2023-12-18 15:49:24 ET
Summary
- Q2 Holdings' top-line growth prospects are healthy thanks to the growing number of partnerships for the company's Q2 Innovation Studio platform.
- QTWO expects its profit margin to improve in 2024 on the back of expense optimization and a more favorable sales mix with higher subscription revenue.
- The company has been named as one of the best workplaces for employees in Greater Austin for the 13th consecutive year.
- I retain a Buy rating for QTWO in view of multiple share price re-rating drivers.
Elevator Pitch
My Buy rating for Q2 Holdings' ( QTWO ) stock remains unchanged, as there are multiple drivers that could boost QTWO's future share price performance. These drivers include profitability improvement, top-line expansion, and employee satisfaction. Also, Q2 Holdings' shares are undervalued based on a comparison of its EV/EBIT and EV/EBITDA multiples with the expected EBIT and EBITDA growth rates for the company.
Share Price Outperformance Was Driven By Profit Margin Improvement
QTWO's share price went up by +28.8% (source: Seeking Alpha price data) after I upgraded my rating for Q2 Holdings to a Buy with my prior August 22, 2023 update . As a comparison, the broader market (as represented by the S&P 500) witnessed a +7.6% increase in the same time frame.
In my late August article, I highlighted "the company's potential for profitability improvement." I turned out to be right, as QTWO delivered a substantial +14.8% earnings beat for Q3 2023 thanks to margin expansion.
Q2 Holdings' normalized EBITDA margin improved by +5.2 percentage points YoY to 12.7% in the third quarter of this year, which was +1.0 percentage points better than the consensus estimate of 11.7% (source: S&P Capital IQ ).
Looking ahead, QTWO guided at its Q3 2023 earnings briefing that the company's FY 2024 profitability is expected to be boosted by "a greater mix of higher-margin (subscription) revenue" and "greater cost efficiencies." The market sees Q2 Holdings' non-GAAP adjusted EBITDA margin expanding from 12.2% for FY 2023 to 15.4% in FY 2024 as per consensus forecasts taken from S&P Capital IQ .
Q2 Innovation Studio Partnerships Will Boost QTWO's Future Revenue Growth
In the early part of this month, Q2 Holdings issued a media release revealing that "Array has extended its integration partnership to a Strategic Alliance partner where Q2 will resell the financial wellness solution - My Credit Manager - directly to banks and credit unions." In the December 5, 2023 press release, Array is referred to as a provider of "private-label fintech solutions", which became a "Q2 Innovation Studio Accelerator Partner."
An Overview Of Q2 Innovation Studio
Q2 Holdings' Corporate Website
The latest announcement relating to Array brings the company's Q2 Innovation Studio partnerships into the spotlight.
At the company's most recent third-quarter results call, QTWO's Q2 Innovation Studio saw close to 100 partnerships established between its banking clients and fintechs in Q3 2023. This was +40% higher than the Q2 Innovation Studio's prior record-breaking quarter in terms of new partnerships.
Q2 Innovation Studio gives QTWO a clear edge over competitors in securing new digital banking mandates. Banks want to keep their existing customers and earn new revenue streams from these clients. The company's Q2 Innovation Studio allows banks to sell fintech products and services to their customers with ease.
Q2 Holdings referred to Q2 Innovation Studio as a key driver "in every digital banking win from the quarter" at its Q3 2023 results call. In specific terms, QTWO cited an example of a new digital banking mandate with a large US bank that aims to leverage on "Innovation Studio to deliver innovative, fee-generating products to small business and commercial customers." Another case study involving Texas Security Bank is presented below.
Q2 Innovation Studio Case Study With Client Texas Security Bank
The Wall Street analysts' consensus FY 2023-2027 top line CAGR for QTWO is an impressive +22.1% (source: S&P Capital IQ ), or higher than +20% which is a yardstick for fast-growing companies. I am of the opinion that there are two top-line expansion drivers for Q2 Holdings. One driver is the Q2 Innovation Studio partnerships, which I mentioned in this section of the article. The other driver is industry consolidation tailwinds that I wrote about in my earlier August 2023 write-up.
Good Talent Management
QTWO has been keeping the company's talent happy as evidenced by a number of key metrics, and I think that this will be a major factor in determining Q2 Holdings' future success.
2023 marked the 13th straight year running that QTWO was named as a "Top Workplaces 2023 award winner by Austin American-Statesman" which is determined by "employee feedback gathered through a third-party survey" as disclosed in an announcement in the middle of last month.
In the company's 2023 Environmental, Social and Corporate Governance or ESG Report , Q2 Holdings cited "increased internal promotions, a key indicator of internal career growth" as one of its employee-centered initiatives. It is worthy of note that more than a quarter of new positions created last year were fulfilled with QTWO's existing employees.
Another indicator of staff satisfaction is the participation rate for a company's internal employee engagement survey. Approximately 88% of Q2 Holdings took part in the company's 2022 employee engagement survey, which was much higher than its peers' mean staff survey participation rate of 71%. These numbers were sourced from QTWO's 2023 ESG report.
According to a 2010 research paper titled "Does the Stock Market Fully Value Intangibles? Employee Satisfaction and Equity Prices", "a value-weighted portfolio of the '100 Best Companies to Work For'" generated a +3.5% alpha for the 1984-2009 time frame. This shows that there is a positive correlation between employee happiness and share price performance.
Valuations
Q2 Holdings' valuations remain appealing, notwithstanding the fact that its stock price increased by +28.8% in the past four months or so.
A rule of thumb is that a stock is regarded as undervalued if the company's earnings growth rate exceeds its earnings multiple.
The market currently values QTWO at consensus forward the next twelve months' EV/EBITDA and EV/EBIT multiples of 27.8 times and 39.0 times, respectively, as per S&P Capital IQ data. In contrast, Q2 Holdings' consensus FY 2023-2025 EBITDA and EBIT CAGRs are +34.1% and +47.8% (source: S&P Capital IQ ), respectively.
Final Thoughts
I still have a Buy rating assigned to Q2 Holdings. There is room for Q2 Holdings' valuation multiples to expand further in the future on the back of robust revenue growth, profitability improvement, and good talent management. This supports a Buy rating for QTWO.
For further details see:
Q2 Holdings: Watch Key Stock Price Drivers