Workday: Continues To Put In Work Despite Market Weakness

Summary

• Workday is still near their all-time highs, despite contracting over 20% pre-earnings during the broader market sell off.
• Q3 revenue grew 34%y/y which was ahead of consensus estimates for 30% y/y growth and an acceleration from Q2.
• With $3 billion run-rate in revenue, Workday is deserving of their premium valuation for the foreseeable future.

After falling 20% from their pre-earnings all-time highs, Workday (NASDAQ:WDAY) has proven to withstand the market correction and has now reached new all-time highs. This is a rather impressive feat given the overall weakness in the tech market, however, WDAY has rallied over 30% since reporting earnings.

WDAY remains the leading HCM company and among the best SaaS companies in the tech coverage. Despite a soft October and early November, WDAY reported another very strong beat and raise quarter with revenue growth accelerating. Their recent acquisition of Adaptive Insights gives them a strong place in the planning software market, competing directly with recent IPO, Anaplan (PLAN).

WDAY data by YCharts

In Q3, revenue grew an impressive 34% y/y, accelerating from Q2 and was ahead of consensus estimates for 30% y/y growth. Despite being the clear leader in the HCM market, WDAY continues to find ways to accelerate growth, which remains above 30%. This is very impressive for a company who just reported a run-rate revenue of nearly $3 billion.

With the stock rising above their previous all-time highs due to impressive and accelerating revenue growth, the current stock price may have fully priced in continued success. Trading at ~$165, WDAY’s valuation is currently above 10x forward revenue, a valuation that may scare off many investors given the recent market turbulence and fears of a market correction/recession.

Q3 Earnings and Guidance

WDAY recently acquired Adaptive Insights, a leading planning software player, competing directly with Anaplan (PLAN), who recently went public. Management remains very confident in software planning tools used in Financial Planning & Analysis. In Q3, WDAY saw their Financials subscription revenue grow more than 50%, a testament to both the growing power of Adaptive Insights and the software planning market.

Source: Company Presentation

In Q3, revenue grew 34% y/y to $743.2 million, reaching a near $3 billion annual run-rate. Revenue for the quarter also beat consensus estimates for $723 million (30% y/y growth). Although part of the revenue beat was due to the Adaptive Insights acquisition, any company growing revenue nearly 35% at this size deserves to trade at a premium multiple.

Subscription revenue of $624 million grew 35% y/y with only $4 million coming from the Adaptive Insights acquisition. Management noted the subscription revenue upside was driven by strong performance across all of their product suites. Subscription revenue is one of the key areas of growth investors look for as it helps them determine the recurring revenue visibility. With nearly 85% of revenue derived from subscription revenue, investors feel very comfortable with this revenue base, placing a higher multiple on the name.

WDAY’s growth has remained very impressive for several years as they have captured a large share of the domestic market. However, their next area of growth is likely to come from international markets. International revenue is approaching 25% of overall revenue, however, is growing at a much faster rate at 47% y/y growth during Q3. With lower penetration in international markets, WDAY has a significant opportunity to maintain their 30%+ y/y growth rate for a few more years.

WDAY continues to post very strong margins, with subscription gross margins of 83.5%, a slight decline from 84.5% in the year ago period. In addition, operating margins decline from 9.0% in the year ago period to 6.7% in Q3. Although margins, both gross and operating, declined y/y, part of the reason is likely due to the near term expenses related to the Adaptive Insights acquisition. Nonetheless, margins remain very healthy and strong compared to the broader tech market.

WDAY also reported a healthy EPS of $0.31 compared to consensus estimates of $0.14. The significant earnings beat is largely attributed to greater than expected revenue growth in addition to margins remaining strong.

Management also provided a small insight into FY20 guidance, with subscription revenue of ~$3.0b billion, representing ~ 26.5% y/y growth. Although this is a slowdown from Q3’s subscription revenue growth of 35% y/y, WDAY typically beats their guidance on almost all accounts. I would not be shocked to see subscription revenue grow closer to 30%+ y/y by the end of FY20.

In addition, management noted they expect operating margins to improve 200bps y/y with the Adaptive Insights headwind to turn into tailwinds by the end of the year. Essentially, management sees WDAY’s $3 billion+ revenue growing around 35% y/y to slow down and in turn, increase their level of profitability.

Management also updated their full year guidance, now expecting revenue to grow 33% y/y to $2.375-2.377 billion. The 33% y/y growth rate is extremely impressive for a company this size given many smaller companies (some of which are new to the public arena) experience a similar growth rate off a much smaller revenue base.

Valuation

There are few tech names that are able to consistently generate revenue growth in excess of 30% y/y and even fewer who are able to do so off a large revenue base. WDAY’s valuation remains challenging due to a lack of a clear peer group exhibiting 30% y/y revenue growth at a $3+ billion run-rate revenue base. Salesforce (CRM) is one of the few names constantly compared to WDAY because of their leadership in the cloud software space. Their growth rate and level of profitability is somewhat comparable to WDAY.

WDAY EV to Revenues (Forward) data by YCharts

Despite having a premium valuation, WDAY is deserving of this. There are very few companies in the tech space that have held up over the past few weeks during the correction. Investors remain very bullish about the growth trajectory of WDAY and I believe they have the potential to continue growing revenue 25-30% y/y for many years to come.

WDAY has a significant opportunity to maintain their revenue growth rate as the international market remains relatively underpenetrated and represents nearly 25% of WDAY revenues. Growing at 47% y/y this past quarter, WDAY should be able to maintain their overall revenue growth rate and focus more on profitability in the more mature domestic market.

Risks to WDAY include a slowdown in international growth or inability to generate consistent profitability. In addition, the acquisition of Adaptive Insights may also pose an integration risk. The stock price may also be under pressure if the market continues to be volatile as higher-valued tech names are typically the first ones to correct and re-rate lower.

With the stock floating around all-time highs right now, it may be challenging to build a new position in this name. However, over the long-term, WDAY is a clear leader in the HCM industry. This name is one to be held in a portfolio for the long-term and look to buy off any weakness.

Analyst’s Disclosure: I/we 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.