ServiceNow: 29% Revenue Growth, 25% Operating Margins

Apr. 28, 2022 12:49 AM ETServiceNow, Inc. (NOW)7 Comments3 Likes

Summary

  • ServiceNow jumped after releasing solid earnings results.
  • The growth was just above issued guidance, and that's enough to spark optimism in a pessimistic market.
  • The company continues to generate impressive profit margins.
  • I rate the stock a buy for those looking for a lower risk name in the tech sector.
  • Looking for a portfolio of ideas like this one? Members of Best Of Breed get exclusive access to our model portfolio. Learn More »
Business process management using flowchart swimlane diagram. Concept with manager using computer to map activities and responsibilities to automate workflow. Corporate organization and strategy.

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ServiceNow (NYSE:NOW) rose after reporting strong first quarter earnings. The company continues to sustain impressive growth rates quarter after quarter and the stock has held up quite impressively amidst the bloodbath in tech stocks. I suspect that much of the relative outperformance is due to some recent M&A in the enterprise tech sector, and I can see the stock continuing to deliver strong returns on the back of its consistent growth and strong profit margins. While NOW is not nearly as cheap as the cheapest stocks in the tech sector, I still rate the stock a buy for investors looking to invest in the tech sector at lower risk.

NOW Stock Price Action

I last covered NOW in January, and the stock has since fallen 10%. The stock was trading at around $465 per share prior to releasing earnings. In that report, I predicted that the stock could show strong performance due to the presence of long-term revenue guidance as well as their strong profitability. That has proven true - in fact more than I had initially expected - as many other high-growth tech stocks have seen their valuations compress much more. There’s yet another potential reason for the outperformance. There has been a slew of deals in the enterprise tech sector, including that of Anaplan (PLAN) and SailPoint (SAIL). It is possible that investors are pricing in a takeover premium for the higher quality enterprise tech companies. Regardless of the current setup, the long-term picture for the stock has only improved considering the lower valuations.

NOW Stock Earnings

NOW delivered strong results which comfortably outpaced previous guidance. Subscription revenues came in at $1.613 billion, and the company increased full year revenue guidance by a sliver to $7.033 billion.

growth relative to guidance

ServiceNow 2022 Q1 Presentation

At this point, the positive reception in the stock price has less to do with the 0.04% improvement in full-year guidance but instead likely due to the fact that earnings were at least OK - the valuation reset in the tech sector may have also reset expectations.

NOW’s 29% constant currency revenue growth isn’t the highest among peers, but is nonetheless quite impressive considering that the company has sustained a similar growth rate for many quarters consecutively.

subscription revenue growth

ServiceNow 2022 Q1 Presentation

What’s more, NOW has coupled the strong revenue growth with solid profit margins. Non-GAAP operating margin stood at 25%. I note that free cash flow margins are very high largely due to the company accepting prepayment for subscription plans - investors should instead exclude deferred revenues from free cash flows for a better understanding of the operational cash flow picture.

profit margins

ServiceNow 2022 Q1 Presentation

On a GAAP basis, NOW is also producing solid cash flows, having generated $75 million in GAAP net income in the quarter. NOW ended the quarter with $5.5 billion of cash, representative of a strong balance sheet. Management reaffirmed 2026 guidance for at least $15 billion of revenue in the conference call.

Is NOW A Good Long Term Investment?

Just to make sure we are all on the same page, let’s quickly recap the business model. NOW is an enterprise technology company which enables its customers to program digital workflows. Here’s one example of a digital workflow. A customer’s employee might wish to request a new computer monitor. Without NOW, this kind of request might be routed all to one distribution point (my sympathies for this employee) before it is forwarded to the right department. NOW’s technology enables the request to be forwarded to the right department without any human intervention.

digital workflows

2021 Analyst Day

NOW is the gold standard for digital workflows and this is evident by their impressive customer lineup.

customer list

2021 Analyst Day

The long-term trend is clear for digital workflows: more and more human “busy work” and interactions can be programmed in order to save time and improve accuracy. NOW stands to benefit from the ongoing digitization of workflows.

Is NOW Stock A Buy, Sell, or Hold?

At recent prices, NOW is still trading very reasonably at around 13x sales. Analysts expect NOW to exceed 2026 revenue guidance, achieving $15.8 billion by then.

consensus revenue estimates

Seeking Alpha

Consensus estimates call for NOW to achieve a 21.7% net margin by 2025, which appears reasonable considering the already positive GAAP net margins and the strong non-GAAP margins.

consensus earnings estimates

Seeking Alpha

NOW isn’t nearly as cheap as the cheapest tech stocks - there’re too many alternatives to name at this point. Yet NOW is offering something that is working in today’s market: reliability of growth with profitability. NOW might have substantial downside due to other tech stocks trading more cheaply, but the premium multiple is arguably warranted considering Wall Street’s historical preference for clean-cut stories. I can see NOW eventually achieving 40% long-term net margins. Based on the 25% projected growth rate in 2023 and a 1.5x price to earnings growth ratio (‘PEG ratio’), I could see NOW trading at 15x sales by next year. That represents potential returns of around 50% over the next 12 months. Key risks to this thesis include disruption to the growth story. As stated above, NOW trades at a noted premium and in the absence of a broader tech recovery, the stock has substantial room to fall if the premium multiple falls apart. The magnitude of that risk cannot be understated, though the company’s strong profit margins may provide another layer of support considering the ever-possible catalyst of share repurchases. I rate the stock a buy as a lower risk play in the tech sector.

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This article was written by

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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.

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