Shares of Workday (WDAY 3.32%) plunged 11% on Oct. 16 after the enterprise cloud services provider's analyst day presentation failed to impress investors. Workday stated that its core human capital management (HCM) revenue would only rise about 20% this year, marking a slowdown from previous years.
That comment cast a dark cloud over Workday's future, but its stock still trades at over 70 times forward earnings after giving up its year-to-date gains. Let's take a closer look at this cloud company to see if it deserves that premium valuation.
Image source: Getty Images.
What happened to Workday?
Workday's HCM platform lets companies staff, organize, and pay their workforces. Companies can also use its analytics tools to make data-driven business decisions, and its financial tools to oversee their budgets.
Workday's HCM platform already serves over 40% of the Fortune 500, including heavyweights like Walmart, Target, and Bank of America. On the surface, Workday's revenue growth looks rock solid.
|
YOY growth |
Q2 2019 |
Q3 2019 |
Q4 2019 |
Q1 2020 |
Q2 2020 |
|---|---|---|---|---|---|
|
Revenue |
28% |
34% |
35% |
33% |
32% |
YOY = Year-over-year Source: Workday quarterly reports.
However, there's a growing concern that Workday is running out of room to grow in the HCM market. In response, it's expanding its ecosystem by cross-selling new services tools for ERP (enterprise resource planning), financial tools, analytics, and credential management.
Unfortunately, tech giants like Oracle, SAP, Salesforce, and Microsoft are all bundling similar tools into their cloud-based services. Workday is also courting smaller companies and overseas customers, which are more exposed to macro headwinds than big Fortune 500 companies. These moves indicate that it's expanding into less reliable markets to offset the slowdown of its core HCM business.
How did the analysts react?
Several analysts immediately expressed their concerns after Workday's analyst day presentation. RBC Capital, which maintained an "outperform" rating on the stock, cut Workday's price target from $225 to $212 and warned that its growth was slowing due to a high "penetration of large accounts." Analysts at Stifel and Deutsche Bank echoed similar concerns about its HCM business.
Macquarie, which maintained a "neutral" rating with a $196 price target, warned that several of Workday's new products (like ERP, analytics, and blockchain-enabled credential tools) would be "difficult to monetize." Citi, which rates the stock as "neutral" with a $192 price target, dubbed its shift toward international and mid-market customers as "lower-confidence sources of growth."
Image source: Getty Images.
Jefferies, which maintained a "hold" rating with a $188 target, also noted that similar software-as-a-service (SaaS) companies are growing at comparable rates with higher margins and cheaper valuations.
Analysts currently expect Workday's revenue to rise just 27% this year and decelerate to 23% next year. Its adjusted earnings, which exclude stock-based compensation and other one-time expenses, are expected to rise 24% this year and 31% next year. Workday, like many high-growth cloud companies, still isn't profitable on a GAAP basis.
Was the sell-off an overreaction?
Investors should always take analysts' comments with a grain of salt, but they highlight valid points about Workday's shift toward less reliable markets and its valuations. It also isn't tough to find other cloud stocks with wider moats and more attractive valuations than Workday.
One notable example is Veeva Systems (VEEV 1.41%), which provides cloud services to life science companies. Veeva doesn't face any meaningful competitors, and analysts expect its revenue and adjusted earnings to rise 24% and 30%, respectively, this year. It's also one of the few cloud companies to remain profitable by both GAAP and non-GAAP measures. Yet Veeva trades at just over 60 times forward earnings, compared to Workday's forward P/E of 72.
Therefore, it wasn't surprising when Workday's stock plummeted after its presentation. Its stock was priced to perfection, but the company couldn't deliver the growth that its valuation demanded. Workday still deserves to trade at a slight premium to its growth rate, but the stock still looks frothy at these levels -- so investors should wait for a pullback or check out stronger cloud plays like Veeva instead.
