2023-06-12 12:50:33 ET
Summary
- I upgraded my rating from Hold to Buy given the strong 1Q23 results and an upward revision of FY23 guidance.
- PCOR's large customer backlog and exposure to thriving construction sub-sectors provide insulation against short-term demand fluctuations and weaker market segments.
- The company's path towards breakeven profitability and continued growth in the untapped construction industry support my optimistic outlook.
Investment thesis
As mentioned previously , Procore Technologies ( PCOR ) is operating in a very large TAM, and it has only penetrated a fraction of it. The fragmented market remains in relatively early stages of digitization. I continue to expect PCOR to benefit from a number of secular growth drivers including rising digital adoption within construction, broader cloud adoption, and increasing importance in business intelligence and analytics as increased communication and collaboration across key industry stakeholders can drive efficiencies and reduce waste and costly rework. My prior downgrade proved correct, as the share price promptly dropped by 24% following the publication of my post. I am changing my rating for PCOR from Hold to Buy given PCOR has exceeded my expectations for revenue, EBIT, FCF, and cRPO in 1Q23. Management also increased their revenue growth forecast for FY23 from 20% to 26%. While I still have some doubts, the 1Q23 results have helped me become more confident that PCOR will be able to deliver breakeven profitability in F24 thanks to its continuous strong top-line growth. As long as the construction industry remains relatively untapped by digital technologies, I expect PCOR to continue expanding for the foreseeable future.
Strong guidance
Management's upward revision of FY23 guidance is one of the two highlights of 1Q23, I take this as management's clear signal that fundamental performance is significantly stronger than anticipated. The fact that they increased guidance in light of the current climate of uncertainty suggests to me that they are very confident in their ability to meet or exceed the guide. If we look at PCOR performance objectively, I also find sufficient evidence to believe that PCOR can meet guidance. For instance, PCOR's large and persistent end-customer backlogs, which typically span anywhere from one year to three, and its strong cRPO growth of 32% in 1Q23 despite a tough comp (mid-30% growth in FY22). I consider the duration of customer backlog to be a significantly undervalued factor in assessing the top-line growth potential of PCOR. This aspect offers substantial protection against any potential short-term decline in demand, as PCOR's customer base’s backlog has priority over any new projects.
By virtue of this backlog duration, PCOR enjoys a level of insulation from immediate fluctuations in market conditions, allowing for a more stable and sustainable growth trajectory. Because of this, I think investors' worries about PCOR sector exposure may be unfounded, at least in the short-term, especially in regards to commercial and residential construction spending (which have been facing tough times recently). In fact, it is worth noting that office construction represents a relatively minor segment of the overall construction spending, and it has not played a significant role in PCOR's exceptional performance over the past two years. Moreover, PCOR has minimal exposure to residential construction. Consequently, when considering the combined impact of office and residential construction, it can be concluded that they do not significantly affect PCOR's financial outcomes.
Profitability
I previously held PCOR because the company still has a long way to go before it can turn a profit, and its valuation is quite high. To recap, management provided its breakeven timeline back in November 2022, indicating breakeven profitability in 2H25/F26. In contrast, PCOR exceeded expectations in terms of margin in FY22, with the company's initial guidance for EBIT margin being -15.5% but ultimately coming in at -10% thanks to the positive effects of revenue outperformance and more measured cost discipline. This makes me think that perhaps management is guiding cautiously in order to set the stage for exceeding guidance. Consequently, if the same magnitude holds true, I think PCOR will be able to deliver an EBIT margin of -1% in FY23, which is better than its guidance of -6%. The way I see it, the major catalyst for the stock is another round of beat in profit guidance.
Things to look out for
While I recognize that PCOR faces some obstacles in the near term, I remain bullish on the company's prospects for FY23 based on the guidance provided. Management has admitted that some returning customers were hesitant to commit to construction volume in 1Q due to worries about a possible economic downturn and difficulties in securing project financing. Despite these challenges, most of PCOR's customers reported higher construction volumes in 1Q, and the company added many new clients. Management has also emphasized the robust growth in the construction of manufacturing facilities, educational facilities, and data centers, despite signs of slowing construction spending in some sectors, such as office buildings. In my opinion, PCOR's exposure to these better-performing construction sub-sectors, combined with the company's low market penetration in a sizable TAM opportunity, should help ease the strain on the weaker segments.
Valuation
Given the change in rating, below is an update to my model. I expect PCOR to continue growing at very healthy levels, supported by its strong backlog. I modeled the multiple to stay at the current level of 8.5x, but I note that the valuation multiple could go higher as PCOR continues to show a faster path to profitability. As I said earlier, the catalyst is profitability being pulled forward.
Own model
Conclusion
I am optimistic about PCOR's potential to outperform based on the guidance for FY23. The company operates in a large TAM and has only tapped a fraction of it. Despite some challenges, PCOR's customer base has shown resilience, with increased construction volumes and strong net new logo additions in 1Q23. The company's exposure to thriving construction sub-sectors and limited exposure to weaker areas provides a favorable position. Additionally, the duration of customer backlog provides insulation against short-term demand fluctuations. With an upward revision of FY23 guidance and a path towards breakeven profitability, I have changed my rating from Hold to Buy. As long as the construction industry remains largely untapped by digital technologies, PCOR is poised for continued growth in my view.
For further details see:
Procore Technologies: Pulled Forward Profitability Timeline