2023-07-15 09:20:25 ET
Summary
- Yext is on the cusp of GAAP profitability, and there are strong indications of commitment from management to reach this significant milestone.
- Despite a deceleration in revenue growth, Yext has demonstrated encouraging progress in margin expansion, fueling their run to profitability.
- Yext's product retention has recently experienced a decline, with net retention falling below 100%, contrasting with historical levels of 110% or higher.
Thesis
Based on two key factors, I recommend a buy rating for Yext (YEXT). Firstly, the company has demonstrated a positive trend of margin expansion, indicating a healthy financial outlook. Secondly, management has shown a strong commitment towards achieving profitability, which they are on the cusp of, further enhancing the potential for long-term value of their stock.
Company Overview
Yext is a B2B software company headquartered in New York City. Founded in 2006, Yext provides a platform that collects and organizes content from a company to deliver relevant and actionable information. Their goal is to ensure accurate answers are provided wherever people ask questions about a business. By embedding a custom search engine on a company's website, Yext aims to enhance the user experience by eliminating the need for users to redirect to external search engines like Google. This approach helps companies retain valuable website users and prospects, as they can find the answers they need directly on the company's site.
Yext went public via an IPO in April of 2017. The stock's price opened at $14 per share. Over the course of the last twelve months, Yext's shares have traded for anywhere between $4-13.45. Currently, shares are trading for ~$10.50.
Financials
Several notable aspects stand out when examining Yext's financials. Of particular interest is the company's decelerating revenue growth, which warrants attention.
Yext's revenue has come to somewhat of a crawl as of late. The company experienced double-digit revenue growth every single year up until this most recent year. Furthermore, the company's revenue from the quarter ending in April 2023 was only up 0.66% from the same quarter a year prior.
This slowdown in revenue growth isn't just a thing of the past, though, as forward estimates look only marginally better. Analyst estimates project revenue growth to continue to be in the ~1-3% range for the near future.
It's worth noting that the AI-trend could possibly help to re-ignite Yext's top-line growth. The company has rolled out a beta version of Yext Chat, which incorporates more AI features into their product. Management seemed bullish about the product in their most recent earnings call, so it will be interesting to see if the added features will help them to attract more customers.
With that being said, attracting new customers with new AI features isn't something that I would bet on. Rather than helping to differentiate a company's product, I feel that most AI features will become commoditized and somewhat expected by customers. For this reason, I wouldn't bank on it carrying their whole business to a new level.
Given the stalling revenue growth, it becomes imperative for Yext to prioritize and fully commit to margin expansion, which has already shown some promising results.
As the graph above shows, Yext's gross margins have consistently hovered in the 73-75% range for the last several years. However, this past quarter, Yext posted a gross margin in excess of 78%. And this margin expansion didn't happen by pure happenstance. Rather, the company has been making a concerted effort to restructure and streamline operations in order to be more efficient. Continued margin expansion will be vital for Yext to reach full-fledged profitability, particularly if revenue growth remains muted.
Meanwhile, Yext maintains a healthy balance sheet and capital structure, with $216.9 million of cash and $114.8 million of total debt.
Although I wouldn't consider Yext's balance sheet to be fully bulletproof, I don't foresee it causing the company any complications or issues in the near future. The company has sufficient capital to fund operations, and isn't burning cash, setting it up well for the future.
Speaking of the lack of cash-burning, Yext is cash flow positive, and has been for the last few quarters.
Yext has demonstrated notable growth in cash from operations over the past few quarters compared to the previous year. While the company has yet to achieve GAAP profitability, these substantial strides indicate a positive trajectory towards that goal.
All in all, Yext's financials reveal an intriguing narrative of a well-capitalized company experiencing decelerating revenue growth but expanding margins. Investors should keep a keen eye on these trends to evaluate Yext's potential value in the future.
Valuation
Upon an initial glance, Yext shares appear to be trading somewhat expensively. This shouldn't come as a surprise as Yext is yet to be profitable and just recently produced its first quarter of positive EBITDA. Overall, SeekingAlpha's quant system, based largely upon relative valuation metrics, grades the company's valuation as a "C."
If Yext's historical financial performance has been meager, what exactly are investors investing in? The answer lies in the enticing potential of future profitability. However, it's worth noting that this path to profitability differs from the typical trajectory of many publicly-listed software companies, which is driven by robust revenue growth. Instead, Yext's journey towards profitability is propelled by a steadfast focus on margin expansion.
Forward EBITDA growth for Yext is projected to be 490%, and forward operating cash flow growth is projected at almost 44%. The same trend continues for forward free cash flow per share growth, which sits at 79%. These numbers are quite impressive, especially considering that revenue projected to increase ~3% over the next year.
Rather than succumbing to the temptation of pursuing unattainable top-line growth, Yext's management has made the strategic decision to leverage and optimize their existing assets. This prudent approach has garnered well-deserved market recognition over the past year, as evident from the graph below.
While Yext may initially seem overvalued, a closer examination reveals that it may indeed justify its current valuation to a certain extent. Yext has the potential to become a solid, albeit relatively small, source of consistent cash flow in the future. For investors, the opportunity lies in getting involved at this stage, even if it means accepting a slight overvaluation, and holding on for the long term. This is where the real opportunity for alpha generation lies.
Catalysts
Two key catalysts that I anticipate for Yext's future success are continued margin expansion and eventual achievement of full-fledged profitability. It will be crucial to closely monitor the reported margins at the end of each quarter and observe their direction, as they will play a pivotal role in unlocking Yext's value and profitability potential. While Yext has already reported positive earnings on a non-GAAP basis, achieving profitability from a GAAP standpoint would mark a significant milestone for the company. It is likely that the market will reward Yext for this accomplishment. Moreover, considering that the company only posted a net income loss of $400 thousand in the most recent quarter, reaching GAAP profitability could be a near-term possibility.
Risks
The most significant risk that I foresee for Yext has to do with their retention metrics. Management reported that Q1 net retention was 97% for direct customers and 92% for third-party resellers. Although this level of retention was in line with the company's Q4 results, it is still something of concern. Historically, Yext's retention levels have been in the 110-112% range, making this recent dip to sub-100% levels concerning.
Management commented that nothing has fundamentally changed with their products, however they have been focusing on different sources of revenue which have helped to improve margins, but haven't aided retention metrics. Management's hope is that making this short-term trade will result in more up-sell and cross-sell opportunities in the future, thus improving net retention metrics. It will be particularly interesting to see how retention metrics play out as Yext continues to develop new products and features, such as their forthcoming AI-powered Yext Chat.
Conclusion
Yext possesses several positive aspects that contribute to its potential success, such as margin expansion and its proximity to achieving GAAP profitability. These factors have significantly influenced the bullish sentiment of the SeekingAlpha quant system towards the stock. Monitoring these trends closely will be crucial, as they will play a pivotal role in determining the company's share price. It's important to recognize that these trends are interconnected and can swing in either direction. If margin expansion stalls, Yext may encounter challenges in sustaining profitability. Therefore, investors should prioritize tracking these trends and evaluating future earnings releases to gain a clearer understanding of the company's future prospects. However, in the meantime, Yext presents an attractive long-term investment opportunity.
For further details see:
Yext: Continued Margin Expansion Is The Key