2023-05-18 02:48:05 ET
Summary
- Splunk's new CEO is 4 quarters in and has performed well against consensus so far.
- The company has seen 4 quarters of >30% revenue growth rate while posting quarterly profitability and positive cash flow for the first time.
- This quarter Splunk was already able to generate a 21.4% net income margin along with a 21.5% free cash flow margin.
- At current forward earnings growth rates, it is set to grow earnings rapidly and be worth significantly more at current valuations.
- Splunk looks set to outperform this quarter and, overall, looks like an excellent growth stock choice at the moment.
Overview
Software infrastructure company Splunk ( SPLK ) has seen volatile trading in its shares over the course of this year. While initially appreciating well past the NASDAQ Composite, Splunk is now trailing it YTD.
Nonetheless there has been strong buying and price movement after its latest earnings report. While initially trading down over the course of 2 days, Splunk got into high gear at the end of the week and continued this for 2 weeks afterwards:
Since its 2012 IPO, Splunk's share price peaked in late 2020 and has since overall experienced a volatile return to 2019 price levels.
This has disappointedly resulted in a lower price return for Splunk than the NASDAQ Composite since its initial public offering. This means that the company's results, inclusive of its forward-looking prospects, are considered to be inferior to the basket of stocks trading on the NASDAQ by the market. It appears that the stock is still trading cheaply relative to its price history even as its new CEO Gary Steele (st. Q2 2022) has done improvingly well against consensus so far:
This combination of relatively cheap share price along with the recent momentum on EPS/revenue warrant a review of its financials to see if it might be a buy going forward.
Fundamentals
Splunk is a high-growth SaaS firm that just crossed the $1 billion quarterly run rate mark. The new CEO appears to have been effective so far, with growth above 30% in every quarter since his Q2 2022 start date and a clear reversal of the previous slowdown.
Notably gross margins have also ticked up, and are at their highest in 10 quarters as well as higher than at any time since fiscal year 2015.
Explaining the recent buying activity we can see that Splunk has posted its first quarterly profit, at an impressive net margin of 21.4%.
Splunk has had a good trajectory on cash flow, with a clear upward trendline over the last 10 quarters and a record quarter to boot.
Cash margins came in above the company's net margin of 21.4%. Operating cash flow was at a 22% margin and free cash flow of $269 for the quarter generating a 21.5% free cash flow margin.
Overall these financials look promising and signal a genuine improvement in Splunk's operations since the appointment of the new CEO. While this trendline may have been less clear before, it is much clearer now that we are 4 quarters out.
At this juncture, the core risk is that Splunk begins to experience a slowdown in its growth. With the current economic context and its associated effects this year across B2B software spend, we could see Splunk encounter this as soon as next quarter. Depending on the severity of this decrease, it could hamstring Splunk and its shares at what appears to be a critical time.
Nonetheless the recent growth rates above the 30% indicate persistent and deep-pocketed demand for the firm's products. This makes me believe that Splunk can, at minimum, continue lower double digit growth if the economic environment deteriorates further. Alternatively, if the company maintains something resembling 30% revenue CAGR in a deteriorated economic environment, it will count for that much more.
Valuation
As mentioned before Splunk's valuation on a price return basis looks appealing. It is also important to consider its relative multiples, however. Here Splunk is trading at a 70% premium to the IT sector on a forward basis, indicating that the stock is still priced expensively for the year ahead.
When we also consider the company's earnings growth rate, however, Splunk start to look a lot cheaper.
Splunk's positioning as a scale technology company just beginning to operate profitably allows it to have near and mid-term earnings growth that is far in excess of the IT sector median.
Extrapolating these growth rates we see that Splunk is trading very cheaply across a 1-4 horizon.
Year | 2022 | 2023 | 2024 | 2025 | 2026 |
P/E at Current Share Price ($88.88) | 31.94 | 19.11 | 7.63 | 2.26 | 0.49 |
Relative Earnings | 1 | 1.67 | 2.51 | 3.38 | 4.57 |
Earnings Growth Rate | 67.1% | 50.0% | 35.0% | 35.0% | |
Implied Price at Current P/E Multiple | $148.52 | $222.78 | $300.57 | $405.77 | |
Year | 2022 | 2023 | 2024 | 2025 | 2026 |
P/E at $88.88 | 31.94 | 21.29 | 9.46 | 3.36 | 0.96 |
Relative Earnings | 1 | 1.5 | 2.25 | 2.81 | 3.52 |
Earnings Growth Rate | 50% | 50% | 25% | 25% | |
Implied Price at Current P/E Multiple | $133.32 | $199.98 | $249.98 | $312.47 |
Source: Excel, Seeking Alpha
If Splunk can hit forward consensus earnings growth numbers this year, while keeping a 50% earnings growth rate for 1 more year, the stock will be worth $148.52 at the end of this year and $222.78 at the end of 2024; a return of 68.8% and 150.6%, respectively. After that, the stock could even go higher if it maintains a decreasing portion of its current expected growth rate.
I'll assert a price target of $248.17 for Splunk by the end of May 2025. As with right now, this will allow investors to fully parse and price in Splunk's earnings for Q4 2022 and FY 2022.
Upcoming Q1 2023 Earnings
On a shorter-term horizon, Splunk is set to release earnings for fiscal Q1 2023 a week from now, May 24. In the run up to this there have been mostly downward revisions to estimates.
This is likely due to softer yearly guidance by management on the latest earnings call . Nonetheless, Splunk has significant momentum as to beating consensus these past 4 quarters. Given the significant and increasing beats against estimates over the last 4 quarters, it is fair to believe that Splunk tends to issue fairly conservative guidance that then gets reflected in consensus.
While there has been some pressure on technology earnings so far this quarter, the overall picture has come out better than expected. Additionally I think that it is worth noting the infrastructure-oriented nature of Splunk's technology offering. Managing software infrastructure for large companies directly using technology to drive revenue ends up being mission critical to their business. Splunk's customer base overall should thus be positioned as less likely to cut spend on this product area overall.
Considering all of this I am expecting Splunk to again exceed expectations this quarter.
Conclusion
Splunk looks it is returning to form and could very well be at the early stages of a new era. It is also set to be worth significantly more in the near to medium term at its current expected earnings growth rate. This could generate an excellent return on investment and makes Splunk a buy in my book.
For further details see:
Splunk: High Earnings Growth With Momentum Into Earnings