Including Second-Quarter Results, I'm Neutral On Workday

| About: Workday (WDAY)

On June 4, 2013, I published an article titled "Workday: Set To Out Grow The Industry." In that article, I suggested that it would be a good time to look for entry spots to get long shares of Workday (NYSE:WDAY). Since that time, shares of Workday have increased from about the $60-$65 range to about $76. That implies a return of anywhere from 17% to 27%, which is pretty good. That said, it is time to analyze what has happened since I that time and determine if investors should continue to remain long shares of Workday.

Well, second-quarter results were just released. I think the second quarter was good: Revenue came in above expectations, but the operating cash flow was a little bit weak. With that factored in and the valuations updated, I think investors should be neutral on shares of Workday. I can't justify being long the stock anymore at 28 times sales and 16 times book value.

Recent Developments

  • Workday announced that WGBH Boston has selected Workday's full suite of enterprise cloud applications.
  • Workday announced that Schumacher Group added Workday Financial Management to the Workday Human Capital Management system, which was already in place.
  • Workday announced it continues to expand its business across Europe with new customers and deployments: Christie's International, Environmental Resources Management, IMC, King, and Spotify.

Business Profile

Workday provides enterprise cloud applications for human capital management, payroll, financial management, grants management, time tracking, procurement, employee expense management and analytics. The company offers innovative and adaptable technology focused on the consumer Internet experience and cloud delivery model. The applications are designed for global enterprises to manage complex and dynamic operating environments. Workday provides customers with highly adaptable, accessible and reliable applications to manage critical business functions that enable them to optimize their financial and human capital resources.

The company has one operating segment, cloud applications. Revenues are generated from subscription services and professional services. Just over 80% of consolidated revenue came from the U.S. Just under 40% of consolidated revenue was invested in research and development.

Workday has incurred significant losses since its inception in 2005. Management does not expect the company to become profitable in the foreseeable future. That said, if management decreases R&D spending, and selling and marketing expenditure each by 20% of revenue, the company would be profitable. Oracle (NASDAQ:ORCL) and SAP AG (NYSE:SAP) compete with Workday. Furthermore, Workday also competes with The Ultimate Software Group, Inc., Automatic Data Processing, Lawson, Inc., Ceridian, Concur Technologies, Inc., and NetSuite, Inc. (NYSE:N).

Workday could have a higher sales growth rate than competitors. Additionally, I'm bullish on the industry. I think its human capital management and FM offerings are competitive in the market. Plus, some large enterprises are diversifying by purchasing application offerings from companies other than Oracle and SAP.

Financial Performance Forecast

The previous revenue forecast that I was using for Workday estimated 2013 revenue at $439 million. Because second-quarter revenue came in at $107.6 million, I am increasing my revenue forecast to $450 million in 2013. The net loss as a percentage of revenue should be in the 33% to 38% range with the operating loss as a percentage of revenue in the 30% to 35% range.

Cash provided by operating activities is a yellow flag; there was a $10 million decline compared to the prior year's six-month period. The decline in cash provided by unearned revenue is a contributing factor. From the end of the fiscal fourth quarter to the end of the fiscal second quarter, current deferred revenue increased from $199.3 million to $247.3 million, which is positive for the valuations.

Revenue accelerated compared to the first-quarter year-over-year comparison, which is bullish for the valuations. Overall, this year is going pretty well thus far. Next, I'll examine the valuations. Including the new data, Workday is trading at 28 times sales and 15.8 times book. The last time I wrote about Workday it was trading at 17.4 times sales. The valuations are extended. I'm bullish on the stock, in general, but neutral at this valuation. In other words, I don't think it is a good short idea, and it is too expensive to be a good long idea.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.