Miscellaneous Photos
Thesis
ServiceNow’s (NYSE: NOW) the recent Q2 card initially disappointed the media and some investors, but not us. As a result, we’ve updated our marketplace service members that we’re ready to be bullish on NOW, as we add soon after sale of its profits. As a result, we were able to reverse its recovery, as NOW is up nearly 14% since we added.
Investors should note that we updated in our last article in June that NOW may continue to underperform. As we painted, the stock also broke through its near support ($405) in July. However, the market rejected further downside, as it firmly held its July lows. Furthermore, we also featured in our July articles the UltraPro QQQ ETF (TQQQ) and Tech ETF (XLK) that we believe the market is bottoming out.
As a result, we are confident that a high-quality enterprise cloud SaaS stock like NOW has also made its medium-term bottom at its $405 support. We also believe the market is sharply rallying to those levels. Therefore, we will not miss the opportunity to accumulate in the market, as we think a re-rating should be on the cards NOW.
We urge investors to move past near-term concerns about a looming economic downturn as the market hopes. Despite this, NOW has recovered sharply back to its nearby resistance ($500), which has seen continued selling pressure since June.
Therefore, we believe that a short-term pullback should occur, given its near-term overbought levels. However, we are not concerned about the resistance and think it should be removed by further buying on the upside in the medium term, given the tech bottom.
Therefore, we change our rating NOW from Hold to Buy. But, we encourage investors to wait for a pullback first, given the near-term overbought technical.
Look Past ServiceNow’s Q2, as Growth May Accelerate Again
The market initially seemed concerned with ServiceNow’s performance in Q2, as NOW sold off post-earnings. The company’s Q2 revenue was below Street consensus, and management revised its guidance, due to macro and forex headwinds. CEO Bill McDermott warned (edited):
We always say that nothing beats the strength of the dollar in this environment. And we also recognize that, especially in operating theaters that are more affected by the macro, you’re going to see a lengthening of the sales cycle because, especially in markets that are used to doing things a certain way, now in the great reprioritization. There’s a time equation there, but there’s also an expansion of the power of our platform that’s not in the numbers. And we have to see how it works in the back half. (ServiceNow FQ2’22 earnings call)
ServiceNow cRPO % change (Company filings)
Notably, ServiceNow’s current outstanding performance obligations ((cRPO)) are declining, with Q3 guidance coming in at 20% YoY growth (also impacted by forex headwinds). However, we believe it’s likely to be less than this, as CFO Gina Mastantuono (edited) stressed:
How many quarters are we talking about now that the renewal cohort is down in Q3, right? It will pop up again in Q4. So Q3 is really under that renewal cohort, and we’ll see that re-acceleration as we move into Q4. (ServiceNow revenues)
Also, investors should note that the company guided for revenue of $16B in FY26 in its Review Day presentation. Accordingly, this implies a TTM revenue CAGR of 21.74% till FY26. Therefore, we believe the company’s guidance under cRPO growth in Q3 is credible.
ServiceNow’s % revenue change and % consensus estimate of EBITDA change (S&P Cap IQ)
Consensus estimates also indicate (very bullish) that its earnings growth rhythm may recover by FY23. Headwinds affecting its profitability growth should also be short-lived and improve from Q3 onwards.
Despite this, given the company’s 35% global revenue base, forex headwinds can still affect its ongoing revenue and profitability. However, our dollar index analyst suggests that the surge in the dollar index should reverse itself as the Fed moves back into a less hawkish mode. But, it could also come sooner, as the market usually anticipates the Fed’s moves in advance. So forex headwinds should reverse the tailwinds going forward.
Is Stock NOW a Buy, Sell, or Hold?
We changed our rating to NOW from Hold to Buy. We have already taken advantage of its post-earnings sell-off to add positions.
While we expect a pullback, given its overbought near-term technicals, we believe a re-rating is on the cards in the medium-term. Therefore, this bodes well for NOW’s buyback, and we encourage investors to capitalize on its recovery.
NOW last traded at a FY24 free cash flow (FCF) yield of 3.66%. It’s certainly not cheap, suggesting an embedded growth premium for its high growth opportunity. Therefore, investors should be prepared for volatility when adding positions to NOW.