Avalara: Expensive But Solid Tax Software

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About: Avalara, Inc. (AVLR), Includes: W
by: Individual Investing Ideas
Summary

Avalara continues to trade around near all-time highs after reporting a strong Q4 earnings and solid 2019 guidance.

The company has a lot of potential room to run stemming from last year's Supreme Court ruling regarding e-Commerce tax laws.

Trading at nearly 11x forward revenue, the stock is not cheap, although there could be some upside to revenue over the next few quarters.

Avalara (AVLR) continues their ride to new all-time highs, riding off the backs of strong investor optimism. After going public in the middle of June 2018, the stock went on a volatile spiral downward and eventually traded down nearly 35%. However, since December lows, the stock has risen over 70% on the back on consecutive strong earnings reports and optimism around the South Dakota v. Wayfair (W) Supreme Court case.

AVLR reported very strong Q4 revenue that was ~8% above consensus expectations in addition to billings growth of 42%, which accelerated from 34% last quarter. The company continues to experience a tailwind from the Supreme Court ruling and management's 2019 guidance could have some additional upside to it.

Chart Data by YCharts

After reporting Q4 earnings and providing initial 2019 guidance, AVLR stock popped over 16% the following day of trading and has continued their upward trend, trading up nearly 25% since last month's earnings. Investors have seemed to become more comfortable in the growth trajectory of the business and both revenue and billings growth in the quarter were above consensus estimates.

There are still some questions concerning the company's operating margins and guidance, as some could believe their guidance is conservative and may not portray the true potential growth of the company. I believe over the long-term, AVLR will positively surprise the investing base and continue their upward trend.

Brief Background

One of the biggest drivers for AVLR is the Supreme Court ruling from the South Dakota V Wayfair case. In this court case, the Supreme Court ruled that online retailers are required to charge state sales taxes. This overturned a previous court case which barred states from placing sales taxes on online sales unless the company was substantially related to the state.

Although there are varying estimates on how big the additional tax could be, this tailwind will surely help AVLR who speciate in sales tax compliance. As the number of tax filers will increase, especially in smaller states, such as South Dakota, there will be a bigger reliance on tax software compliance companies, such as AVLR.

Over the course of 2019, there will be several larger states where the state tax changes will come into effect, most notably California, Texas, and New York. The Supreme Court decision had led to over 30 states to adopt that sales tax changes, which are driven by the actual economic activity of the transaction rather than the location of the transaction.

Q4 Earnings and Guidance

AVLR reported another strong earnings report with revenue of $76.9 million and grew 35%, which was nearly 8% above consensus expectations for $71.3 million. Subscription revenue, which tends to be stickier and gives management better visibility, grew 33% for the quarter to $71.7 million, representing 93% of total revenue. Billings were also strong for the quarter coming in at 42% growth, up from 34% growth AVLR had in the last quarter. The significant acceleration in billings was largely driven by continued strong execution and the beneficial tailwinds stemming from the Supreme Court decision.

Source: Company Presentation

For the quarter, gross margins came in at 73%, compressing from the 76% in the year ago period. However for the full year, gross margins were 73% and only compressed slightly from 75% last year. Despite the revenue beat, operating margins remained surpassed at -17% and came in slightly below consensus expectations. This led to an EPS loss of $0.19, which was in line with consensus expectations.

AVLR also added 580 core customers during the quarter which represented a significant increase from 238 in the year ago period and 410 last quarter. The company will likely continue to experience high growth in their core customers due to the Supreme Court ruling and AVLR's market leading tax software compliance offerings.

Source: Company Presentation

AVLR also continues to post impressive net revenue retention rates, with the latest quarter coming in at 108%. Over the past eight quarters, net revenue retention has ranged from 105-109%, showing the company's consistency to maintain this above the coveted 100% mark.

Source: Company Presentation

Management also provided guidance for Q1 and 2019. For Q1, management expects revenue between $78-79 million with non-GAAP operating loss of $10-11 million, representing a -13.4% margin at the midpoint.

For the full year, management expects revenue between $328-332 million with a non-GAAP operating loss between $30-35 million, representing an operating margin of -9.8% for the full year. As the Supreme Court ruling is still relatively new and some of the larger states are still being ramped up, I believe there is continued upside to the revenue guidance. However, as the company grows at a faster rate, they will likely experience higher operating expenses, which could keep operating margins surpassed for the time being.

Valuation

Right now, valuation is still challenging to grasp given AVLR's largely unknown market potential and uncertainty around what the long-term revenue growth rate and margin potential could be.

When looking at management's 2019 revenue guidance of $328-332 million, this represents ~22% growth at the midpoint, which I see to be conservative and ultimately beatable throughout the year.

AVLR currently has a market cap ~$3.75 billion and with cash of $142 million, the company has an enterprise value ~$3.6 billion. Using management's 2019 guidance, AVLR currently trades at ~10.9x 2019 revenue, quite an expensive multiple to pay in the current environment. However, I believe AVLR will ultimately beat their 2019 revenue guidance and quite possible post multiple beat and raise quarters this year. I think revenue could end up closer to the $350-360 million range (and could even see further upside depending on how fast the larger states ramp up on the new tax laws). Using the potential upside revenue range, AVLR is trading closer to 10x 2019 revenue.

Chart Data by YCharts

The market remains filled with several SaaS companies with 20%+ revenue growth trading at expensive multiples and the above chart reflects only a very small subset. However, it goes to demonstrate that SaaS companies have vary greatly on their forward revenue multiple and some of the leading, more industry-leading SaaS companies have a higher multiple than AVLR.

With the stock trading near all-time highs right now, it is challenging to justify building a large position in this name. However, if one were to afford a riskier portfolio, this would be one name to include on the list. There are several levers the company is able to pull over the next year which could drive revenue to the upside of guidance. As more and more states roll out the new tax rule stemming from the Supreme Court ruling, AVLR has a lot of potential room to run.

At nearly 11x 2019 revenue, I am hesitant to build a position, however, I will definitely be looking at any meaningful pullbacks in the name to take advantage of. I believe over the next 12-18 months, AVLR has a lot of potential revenue streams and ability to demonstrate their long-term viability.

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.