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Thesis
ServiceNow, Inc. (NYSE: NOW) is set to deliver its Q3 earnings release on October 26 (Wednesday), with CEO Bill McDermott and the team under pressure to deliver. We highlighted in our post-Q2 update that we is expecting NOW’s May lows to hold steady.
However, the market decided to force a decisive breakdown in September after the CPI report suggested the Fed needed to be more aggressive in its rate hikes. As a result, we believe the market has reasonable additional de-rated high P/E stocks like NOW to reflect the Fed’s more hawkish posture.
Moreover, ServiceNow’s large ex-US exposure could also contribute to further vulnerability as the world moves closer to a global recession. The dollar index has also strengthened significantly since its Q2 card, further lifting the forex headwinds affecting ServiceNow’s Q3 operating performance. As such, we believe the market needs to de-risk ServiceNow’s implementation risks for FY23, with ServiceNow’s earnings on tap in Q3.
Our analysis suggests that NOW is at a critical juncture after shedding its important May lows. Also, the market forced another quick selloff that brought out an important low from May 2020. As a result, the market has diluted more than two years of gains as it tries to normalize its excess value from its highs. in 2021.
We remain bullish on NOW at its current valuations, even though its price action has weakened significantly since August. Therefore, investors looking to add to current levels should heed our caution that we are yet to get a bullish reversal at current levels. Therefore, downside risks of a steeper fall seem higher than in August if the market rejects its buying momentum at current levels.
Despite its battering, its NTM normalized P/E of 44x could still be a significant headwind if the market anticipates a worse-than-expected global recession. Therefore, investors are encouraged to layer over time to reduce allocation/timing risks due to NOW’s growth premium.
Accordingly, we reiterate our Buy rating at NOW.
ServiceNow Valuations at 5Y Lows
NOW NTM EBITDA multiple valuation trend (coiffine)
As seen above, NOW last traded at an NTM EBITDA multiple of 27.6x after falling below two standard deviation zones below its 5Y mean.
Hence, NOW is valued at a lower EBITDA multiple than its COVID lows. Despite this, we assess that the market could be positioned for significant changes in ServiceNow’s guidance after it is down nearly 36% from its August highs, severely underperforming the market.
A recent commentary by UBS (UBS) suggests that the potential for a revision to the guidance cannot be ignored, as it stated:
[Our] Reviews before the company’s Q3 results came back “mixed”, and perhaps a shade worse than his last round three months ago, with more partners than not missing the their Q3 ServiceNow training targets. – The fly
Furthermore, despite the recent battering, NOW still trades at a premium against its peers. Its NTM EBITDA multiple of 27.6x is higher than its peers’ median of 22.9x (according to S&P Cap IQ data). In addition, its NTM P/E of 44x is well above the S&P 500 software industry’s forward P/E of 24.9x. As such, we assess that the market needs to de-risk ServiceNow’s more aggressive growth estimates as we approach a potential global recession.
Is Stock NOW a Buy, Sell, or Hold?
NOW price chart (weekly) (TradingView)
With NOW breaking off its May lows, we believe the stage is now set for ServiceNow to report a Q3 report card with lowered guidance for FY23.
With valuations at 5Y lows, the market is likely to expect significant headwinds in FY23 for its global business. Despite this, we assume that its near and moderate downside is likely to be seen if ServiceNow does not deliver a bomb on its forward guidance.
We have parsed that NOW’s price action suggests it has broken its May lows and 200-week moving average (purple). This was a decisive win for the bears, as it turned the 200-week moving average into a resistance (for now) that buyers need to overcome for NOW to reverse its medium-term bullish bias.
Hence, we urge investors to watch NOW’s price action closely if it can recover its critical support level. Therefore, the initiative remains with the sellers for now. A bombshell guidance could see NOW lose its October lows, with a sharp selloff towards the gap between its near-term and long-term support. It should also improve its valuations significantly, digging out more of its COVID gains significantly.
As such, investors are encouraged to act tactically on NOW heading into its earnings, keeping spare ammo to capitalize on downside volatility.
We reiterate our Buy NOW rating.