2023-07-22 00:41:11 ET
Summary
- Procore's cloud-based tools, aimed at improving workflow inefficiencies, stand to capitalize on the growing demand and anticipated increase in global construction spending.
- Real-time data aggregation and analysis offered by Procore could automate complex workflows, providing a competitive advantage and increased transparency in the construction industry.
- Recommend a "hold" due to the company's overvaluation, unprofitability due to high SG&A expenses, and risks associated with fluctuations in construction spending, heightened competition, and reliance on third-party services.
- Despite these concerns, Procore shows substantial growth potential with high gross margins, a robust balance sheet, and a positive free cash flow.
Procore Technologies ( PCOR ) is a key player in a growing construction industry, which is ripe for disruption by cloud-based tools to improve process inefficiencies. However, a "hold" is recommended due to several factors. Despite high gross margins, Procore's profitability is hampered by high sales and marketing expenses. The company's reliance on third-party resources like AWS could pose operational risks, and its high forward revenue valuation compared to the industry median signals overvaluation concerns. Procore's solutions present promising potential, but these concerns require caution before investing.
Company Overview
Procore, a cloud-native construction software solutions platform, was established more than two decades ago by the current CEO with the vision to modernize project management in the construction industry.
Procore was founded when digital project management in construction was limited due to inadequate computing power. This resulted in a challenging first decade, impaired by the need for the widespread use of smartphones and WiFi on construction sites. Nevertheless, the company has flourished in the past ten years, championing the transition from the traditional "pen and paper" model to technology-based solutions.
Although its products are agnostic to the construction sector, Procore primarily focuses on non-residential construction but also extends services to parts of the residential market, including multi-family construction.
Procore offers an array of cloud-based solutions to transform and automate previously manual processes and workflows in the construction industry. Its product offerings fall under four categories: Project Execution, Pre-construction, Workforce Management, and Financial Management.
While initially targeting general contractors, Procore has widened its scope to include specialty contractors and owners, expanding its customer base to over 15,000. The company's revenue model relies entirely on recurring subscription revenue, providing a stable and predictable income stream.
Stakeholders and Customers
Procore plays an essential role in the construction ecosystem, connecting key stakeholders and servicing over 15,000 customers. These customers are broadly categorized into three main groups: general contractors (~61% of ARR), specialty contractors (~14% of ARR), and project owners (~22% of ARR).
Project owners initiate and finance construction projects, oversee building design with architects, engineers, and consultants, and are responsible for hiring general contractors to supervise the construction process. Notable owners include corporations, universities, government entities, and commercial and residential real estate developers. Post-completion, these owners either manage, lease or sell the developed structure or may delegate these responsibilities to a third party.
General contractors play a key coordinating role in construction projects, tasked with fulfilling owners' requirements and supervising the work of specialty contractors and other service providers.
Specialty contractors, or subcontractors, bring specialized skills to the table, such as mechanical, electrical, plumbing, roofing, or concrete trades. Hired by general contractors, they carry out the lion's share of construction work and are often responsible for material procurement.
Product Evolution
Procore offers additional functionalities that enhance its value proposition. A notable feature is its integration with third-party Enterprise Resource Planning (ERP) vendors, primarily Sage and QuickBooks. This allows for seamless project accounting while managing potential cost overruns, an essential feature in the construction industry. The App Marketplace of Procore offers over 400 integrations, with most customers using at least one. These integrations encompass various solutions, including accounting, analytics, client relationship management, and legal and compliance tools.
Procore strategically acquired Honest Buildings in 2019 to better cater to project owners, offering tailored financial management, project execution, and planning software. This lets owners view their portfolios across various projects, aiding investment decisions and timing.
Furthermore, the Procore platform includes an App Marketplace, a one-stop shop for third-party applications that seamlessly integrate with Procore. This not only allows Procore to monitor customer adoption trends but also serves as a pipeline for potential M&A opportunities.
Another powerful tool is Procore Analytics, enabling customers to glean in-depth insights across aggregated data from all projects, products, and integrated accounting software.
Procore's SaaS-based platform's mobility is a significant differentiator, providing a consistent user experience across desktops, mobile phones, and tablets. Given the office-and-field dynamic of the construction industry, this feature allows for real-time information access and 3D modeling capabilities on-site.
Looking ahead, Procore plans to focus on the payments aspect of their platform, with the introduction of "Procore Pay," set to launch later this year. This feature will allow customers to complete the final step of the workflow within the platform itself: payment to subcontractors. Procore's approach to the payments process and future monetization opportunities suggests a promising growth trajectory in the future.
Construction Industry Opportunity
The construction industry, representing $11 trillion of global construction expenditure in 2020 and accounting for 13% of global GDP, is expected to reach $15 trillion by 2030. However, the sector has traditionally struggled with inefficient practices and costly change orders that compromise project profitability and contribute to physical waste. McKinsey has ranked construction among the least modernized and digitized industries, only exceeding the agriculture industry's digitization lag.
Procore stands to gain considerably from the industry's increased demand, underscored by a few key statistics. The IT budget for construction and infrastructure is less than 2% of revenues, indicating significant potential for digital solutions adoption. Additionally, the annual growth rate in construction labor productivity has been below 1% over the past two decades, showing ample efficiency improvement opportunities. Furthermore, the construction industry can add $1.6 trillion to the global GDP annually through productivity gains, further emphasizing the potential for Procore's growth in the sector.
Financial Overview
Procore's financial profile exhibits a high gross margin, reporting an impressive 85% in the first quarter of 2023. The major components of its cost of revenue include hosting fees, implementation costs, and customer support. However, the high gross margin profitability is more than offset by an aggressive cost allocation strategy, with nearly half of the total revenue spent on sales and marketing expenses, leading to a negative operating margin of -2% on a non-GAAP basis.
Nevertheless, Procore shows substantial growth potential, boasting attractive unit economics. The company's total revenue exhibited a year-on-year growth of 34%, coupled with a healthy net retention rate of 116%. Procore's revenue model is built on an average contract length of 20 months, with 38% of the ARR stemming from multi-year contracts.
The company's financial health is demonstrated in its robust balance sheet, marked by a low debt-to-equity ratio of 7.5% and a quick ratio of 1.4x. Furthermore, Procore has generated a positive free cash flow of $19 million (9% margin) in the first quarter of 2023, underlining its stable cash position.
Currently, Procore is overvalued at 10.5x forward revenue and 9.8x forward price to book multiple, as evidenced by Seeking Alpha’s current valuation grade of “F”.
Risks
Key investment risks associated with Procore encompass fluctuations in construction spending, a sales-driven revenue growth model, heightened competition, and reliance on third-party services. The current high-interest rate environment may lead to a pullback in construction spending in 2024 due to tightening credit conditions, posing a significant risk. Procore's revenue growth depends heavily on expanding its sales team, and a failure to improve sales staff productivity might hamper projected revenue growth. Furthermore, high sales and marketing expenditures challenge the company's profitability, which could constrain its capacity to achieve economies of scale. Additionally, increased competition from other construction management tools and accounting software providers, such as Autodesk ( ADSK ), could hinder Procore's market share. The company's complete reliance on third-party data centers such as AWS also poses operational risks, as any disruptions could have a negative impact on performance.
After examining Procore's operational and financial metrics, I advise investors to adopt a "hold" position on the stock, given the balance of potential opportunities and evident risks.
For further details see:
Procore Technologies: Attractive Growth Potential, But Concerns Remain