Over the past few months, investors have seen many high-value technology stocks impacted as the market adjusts to rising rates and fears around an economic recession. Service Today (NYSE: NOW) seen their stock pullback is around 25% so far this year, which is quite similar to the NASDAQ pullback, which is mostly made up of technology stocks.
The company recently reported a strong start to the year with revenue growing 26.5% to $ 1.72 billion and more than expected. While there was some margin pressure in the quarter, the company’s free cash flow margin of 45% was very strong.
In the long run, I believe the company will continue to grow revenue by more than 20%, including management’s guidance of 28.5% yoy subscription revenue growth (in the same currency). Investors may start to focus less on margin expansion due to fears of a potential recession increase, and management’s 25% margin guidance for 2022 should be viewed positively due to increased pressures on margin from wage inflation and adverse effects on money.
From a valuation standpoint, the stock is currently trading around 12.5x forward revenue, which seems to fit the price in the face of strong growth expectations. With a Rule of 40 score of 51 in the most recent quarter, a premium valuation is definitely deserved, though I would hesitate to call for mid-teens valuation multiples in the current market environment.
For now, I think investors might be better off waiting for a better entry point. If the stock pulls back closer to $ 400 or is analyzing closer to 10x forward earnings, I am likely to be more bullish for near-term outperformance.
From a long -term perspective, I believe investors should continue to trust the algorithm and growth potential.
Q1 Financial Analysis
During the company’s recently reported earnings in Q1, revenue grew 26.5% yoy to $ 1.72 billion, exceeding consensus expectations of $ 20 million. Most of the company’s revenue stream is subscription-based, with subscription revenue growing 26% yoy to $ 1.63 billion (29% yoy growth on a constant currency basis), representing ~ 95% of total revenue. company.
Additionally, outstanding performance obligations, which are a good indicator of future revenue growth, grew an impressive 30% yoy (or 31.5% yoy on a constant monetary basis) to $ 11.5 billion. Regarding strong performance in the quarter, management cited a strong demand environment, facing accelerated enterprise spending on digital solutions we’ve seen across the industry.
We are in a sustainable environment of demand. Companies invest with a sense of urgency in technologies that bring them the right results, quickly. It is very clear that businesses can no longer return to the ‘status quo.’ We are now in the world of tech ‑ to ‑ compete. The ServiceNow Platform enables employees, customers, and citizen developers with the experiences they want.
In addition to strong topline growth metrics, the company maintains a relatively stable non-GAAP operating margin. In Q1, margins came in at 25%, down ~ 200bps from last year, although somewhat similar to the previous few quarters of 23-26% margins. I believe that investors will start to put more emphasis on profitability, especially since the company’s revenue growth naturally decreases due to the law of large numbers.
Even with slight margin pressure, the company’s 26% revenue growth plus a 25% margin results in a Rule 40 mark of 51, which continues to be above the 40-level.
However, I admire the company’s 45% free cash flow margin. Three of the past five quarters have been around the 45-46% free cash flow margin level, giving the company a substantial amount of capital to reinvest for growth.
One of the biggest drivers of a company’s growth is their ability to expand customer relationships. In the last quarter alone, the company had 52 new transactions with> $ 1 million in net new annual contract value, representing a 41% yoy growth.
With a total of 1,401 customers with> $ 1 million of ACV, the company continues to lead in larger deals. In fact, the average ACV of customers with> $ 1 million of ACV reached a new high of $ 3.9 million, from $ 3.8 million last quarter and $ 3.5 million last year.
I believe this is the biggest point of proof on how ServiceNow will continue to grow, as there remains huge space for penetration within their current client base. Not only is the company signing more ACV contracts> $ 1 million, but the average ACV of their large contracts continues to rise, meaning customers are willing to continue to increase their spending on ServiceNow.
For Q2, the company expects subscription revenue of $ 1.67-1.68 billion, reflecting 29% yoy growth in continued currency. In addition, the non-GAAP operating margin is expected to be 22%, which would be a ~ 300bps yoy contraction.
For the full year 2022, subscription revenue is expected to be $ 7.025-7.04 billion, reflecting 28.5% yoy growth in the same currency. In the middle, it shows a $ 3 million increase in their guide, however, bad money brings an additional $ 20 million headwind until 2022, meaning the main guide revenue increase is actually $ 23 million.
From a non-GAAP operating income margin viewpoint, the guide would require 25%, which would be similar to the 2021 margin. The free cash flow margin is expected to be 31%, which will drop by 50bps yoy.
At first glance, the company’s updated guide isn’t too impressive. However, after excluding adverse monetary effects, major business trends seem strong and a guide increase, or even repetition, in the current macro environment is a good place to be.
With the stock down about 25% year to date, ServiceNow has maintained well compared to the NASDAQ which has also dropped about 25%. However, investors should continue to look at the long -term thesis when making an investment decision.
Yes, the company’s revenue growth will slow slightly in the coming years, but that’s to be expected due to the $ 7+ billion revenue guidance and the law of large numbers coming in. I understand how some investors may worry about non-GAAP operating margins remaining flat relative to 2021, but given the challenging macro environment such as high wage inflation and adverse currency effects, the underlying the trend doesn’t look good.
The stock is currently trading at approximately 12.5x forward profit, which seems right given the current mix of earnings and profitability. Yes, revenue growth remains shy of 30% yoy, which is a very strong place to be. And yes, the non-GAAP operating margin of around 25% is strong.
However, it appears to have been priced in stock given the current analysis. With the stock returning to just over $ 400 a few weeks ago, investors quickly saw a 10% pop, giving me greater confidence in a potential floor. Although there is a challenging macro backdrop and valuation that seems to be in good place, I’m hesitant to be ultra-bullish right now.
Since the stock is currently trading at approximately $ 475, I believe long-term investors will be rewarded, though I believe we will see some volatility in the coming quarters as investors with the right mix of income/profitability and valuation. .