare, a profitable IT solution provider to the healthcare industry, is trading today at 6.6x forward revenue). That said, I am not assuming a big vision, as PHR needs to show that it can continue to grow at >20% and be profitable. In any case, a 12% 1-year upside is quite attractive, in my opinion.
Risk
PHR cutting back on growth expenditures might hurt top-line growth more than expected. If the slowdown in growth is way more than what consensus is expecting, it might cast doubt on whether PHR can balance growth and profits. This could cause the stock valuation to be rangebound in the near term.
Conclusion
I remain buy rated for PHR remains positive. PHR fundamentals continue to be sound as shown in the impressive performance in 3Q24, surpassing revenue expectations and showcasing substantial growth in subscriptions and solutions. The sequential improvement in EBITDA also tracks well against management FY24 and FY25 guidance. Notably, management's focus on profitability, with revised EBITDA guidance for FY24 and FY25, signifies a transition from a growth-centric to a profitable-growth model.
For further details see:
Phreesia: Remain Buy Rated As The Business Pivot Towards Profitable Growth