2023-11-30 09:44:13 ET
Summary
- Workday, Inc. provides software solutions for businesses, focusing on Human Capital Management and Financial Management.
- Workday stock may appear expensive, but it is actually cheaper than it seems due to its strong growth and clean balance sheet.
- Workday's near-term prospects look promising, with emphasis on culture, international growth, and leveraging AI technology.
Investment Thesis
Workday, Inc. (WDAY) provides software solutions for businesses. Their primary focus is on Human Capital Management (''HCM'') and Financial Management, offering tools for managing workforce-related tasks like payroll, benefits, and HR, as well as financial processes such as accounting and planning. Essentially, Workday helps organizations streamline and automate their HR and financial operations using accessible and integrated cloud technology.
Here, I make the case that Workday is cheaper than it may appear on the surface. In fact, as you'll soon see, I've been making this argument throughout 2023.
As succinctly as possible, I contend that paying 37x next year's free cash flows makes sense. Why? Because the company is growing at very close to 20% CAGR and it has a strong balance sheet . And finally, it makes a lot of free cash flow, or FCF, that's growing.
Rapid Recap
In my previous analysis back in September, I said:
As Workday describes itself, they provide ''trust'' to a company's two most valuable assets, its people and its capital , and thereby they provide a comprehensive solution for finance and human resources.
If we take a step back and think more holistically, what this boils down to is how much one buys into the idea that ''software is eating the world.''
Through that lens, Workday's stock is not expensive as it's priced at 32x next year's non-GAAP operating profit.
Indeed, I've been bullish on this stock throughout 2023, and my recommendation has clearly performed strongly so far.
Michael Wiggins De Oliveira on WDAY
However, I believe that there's still more juice left in this idea.
Workday's Near-Term Prospects
Workday's near-term prospects appear promising. During Workday's recent earnings call for its Q3 earnings release , Carl Eschenbach, Workday's recent co-CEO, emphasized the strong culture and values within the company, citing these as factors that continue to excite him about Workday's future: "[we have] an incredible culture and strong values, and that is more evident to me than ever before." Additionally, he highlighted specific growth opportunities, such as the international market where the EMEA team demonstrated significant year-over-year business growth: "Our international opportunity... continues to see strong potential through the partner ecosystem."
The emphasis on the financials sector as a large and strategic opportunity, with increased hiring and positive early results, further underscores the company's optimistic outlook: "Financials represent a large opportunity for us that we're leaning into heavily."
Furthermore, Workday's focus on leveraging its unrivaled data set for AI and Generative AI was highlighted as a key advantage. Eschenbach pointed out that Workday possesses a unique enterprise large language model, contributing to tangible and productive results for customers through generative AI:
"No one has an enterprise large language model like Workday has, and it is driving tangible and productive results for our customers through generative AI."
This emphasis on innovation and cutting-edge technology positions Workday well in the evolving landscape of enterprise solutions.
Additionally, Workday is navigating the sales cycle by highlighting the role of AI, particularly in talent optimization. While customers may not be making decisions solely based on AI at this stage, it is considered a critical element that showcases innovation and sets Workday apart in the competitive landscape. The company's success in early renewals, coupled with full-platform wins in financials and human capital management, underlines the strong satisfaction and commitment of customers to Workday's suite of solutions. As the company expands globally and strengthens its partner ecosystem, there is a notable investment from partners in building out financials practices around Workday.
Given this context, let's now discuss its financials and outlook.
Revenue Growth Rates Are Still Attractive
The one thing that stands out in the graphic above is just how steady and consistent Workday's growth rates are. Investors are paying a premium for a lack of negative surprises. And that's what they are getting.
It appears quite plausible that Workday could sustain its high-teen growth rates without much ado as we look ahead toward fiscal 2025.
One notable aspect is the ongoing macroeconomic uncertainties. As Carl Eschenbach, Co-CEO of Workday, acknowledges, "I don't think we see any improvement in the macro or do we see it getting any worse. It's pretty consistent with what we've seen all year long." The persisting macroeconomic unpredictability introduces an element of complexity in deal scrutiny, particularly in net new opportunities. Heightened scrutiny in decision-making processes, especially for large-scale transformations, poses a challenge that Workday's sales teams adeptly manage but remains a factor to contend with.
Another challenge lies in the evolving landscape of AI adoption in the industry. While Workday is well-positioned with its unrivaled enterprise data set, the broader market is still in the early stages of large-scale AI deployments, particularly in HR and finance. Despite Workday's leadership in AI, there is a need to align customer perspectives and industry readiness for widespread AI integration.
Workday Stock Valuation - 37x Forward Free Cash Flows
Workday's bull case can be found in its strong improvement in its underlying profitability. This is, to some extent, the same playbook that Salesforce ( CRM ) has been delivering. And incidentally, investors have been delighted with software companies that are showing resilient growth, together with improving bottom-line prospects.
Let's get some context, back in fiscal Q3 2023, Workday's non-GAAP operating margins stood at 19.7%. While its latest set of results saw its non-GAAP operating margins expanding to 24.8%, a whopping 710 basis points expansion in profitability in 12 months.
Consequently, this goes a long way to reinforce Workday's fiscal 2027 financial targets, so that it now appears possible that Workday could reach this target at least 1 year ahead of schedule on a sustainable basis.
Workday is likely to see its free cash flows reaching around $1,380 million in fiscal 2024 (ending January 2024), see below Workday's trailing nine months free cash flow figures.
Given that the business is clearly focused on improving its underlying profitability, I suspect that it's relatively easy for Workday to grow its free cash flows next year by 30%. Here's my rationale.
I don't expect Workday to be as successful as Salesforce in growing its underlying profitability. But at the same time, keep in mind that Workday is growing its profitability in the high teens already. Therefore, getting its bottom line free cash flows to grow further by 30% next year should be within the realms of what's achievable.
This implies that Workday could reach $1.8 billion of free cash flows in fiscal 2025 (ending January 2025).
Altogether, this leaves Workday priced at 37x forward free cash flow. This is a significant premium to Salesforce, but also, keep in mind that Salesforce is growing at a much slower rate.
On the other hand, note that Workday's balance sheet carries about $4 billion of net cash. This means that more than 5% of Workday's market cap is made up of cash and the business is well on a path towards making $2 billion of free cash flows starting next fiscal year.
This leaves plenty of room for Workday to repurchase shares, thereby reducing the size of its market cap valuation.
The Bottom Line
In summary, my unwavering optimism about Workday's performance in 2023 has been substantiated by its compelling valuation and robust growth rates.
The company's stock, priced at 37x forward free cash flow, might seem at a premium, but considering its consistent high-teen growth rates and the notable expansion in non-GAAP operating margins, the valuation appears justified.
Workday's strategic focus on improving profitability aligns with impressive financial targets, potentially reaching $1.8 billion in free cash flows by fiscal 2025 (ending January 2025). Plus, with a resilient balance sheet, the company is well-positioned for share repurchases, enhancing its overall market appeal.
For further details see:
Workday Fiscal Q3 Earnings: Resilient Business, Priced At 37x Forward FCF