Okta: Q4 Earnings, Avoid This Stock For Now, Here's Why

Summary

• Okta put out topline guidance slightly above its previously discussed targets, pointing to an approximately 38% y/y  revenue increase.
• The biggest blemish in its Q4 results is that its profit margins are rapidly moving in the wrong direction, and are guided to become more negative.
• It becomes increasingly difficult to justify its elevated valuation of 16x forward sales.
• I do much more than just articles at Deep Value Returns: Members get access to model portfolios, regular updates, a chat room, and more. Learn More »

Vertigo3d/E+ via Getty Images

Investment Thesis

Okta (NASDAQ:OKTA) put out strong revenue guidance for the year ahead. However, its bottom line profitability is evidently moving in the wrong direction.

Management remarks that its acquisition of Auth0, an early-stage business, has a very different profitability profile from Okta's standalone business.

From many different perspectives, it appears to be the case that the more Okta grows the worst its profits margins become.

Ultimately, it's now too difficult to support its valuation. Investors will do well to avoid this name.

Investor Sentiment Starts to Dry Up For Okta

Data by YCharts

Last month I concluded my Okta article by saying,

[...] if this was 2021, when investors are more than willing to buy anything that is well positioned to grow, while embracing meaningful bottom line losses, the stock would do quite well.

The problem here, is that new investors coming to the stock are looking at a company, that isn't particularly cheap, at 18x forward sales, with mounting losses.

Given this renewed context, I believe that there are better investment opportunities elsewhere.

Along with this theme, I'll continue today's note.

Okta's Revenue Growth Rates Remain Strong

Okta's revenue growth rates

As you can see above, Okta's revenue growth rates remain fairly strong as we head into fiscal 2023.

If you follow Okta closely, this should come to you as no real surprise as management has consistently argued that Okta is expected to grow by 35% CAGR over the next several years. Thus, this should put investors' minds at ease, that Okta's runway above 35% CAGR remains long.

Furthermore, as you can see below, current billings are up very strongly in Q4 2022.

Okta Q4 2022 investor presentation

Billings are a leading indicator of revenues yet to be recognized. In the ideal scenario, you want to see billings higher than revenues, as this indicates that there are plenty of revenues still to be recognized in the coming year.

What you see above is the billings are not only ''just'' higher than revenues, but they are in fact meaningfully higher than revenues.

Why Okta?

Okta allows the right user to get access to technology. Through its flagship product, Single Sign-On (''SSO''), users only need to verify their credentials once and get access to any platform, device, or application.

As companies migrate to the cloud, they are increasingly forced to replace their legacy identity access management (“IAM”) infrastructure. Okta solves a serious customer frustration with its Okta Identity Cloud.

During the earnings call, we heard Okta's management highlighting the success of its core product aimed at workforce solutions during the quarter, as well as, Okta's increased focus on customer identity solutions.

As you may recall, Okta's large acquisition of Auth0 for $6.5 billion last May was made to give Okta a foothold into servicing customer identity problems.

Furthermore, as you would expect, given the backdrop of investors' worries over security concerns, Okta declared that its position as the leading identity management platform has strong tailwinds as customers and enterprises are increasingly forced to work in a zero-trust environment.

Okta's Profitability Profile Leaves Much to be Desired

Okta Q4 2022 investor presentation

As you can see above, Okta's bottom line profitability took a turn for the worst in Q4 2022, with its non-GAAP operating margins reporting negative 6.2% compared with positive 3.4% in the same period a year ago.

For the year ahead, Okta's guiding investors towards negative 10% non-GAAP operating margins.

Once you consider that Okta finished fiscal 2022 with negative 5.7% operating margins, it appears to be the case that the more Okta grows, the less profitable it becomes.

Will Okta over the next several years report "clean" profits? That's difficult to say. What we can say is that over the next twelve months that will categorically not be the case.

Okta Q4 2022 investor presentation

If you follow Okta closely, you'll know that the bulk of the bull thesis is focused on Okta having a high Rule of 40. As you can see above, Okta states that as it gets closer to fiscal 2026, over the next 3 years, it's expected to see about 20% free cash flow margins.

Okta Q4 2022 investor presentation

That being said, the facts above appear to bring that assertion into question. What's more, during the earnings call management stated that "we expect free cash flow margin to be down a few points y/y" in fiscal 2023.

Therefore, it's possible that Okta's free cash flow margins may only reach 5% in fiscal 2023, meaningfully down from fiscal 2021.

Thus, I very much doubt that by fiscal 2026, 3 years out, Okta's free cash flow margins will reach 20%. This looks highly unlikely.

OKTA Stock Valuation - Richly Priced

Okta is focused on disrupting legacy's enterprise log in security access with its own cloud-based identity platform.

Thus, there's no question that there's a lot of demand in this space; indeed, Okta notes that its total addressable market now reaches $80 billion. However, paying approximately 16x forward sales for this business doesn't appear to provide new investors with enough upside potential.

To be clear, I'm not talking about investors that are already shareholders here and fully committed and entrenched in their views. I'm talking about new investors to the stock, looking at this business with a fresh pair of eyes and equally important, fresh capital.

With so many high-growth stocks from seriously great quality businesses now in the bargain basement, I'm unsure of whether the risk-reward here isn't skewed in the wrong direction?

The Bottom Line

Okta has a very promising narrative. But is it enough? It's difficult to dispassionately and rationally argue that the opportunity here is all that compelling.

Investors are asked to pay 16x forward sales for a business that is still attempting to grow its revenues at any cost. Meanwhile, its profitability profile appears to be pointing in the wrong direction.

I honestly believe that there are much better investment opportunities elsewhere. Whatever you decide, good luck and happy investing.

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such 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.