2023-04-18 02:29:38 ET
Summary
- Shares of Splunk have pulled back since reporting Q4 results in March, despite strong fundamental performance and bullish guidance for FY24.
- The company is managing to grow cloud revenue at a >40% y/y pace, despite keeping opex relatively flat.
- The company is expecting free cash flow to nearly double in FY24.
- The stock is still cheap at ~4x forward revenue.
To beat this market in the current volatile environment, careful stock-picking is the name of the game. In particular, I have my eye on a basket of "growth at a reasonable price" stocks that have not yet seen tremendous year to date appreciation, despite strong fundamental performance in the wake of cloudier macro trends.
Splunk ( SPLK ), in particular, is a name I am comfortable doubling down on. This machine data and observability platform is one of the few tech stocks to barely see any price growth this year, despite hitting a fundamental stride after completing a multi-year transition into a subscription-first business. Up only 5% year to date, I think Splunk has plenty of rebound momentum left to go, especially as the stock sits at less than half of its 2020 highs and is trading at a very reasonable valuation:
The bull case for Splunk remains vibrant; focus on the long term rather than the current environment
I remain stoutly bullish on Splunk and am holding onto the name in my portfolio. We've heard from almost every software company, of course, that enterprise clients are pulling back on their IT spending amid budget cuts. Near-term deal momentum may suffer, but what is important is that we look for technology companies with huge market potential and category-leading brands that will catch up on lost demand after the current crunch is over.
Gary Steele, Splunk's CEO, noted on the recent Q4 earnings call that management doesn't believe any deal cycle elongation in the current environment translates to total loss; rather, it's a timing shift:
During Q4, we continued to see cloud migrations and expansions impacted by the macro environment, as well as increased deal scrutiny, which is factored into our guidance for the current year. We do not view this buying behavior as a demand issue, but rather that of timing as many organizations continue to utilize on-prem Splunk solutions with longer term plans to shift more of their workloads to the cloud."
Longer term, I think Splunk is well-positioned to continue building its sizable ARR base and generating generous profits. Here is my full bull case for the company:
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The use cases for Splunk are infinite. In its early days, Splunk's machine data-mining capabilities were often used for security purposes to flag and respond to anomalies within corporate systems. But as Splunk has evolved, the company's machine data capabilities are applicable across virtually any industry and across many functions.
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Usage-based pricing. Some of the most successful software stocks are usage-based, meaning that revenue climbs proportionally to a customer's usage of the product. Splunk's platform is charged on a data volumes/computing power basis. As data volumes continue to explode and companies push the boundaries of how they integrate data into operations and decision-making, Splunk has a tremendous opportunity to derive growth from within its install base.
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Splunk isn't without competitors, but the company's focus on machine data is unique. It's also the largest company in the space . The company's closest large/public peers are the monitoring companies like Datadog ( DDOG ) and New Relic ( NEWR ), which primarily focus on monitoring the performance and uptime of applications and infrastructure. Splunk focuses on visualizing and analyzing machine data (information passively generated by computers, phones, and other endpoints within networks). We note as well that Splunk's ~$3.7 billion annual revenue scale makes it twice as large as its next-closest competitor, Datadog.
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Industry-wide recognition - More to the point above, it's fine to have competition when Splunk also is widely considered the best-in-breed vendor for machine data analytics. Gartner, the software industry's leading analyst and reviewer, has bestowed the "Leader" designation to Splunk in the security information and event management space, and also named it as the vendor with the highest ability to execute. These commendations don't come lightly to IT buyers when making a purchase decision.
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Significant international expansion opportunity - Splunk has become a global brand name, and it's time for Splunk to chase more opportunities overseas. Currently, only about ~35% of its revenue base comes from international markets (and an even smaller ~20% slice of the cloud business is overseas). I see significant opportunity for Splunk to expand its presence outside of the U.S.
Valuation remains reasonable against robust FY24 guidance
Splunk also trades quite cheaply. At current share prices near $91, Splunk trades at a market cap of $15.06 billion. After we net off the $2.05 billion of cash and $3.88 billion of debt on the company's most recent balance sheet, Splunk's resulting enterprise value is $16.89 billion.
For the current fiscal year FY24, Splunk has guided to $3.85-$3.90 billion in revenue, representing 5-7% y/y growth (deceleration from current ~40% y/y growth is expected due to Splunk having easier comps this year, owing to the recency of Splunk's subscription transition maturing; nevertheless, the outlook does feel a few points too conservative).
Splunk outlook (Splunk Q4 earnings deck)
Taking the midpoint of this guidance range at face value, Splunk trades at just 4.3x EV/FY24 revenue, and also 21.5x EV/FY24 FCF. In my view, there is plenty of opportunity for Splunk's multiples to slide upward.
Q4 download
Let's now go through Splunk's latest Q4 results in greater detail. The Q4 earnings summary is shown below:
Splunk Q4 results (Splunk Q4 earnings deck)
Splunk's revenue in the fourth quarter soared 39% y/y to $1.25 billion, beating Wall Street's expectations of just $1.07 billion (+19% y/y) by a huge twenty-point margin.
The majority of the beat was largely timing-based: the company noted that delayed cloud migrations led to a boost in term contract renewals, which led to a large chunk of revenue being recognized upfront.
Nevertheless, as shown in the chart below, total ARR still grew 18% y/y to $3.67 billion, while the cloud portion of ARR grew at a much faster 33% y/y growth rate. Cloud revenue recognized in the fourth quarter grew 43% y/y.
Splunk ARR growth (Splunk Q4 earnings deck)
Greater scale has also brought in a more favorable margin profile. The company's gross margin in FY23 hit 81.4%, a 420bps improvement y/y and the start of a rebound after the company began its cloud transition. Cloud gross margins in the fourth quarter also bumped up to 73.5%, an 80bps sequential improvement.
Splunk gross margins (Splunk Q4 earnings deck)
The company is also laser-focused on managing opex carefully. In spite of double-digit revenue growth, the company notes that operating expenses only grew 2% y/y. More leverage is expected in FY24 as the company executes a headcount trimming plan. Per CEO Steele's remarks on the Q4 earnings call:
Finally, our approach to hiring remains measured and focused on prioritizing sales and customer-facing roles. During a year in which we grew ARR by 18%, our approach enabled us to end our fiscal year with a modest and efficient headcount increase to approximately 8,000 Splunkers.
Consistent with our hiring approach, and as we announced in early February, we made the difficult but necessary decision to reduce our global workforce by approximately 4%, mostly in North America. This action was another step in a broader set of proactive organizational and strategic changes, including those we made in November to support our sales team's transition to a single seller model."
Management is guiding to a midpoint of $785 million in free cash flow, which represents a huge 84% y/y growth rate versus FY23.
Splunk FCF (Splunk Q4 earnings deck)
Key takeaways
With consistent ARR growth, a path to significant free cash flow expansion, and a massive global TAM, there are a lot of things to like about Splunk after the recent dip. Trading at just over >4x forward revenue, Splunk is at a safe entry point in the low $90s.
Near-term catalysts for share price upside are numerous:
- Catch-up on delayed deals may lead to surprise revenue upsides, which may lead to a pronounced stock pop when expectations are low
- Significant free cash flow growth in FY24 can continue to catch investors' eyes, especially in a more risk-averse market that has valued tech companies' profitability more
- Upward valuation re-rating, as Splunk's high gross margin profile plus strong bottom-line metrics amid consistent growth merits greater than a >4x forward revenue multiple
Stay long here.
For further details see:
Splunk: Hitting Its Stride