2023-08-24 13:04:19 ET
Summary
- Workday is expected to report Q2 earnings with a YoY EPS growth of 52% and a revenue growth of 15%.
- I predict a small beat on both EPS and revenue.
- Workday's GAAP profitability and margin are important factors to watch, as well as the company's stock-based expense and valuation.
Workday, Inc. ( WDAY ) will report earnings fiscal Q2 that ended July 30th, 2023, post-market on Thursday, August 24th. Analysts expect Workday to report a non-GAAP EPS of $1.246 on revenue of $1.77 billion. Should Workday meet these numbers, it would represent a YoY EPS growth of 52% and a revenue growth of 15% YoY.
WDAY Q2 Preview (Seekingalpha.com)
Since this is my first coverage on Workday, let's start with a brief introduction about the company. Workday is an Application Software company that provides cloud-based Enterprise Resource Planning [ERP], Human Capital Management [HCM], Financial Management, and Student Information System platforms to businesses. The company was founded in 2005 and went public in 2012. But Workday has an even richer history given the fact that its founder, David Duffield was also the founder and CEO of one of the most popular CRM software ever, PeopleSoft, which was acquired by Oracle Corporation ( ORCL ) in 2004. Workday currently serves organizations of various sizes and domains, as shown below.
Workday Clients (workday.com)
With that background out of the way, let's preview Workday's Q2 without any further ado.
Steadily Increasing Expectations
Since the beginning of the year, (non-GAAP) EPS expectations for Q2 2024 has been on a steady increase with the estimate going up from $1.15 to $1.26 as shown below.
Given the gap between the expected YoY EPS growth and revenue growth (50% vs 15%), it appears like the market is expecting Workday to enter the maturity phase where it is no longer the revenue-hungry start up but one that is expected to show maturity and scalability in its operations. This expectation is reflected in the fact that 23 out of the 27 EPS revisions have been to the upside, while only 17 out of 26 revenue revisions have been to the upside.
Beat or Miss? I Say A Small Beat on Both
Over the last 12 quarters , Workday has beaten EPS estimates 11 times and revenue estimates 12 times. While that sounds great on paper, the biggest revenue beat in this time span was by 1.83% while the EPS surprise percentage has dropped to low double-digits (~15%) over the last 4 quarters. These, once again, point to a maturing company whose operations are fairly predictable. That can be both good and bad. Let's wait and see, but for now, I predict the company will beat on EPS (a decent margin) and revenue (much smaller margin).
Main Stories - GAAP Profitability, Dilution
- Workday is expected to report a GAAP EPS of 1 cent in Q2. Should this come to fruition, it would mark only the third quarter ever that the company has been GAAP profitable based on the source I've used below. Once again, this could be a sign of a maturing company, which is good news from profitability perspective but may also introduce doubts about the company's ability to grow revenue organically. Some Seeking Alpha analysts expect the company to be GAAP profitable this FY, and a positive Q2 would go a long way in meeting this target.
- Software as a Service [SaaS] operators leveraging cloud are generally expected to have their (gross) margins sky-high, to the level of 75% to 80%. Granted, public companies operate differently that private companies, which make up most of the numbers in the statistics. And, however, Workday guiding for just 22% Non-GAAP operating margin is something to be tracked closer as the company continues maturing. With revenue growth projected to be slower, margin becomes even more important.
- I suggest investors to pay specific attention to the company's shares count and stock-based expense column when the Q2 report comes out. There has been a steady increase in Workday's total shares outstanding over the last 5 years, with the cumulative total reaching 20%. One of the hotly contested topics of GAAP vs. Non-GAAP reporting is around stock-based compensation expense, and rightly so. In Q1 alone, there was a difference of nearly $370 million in the company's earnings between GAAP and Non-GAAP just due to stock-based compensation expenses.
Valuation
I believe the stock is overvalued heading into earnings for the following reasons:
- The company is trading at nearly 40 times 2023's full-year revenue of $1.65 billion.
- The company is far from being consistently profitable on GAAP basis.
- Even using Non-GAAP estimates, based on 2025's estimate of $6.41, the stock is once again trading close to a forward multiple of 40.
- The stock is up nearly 40% YTD and has been stuck below $250 except for a small period in 2021 (height of market frenzy).
Technical Strength
Workday's stock has comfortably moved past all the commonly used moving averages, thanks to the recent reinvigorated tech rally. Even if the earnings report disappoints, I expect reasonable support for the stock in the low $200s level. However, should earnings and/or guidance surprise the market to the upside, the stock has enough technical room to make a run for the highs, with the Relative Strength Index [RSI] reaching my sweet spot of about 60 heading into earnings.
Conclusion
As I recently wrote in an article about Paycor HCM, Inc. ( PYCR ), the competition in the HCM space is stiff, and it may be a race to the bottom when it comes to pricing. I acknowledge that Workday operates in many other spaces like Student Management and is in a unique spot of being an established player (serves 50% of Fortune 500) in an expanding market. However, the market space is extremely competitive with many established players like Oracle and SAP while mid-level players like Paycor and Paycom Software, Inc. ( PAYC ) cannot be discounted entirely either.
Workday can be part of a long-term portfolio if you need exposure to the Application Software industry but at the right time. And the price in my opinion is far from right at the moment as explained above, and I rate the stock a Hold heading into earnings.
For further details see:
Workday Q2 Earnings Preview: Stock Is Overvalued As Company Expects GAAP Profitability