HubSpot: 2019 Guidance Reflected By Premium Valuation

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About: HubSpot, Inc. (HUBS)
by: Individual Investing Ideas
Summary

HubSpot has performed exceptionally well year to date even after a strong 2018 performance.

Q4 revenue grew 35% and 2018 revenue growth ended up at 37%, very impressive for a company that just surpassed the $500 million revenue figure.

Current valuation appears to price in a very strong 2019 performance and likely includes revenue coming in ahead of management's guidance.

HubSpot (HUBS) has been a volatile stock over the past few months, at one point down nearly 30% from their high and now up over 40% since. The stock was a big success in 2018 and is off to another hot start in 2019. The company is coming off a solid Q4 earnings report and 2019 guidance that pleased the investing community.

Despite revenue growth decelerating slightly in Q3, the company reported Q4 revenue growth of 35%, the same growth rate as Q3. The nice performance in revenue growth led to a full year revenue growth of 37%, quite impressive for a company that had $513 million in revenue.

Chart Data by YCharts

Despite being up over 40% year to date, investors continue to love this name and continue to push the price up higher. Although the stock is ~5% below all-time highs, the name continues to have positive momentum heading into 2019, backed by management's continued positivity around 2019 guidance.

Investors quickly became very comfortable with HUBS during the most recent stock market correction. The risk/reward benefit was very positive as valuation contracted and revenue growth was still 35%+.

The stock has been a winner year to date, up ~30%. This continues to remain impressive as some of the other tech names have reported okay earnings but guidance falling below consensus expectations. HUBS valuation continues to trade at a premium, although this appears to be warranted given the solid performance in 2018 and the outlook for 2019.

Q4 Earnings And Guidance

During Q4, revenue grew 35% y/y to $144.0 million, which beat consensus estimates. I believe consensus estimates were rather weak to begin with, as HUBS posted a 38% growth rate in Q2 and 35% growth in Q3. They were likely expecting another sequential deceleration in revenue, however, HUBS posted a very solid quarter. For the full year, the company reported revenue of $513 million, which grew 35% compared to 2017.

Source: Company Presentation

During the quarter, subscription revenue grew at an impressive 35% rate and now represents 95% of total revenue. Although professional services and other revenue continues to grow at a much faster pace, at 49% during Q4, their contribution to revenue remains very minimal and does not impact the overall growth rate of the company.

Source: Company Presentation

Despite the company performing very well, margins have remained flattish, albeit at a very high margin. For the year, subscription margins were 86.3%, which expanded slightly from 85.8% last year. Because of their software-centric operating model and subscription-based sales, the company will continue to perform at high margin levels. This ultimately flows through to the bottom line as over time, as the company matures and gains a greater customer base, operating expenses will naturally slow down. This will lead to greater profitability and cash flow.

Also during the year, the company was able to grow their customer base by 36%, ending the year at 56,628 customers. In addition, the total average subscription revenue per customer eclipsed the $10k rate, which was down 2% from the year-ago period. Part of this is because of the company's rapid customer expansion. New customers tend to have lower contract value which naturally increases over time.

Source: Company Presentation

Part of the company's strong revenue growth trajectory comes from their ability to expand internationally. Since Q3 2014, HUBS has been able to grow international revenues at a 65% CAGR. At the time, international revenue represented only 22% of total revenue. As of Q4, international revenue represented 38% of total revenue. As the company continues to increase internationally and further penetrating their customer's wallet, we could see revenue growth above 25% for a few more years.

Source: Company Presentation

Management also provided guidance for Q1 and the full year. For Q1, management expects total revenue to be $146.5-147.5 million with operating income of $9.5-10.5 million, representing ~7% margin at the midpoint. In addition, management is expecting EPS of $0.23-0.25.

For the full year, management expects revenue of $648-652 million, which represents growth of ~27% at the midpoint. The 27% revenue growth implies a somewhat significant deceleration from 37% in 2018. However, as the company's revenue has expanded to a meaningful base, deceleration is naturally going to occur. Operating income is expected to be $46-50 million, representing a 7.3% margin at the midpoint. Management is also expecting EPS of $1.08-1.16 for the full year.

Source: Company Presentation

Management also provided insight into their long-term guidance. Management sees gross margins remaining in the 81-83% range, which implies a slight expansion from 2018 gross margins of 80.4%. With subscription revenue representing ~95% of total revenue and coming with higher margins, this long-term target is definitely achievable.

As the company slows down their top line growth, it is natural to see operating margins expand. Management is expecting operating margins to expand to 20-25% over the long term, driven by significantly lower R&D and S&M expenses. Although these expenses will vary on a quarterly basis, over the long term, I believe the company can achieve these goals.

Valuation

Although valuation has contracted a bit over the past few weeks, HUBS still holds a rather high premium valuation. With management's guidance implying revenue growth of 27% for 2019, decelerating from 35% in 2018, one would expect valuation to not be so high.

Chart Data by YCharts

Not too long ago, forward revenue valuation was approaching 12x, at which the stock was trading near all-time highs. However, the big stock market correction near the end of 2018 eventually caused HUBS valuation to fall below 7x. Shares were very attractive at that time as investors saw the long-term revenue growth potential and long-term path to profitability.

However, with the stock back up to near all-time highs and valuation at 9.5x forward revenue, it seems as if investors are expecting a solid 2019 performance and I am not too sure if there is much upside remaining.

For now, I remain on the sidelines and will wait for a better buying opportunity. For investors who currently own shares, it is worth it to hold onto them. However, with valuation rising 2-3 turns over the past few months, I would be skeptical to believe there is much room left for continued multiple expansion.

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.