Workday Inc. (WDAY, Financial) engineers cloud-based software for clients interested in consolidating their management systems and data. It essentially serves as a one-stop shop for companies – both large and small – to get their management and human resources technical needs met.
Workday is ramping up revenue growth, adjusting its pricing schemes, developing new products and cultivating a strong customer base. Overall, the company is still suffering from anemic earnings, and it continues to run at a significant loss. The outlook for the future is positive, however, and as revenue increases, the goal is to bring the company into the black.
In today’s research note, we take a look at Workday and explain why it is worth keeping an eye on.
Solid revenue trend
Workday is growing. There’s no doubting that.
Revenue has increased steadily every year for quite a stretch. The rate of increase is the most promising factor of all. Over the last three years, revenue has increased annually by 47%, 36% and 27% respectively. That is an average annual rate of almost 37%. If Workday can continue to grow at such an explosive rate, the company should surpass $5 billion within about three years. This is solid growth, although it is important to remark on the decrease in growth rate seen over the last three years.
Relative to revenue alone, the share price is not outrageously overvalued. Of course, the price-earnings ratio is fairly meaningless when the company is running at a significant loss, but revenue trends can give us some manner of insight.
But costs are high
Now, cost is the other important factor. From a cost analysis, it is clear that Workday’s revenue and growth are coming at a significant financial cost. Cost of revenue has increased steadily, remaining fairly in line with revenue. For 2017, cost of revenue was 29% of revenue. That is not unreasonable and low compared to many consumer goods companies, for instance.
The problems arise when you look at increasingly out-of-control research and development costs, as well as high sales and administrative expenses. No doubt Workday needs to ramp up spending to increase revenue and brand exposure, but it is a delicate balancing act to prevent costs from ballooning out of control. Operating expenses continue to exceed gross profit year in and year out.
This standoff between revenue and costs has, predictably, affected earnings, which remain negative. There are some signs of a positive trend, however. Earnings per share over the last four quarters have been -19 cents, -32 cents, -35 cents and -35 cents. The most recent earnings per share report of -19 cents was the best result in a long time, and a 39% positive surprise.
A future in the clouds
Workday is in the business of the future and it has been thriving thus far. Most of Workday’s revenue comes from clients of its subscription-based services, which means these are not one-off purchases. The company can count on continued revenue flow. Further, it is operating in a fairly healthy financial state, including almost $2 billion in cash and posting $300 million in free cash flow, despite the persistent net losses.
The biggest reservation about Workday is, unsurprisingly, earnings. Yes, the company can continue on goodwill and a strong revenue growth story. But eventually a company that cannot turn a profit will fall out of favor with investors.
Nonetheless, Workday appears moderately well-positioned to rise to the occasion. Its leadership team is composed of human resources software veterans from the former PeopleSoft and they have been through this entire game before. They believe that if they can grow the business enough, revenue will outpace costs and bring the company into positive earnings land.
At least in the short term, there is no reason to doubt the effectiveness of this plan or the market’s assessment of it, though it is hardly a value story.
Disclosure: I/We own no stocks mentioned in this article.
