SPS Commerce (NASDAQ:SPSC) reported another strong, consistent quarter with revenue, EBITDA, and EPS all above expectations. The stock was up ~7% after the strong earnings where management also raised 2019 guidance that was ahead of expectations. While boasting a market cap of only $1.8 billion, this name seems to fly under the radar for a software company growing 13% with EBITDA margins of ~25%.
Although the stock is not nearly as fast of a revenue grower compared to some of the leading software players in the market, SPSC provides a level of consistency that not many software companies are able to provide. The company actually notes they have achieved 75 consecutive quarters of revenue growth, an impressive track record no matter the size or scale of the company.
I believe part of the reason why SPSC remains under the radar is due to their valuation. At ~5.2x forward revenue and ~19.3x forward adjusted EBITDA, the stock is not cheap for their growth profile. However, the company is positioned correctly in a faster growing part of the software market. SPSC provides cloud-based supply chain management software to retailers, suppliers, third-party logistics, providers, and other partners. While the company is a little more exposed to the retail cycle, software sales tend to be stickier and more difficult for companies to quickly replace.
While the stock is up nearly 30% year to date, the recent earnings reinforce the long-term growth and margin expansion potential the company has. Though the stock is only 5% below their all-time high of ~57, this is one name investors should keep their eye on in case valuation ever reaches a more attractive entry point.
SPSC competes in the Electronic Data Interchange part of the market, which looks to automate the communication between retailers and their suppliers. Rather than manually working with their suppliers, SPSC aims to converge all communication to an electronic platform via their cloud-based software. Retailers would be able to automatically order their goods with suppliers automatically shipping them.
In addition, SPSC's software will help retailers analyze the data, helping their customers optimize their inventory and supply chain management functions. As the retail world becomes more digital, companies are constantly looking for ways to improve their operations and streamline any efficiencies.
During the quarter, SPSC grew their revenue 13% to $70.9 million, which marked the 75th consecutive quarter of revenue growth. Q3 revenue was also above consensus estimates of ~$70 million, rather impressive considering the consistency the company has displayed over the past 20 years.
Source: Company Presentation
Gross margins continued to remain strong at 67.2%, compared to 67.5% in the year ago period. As the company continues to scale, gross margins should start to expand a little bit more given the fixed cost nature of the business. In other words, a higher revenue value less the same amount of fixed costs will yield a better gross margin.
Also during the quarter, the company had 662 net new customer adds, which is up from 423 net new adds during the last quarter. While Q3 did have a ~100 benefit from the MAPADOC acquisition, 562 net new customer adds remains impressive.Source: Company Presentation
I believe a better financial metric for SPSC is their EBTIDA and EBITDA margin. During the quarter, EBITDA grew nearly 26% to $18.1 million and was nearly $1 million better than consensus expectations. Adjusted EBITDA margin of 25.4% expanded 260bps from the year ago adjusted EBITDA margin of 22.8%. A large function of the margin expansion is driven by the fixed cost nature of the business.
Given SPSC's revenue has a large software function to it, as revenue grows, the incremental margins are better than the company average. Over time, it is plausible that margins continue to expand as the company gains scale and we could end up seeing adjusted EBITDA margins closer to 30-35%.
The combination of revenue and adjusted EBITDA beating expectations led to EPS for the quarter of $0.33, which was above consensus expectations of ~$0.28.
For Q4, revenue is expected to be $72.2-72.8 million, which is slightly above expectations of ~$72 million. While above expectations, I believe guidance could be slightly conservative as revenue growth represents 11-12%, compared to 13% during Q3. Adjusted EBITDA is expected to be $17.9-18.4 million, representing ~25% margin at the midpoint. Finally, EPS is expected to be $0.29-0.30.
Management also provided an insight into 2020 guidance, noting ~10% revenue growth and ~20% EBITDA growth. While these estimates show signs of deceleration, I believe they are slightly conservative as management talked about starting to see some stabilization in the retail end-market. As the company starts to deploy more resources for that end-market, we could see some upside to initial 2020 guidance.
SPSC also announced a $50 million increase to their share repurchase program, which will now go through November 2021. This is another layer of potential upside to earnings as the company now has more firepower to repurchase shares if their stock experiences a period of weakness.
Given the relative size of SPSC, there are no true pure-play competitors. However, investors can still look at similar valuation metrics. SPSC has a long history of consistent revenue growth, now reaching 75 consecutive quarters. EBITDA margins continue to remain healthy at ~25%, which I believe could expand to 30-35% over the long term given the fixed cost structure of the company.
Given management's 2019 revenue guidance of $278.6-279.2 million and adjusted EBITDA of $68.8-69.3 million, we can start to build out a 2020 scenario. Early 2020 guidance includes revenue growth of 10% and adjusted EBITDA growth of 20%.
While the remaining 2019 guidance could be slightly conservative, let's assume both revenue and adjusted EBITDA come in at the midpoint. Using ~$279 million in revenue and ~$69 million in adjusted EBITDA as a base, we can grow from there. If revenue and adjusted EBITDA follow management's 10% and 20% guidance respectively, this could result in 2020 revenue of ~$307 million and adjusted EBITDA of ~$83 million.
With a current market cap of ~$1.82 billion and net cash/investments of ~$200 million, this results in a current enterprise value of ~$1.6 billion. Using our above 2020 revenue and adjusted EBITDA potentials, this results in a 2020 revenue multiple of ~5.2x and a 2020 adjusted EBITDA multiple of ~19.3x.
While these metrics seem like the stock is currently fully priced in for a successful year, there could be some additional upside to what seems like a somewhat conservative guidance. If revenue were to grow closer to 12-14% with margins expanding a little more than guidance, we could see upside to 2020 metrics.
With the current stock price ~$52 after the recent post-earnings outperformance, it appears the stock is fully priced in following management's 2020 early guidance metrics. However, if the stock were to go through a pullback or the retail end-market starts to show more signs of life, I would be eager to build up a position in the name.
Fundamentals remain healthy and management's early look into 2020 guidance gives long-term investors confidence in another successful year of growth. The main thing keeping me on the sidelines for now is valuation.
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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.