2023-06-02 06:15:42 ET
Summary
- SentinelOne's weak revenue outlook for FY2024 raises concerns about its growth momentum and sustainability, as the company remains highly unprofitable.
- The company's widening non-GAAP operating loss and negative net profit indicate a longer path to profitability, despite improvements in adjusted EPS.
- Investors should be cautious and wait for a clearer picture of SentinelOne's growth visibility, as its current valuation is driven by top-line growth and vulnerable to slowdowns.
Investment Thesis
SentinelOne ( S ) was down almost 35% following the release of a weak revenue outlook by the management. This reflects investors' concern on the sustainability of its growth momentum. S is a hypergrowth cybersecurity company with a 109% CAGR from FY2020 to FY2023. The company's flagship product, Singularity Platform, processes real-time data from various sources, using AI models. It predicts and prevents file-based attacks, monitors user behaviors, and takes action against potential threats.
We should keep in mind that high growth momentum is a key factor supporting SentinelOne's valuation, as the company remains highly unprofitable, with its losses increasing from $72 million in FY2020 to $195 million in FY2023. This is concerning for investors because the company hasn't reached a point where it can consistently make money. Additionally, while there was some improvement in adjusted EPS in FY2023, the company diluted its existing shareholders by issuing more shares, which offset the increased net loss.
Although SentinelOne is running a business in a growing industry with the rise of AI and cybersecurity, I think we should be cautious. Particularly, the company just provided a weak revenue forecast for FY2024, which will put additional pressure on its valuation. Therefore, I'm neutral on S stock.
1Q24 Takeaway
The company reported a mixed performance for 1Q FY2024. While non-GAAP EPS beat expectations by $0.02, the total revenue of $133.4 million was below the estimates by $3.21 million, which disappointed investors. Furthermore, the company's Annual Recurring Revenue ((ARR)) also fell below the street estimates.
As a hypergrowth company, I believe investors currently prioritize top-line growth over profitability. Therefore, if investors perceive any signs of a potential slowdown in growth, the stock may experience a sell-off. I'll discuss reasons in the next section.
In addition, the company achieved an impressive net retention rate ((NRR)) of 125%. This demonstrates the company's ability to retain and expand its existing customer base. As shown in the chart, the NRR has consistently exceeded the company's target of 120% over the past five quarters. I believe a consistent high NRR trend is generally associated with high valuation, which is considered a positive growth driver for software companies. According to Stats For Startups , a NRR exceeding 110% is considered best in class, highlighting SentinelOne's strong performance as a software company.
Looking forward, the company is expected to achieve total revenue of $141 million in 2Q FY2024, which is below the estimate of $152.07 million. Moreover, the management forecasts FY2024 revenue to be in the range of $590 million to $600 million, lower than the previous guidance of $631 million to $640 million, and below the street estimate of $637.63 million. These forecasts have raised concerns among investors about potential growth slowdown.
Focus on Revenue Growth
As previously mentioned, SentinelOne is a hypergrowth company, achieving an impressive 106% growth in FY2023. However, its net profit margin was -46.1%. The company still achieved an impressive 60% which is significantly above the 40-rule threshold. This rule combines revenue growth rate and profit margin to determine a company's performance, which is a very important metric for valuing SaaS companies as it considers both top-line growth and profitability. Therefore, despite the widening net losses, investors continued to drive the stock price higher due to the healthy top-line growth. This makes the stock price particularly vulnerable to any signs of growth slowdown.
When it comes to early-stage or growth companies with strong growth potential (revenue growth of 20% or higher), investors typically prioritize stable growth momentum over weak margin profiles and negative earnings. Valuations for these companies remain high as long as the growth momentum continues. These companies often have high capex and invest heavily in research and development and sells and marketing, which can result in negative operating income and net profit. As a result, profitability may not be a priority as companies focus on capturing market share and scaling their businesses. Therefore, investors pay less attention to negative FCF and negative EPS for such companies during that period.
However, for mature companies, investors shift their focus toward margins and FCF growth as the growth rate tends to slow down once a company has already captured a significant market share. They understand that high revenue growth cannot be sustained indefinitely.
Therefore, if SentinelOne fails to maintain a consistent high growth momentum and doesn't achieve profitability, it could lead to a contraction in its valuation and subsequently trigger a big selloff.
Very Unprofitable
As we can see from the charts, the widening non-GAAP operating loss, combined with the potential slowdown in top-line growth expected for FY2024, is a warning sign for investors. The company may have touted margins improvement in their press releases, but the widening non-GAAP operating loss indicates a longer path to earnings and FCF breakeven.
Additionally, I admit that the company has made a significant improvement in its net margin, but its bottom line has been deteriorating over the past few quarters. We notice the red line in the chart, where the adjusted net profit has been consistently declining and staying in a certain range. Although there has been improvement in adjusted EPS, we should keep in mind that this improvement was achieved by issuing more shares, diluting the net loss. Therefore, the adjusted EPS is improving, but it's influenced by the dilution of shares rather than true profitability.
Valuation
Due to the company's significant negative operating income and adjusted EPS, we can't value the stock based on metrics like P/E FTM and EV/EBITDA FTM. However, by considering the company's FY2024 revenue outlook, we can calculate P/S FY2024. Taking into account a 35% selloff after the 1Q earnings report, the stock is currently trading at 6.4x P/S FY2024. This valuation is nearly in line with the average for the software industry. Therefore, the stock is not currently trading at a lofty multiple, indicating that market sentiment recognizes the company's growth challenges in the near term.
Conclusion
In sum, SentinelOne has a strong growth history, but its growth outlook remains a concern. The widening operating loss and negative net profit indicate a longer path to profitability. The 1Q24 earnings results, with revenue falling short of expectations, highlight potential growth headwinds. The stock's valuation is driven by top-line growth, making it vulnerable to any signs of a growth slowdown. However, the current P/S reflects an average valuation in the software industry. Therefore, given the uncertainties surrounding SentinelOne's growth momentum and profitability, it would be prudent for investors to be cautious and wait for a clearer picture of the company's growth visibility.
For further details see:
SentinelOne: Disappointing Growth Outlook Raises Red Flags For Hypergrowth Company