Cloud software company Workday (NASDAQ:WDAY) has seen its shares climb by more than 35 percent in 2023 due to ongoing revenue growth and positive earnings surprises.
While Workday has managed to navigate a difficult market quite well this year, the company’s $60.3 billion market capitalization opens up questions about the stock’s intrinsic value and, in particular, whether now is a good time to buy it?
If you’re not already familiar with the firm, Workday is a cloud services provider that focuses on financial management software tools.
It provides services to financial, hospitality, retail and healthcare businesses, among other industries. In addition to its suite of financial management tools, Workday also provides HR tools that allow organizations to manage their labor forces effectively.
Workday Earnings Soar Last Quarter
On a GAAP basis, Workday generated earnings of $0.30 per share in the most recently reported quarter. This represented an enormous improvement in the company’s financial performance, as Workday’s last profitable quarter had previously been in Q3 of 2021.
It should be noted, however, that Workday has still lost money over the past year. On a trailing 12-month basis, the company’s earnings per share have totaled $-0.48.
While not as spectacular in the year-over-year earnings improvement, Workday also delivered solid revenue growth in Q2.
Total revenues increased 16.3 percent to $1.79 billion. On this front, Workday has also delivered fairly consistent performance over many years. The company’s 12-month revenues have steadily risen from $470 million in 2013 to $6.72 billion over the most recent 12-month period.
Subscription revenue growth was even more positive than overall revenue growth, reaching 18.8 percent.
The company’s total subscription revenue backlog currently stands at $17.85 billion, and the total number of workday users surpassed 65 million in Q2. Given these impressive growth numbers, the odds are high that Workday revenues will continue to climb in the near future.
While revenue growth is a net positive for investors, it will have to be accompanied by earnings growth to support higher share prices. The good news for bulls is that, over the next five years, Workday’s earnings are expected to grow at a compounded rate of about 34 percent.
Although this projection is quite high, it’s worth noting that this growth will begin from what is currently a very low earnings baseline.
Workday’s weakest performance is arguably in the area of its margins. Even with better-than-expected earnings in Q2, for example, the company’s GAAP operating margin was a rather slim 2 percent.
Net margin over the past year has been -1.8 percent, while return on equity has been 2.1 percent. In order to deliver significant shareholder returns, Workday will have to be able to raise its margins through greater scale or reductions in operating expenses.
What Does Wall Street Think?
At 41.2 times projected forward earnings and 133.4 times cash flow, Workday stock is priced at a level that will require much higher earnings to justify.
Analysts expect rapid growth in Workday’s earnings per share over the coming years. This trend may be especially pronounced over the next 12 months, as the analyst forecast for GAAP earnings growth over that period is 130.6 percent.
Wall Street also seems to hold a fairly favorable view of Workday’s prospects. The current median target price for Workday shares is $260, about 13.1 percent above the most recent price of $230.
Institutional investors currently own about 68.5 percent of the company, suggesting considerable big money interest in WDAY’s value proposition.
Another possible positive for the company’s valuation is its relatively strong moat. As noted above, the company recently surpassed 65 million total customers.
The company currently enjoys a market share of over 25 percent in the human capital management market, and future growth could expand its competitive advantage.
Sporadic Profitability Is Concerning
The largest problem for Workday investors is the company’s long-standing difficulty in achieving and maintaining profitability.
While Workday has sporadically enjoyed profitable quarters, it has yet to generate positive earnings over prolonged periods. This presents inherent risks to shareholders, as future periods of negative earnings could diminish the value of the stock.
Another downside of Workday stock is the fact that institutional investors have been selling their stakes at a fairly brisk pace over the past year.
Despite the high rate of institutional ownership, outflows have been roughly three times higher than inflows in the past 12 months. This may suggest that institutional investors are taking advantage of Workday’s higher share prices to exit their positions, potentially indicating a lack of long-term enthusiasm for the stock.
Is Workday Stock Undervalued?
According to 36 analysts, Workday stock is undervalued by 13% with fair value at $253 per share.
A mix of factors plays into the valuation now. On a positive note, the company’s recent turn toward profitability and high rate of projected earnings growth could both support higher share prices. Workday also has a strong history of revenue growth that is likely to continue into the future thanks to the growth of its subscription-based offerings.
On the downside, it is priced high multiples according to several key financial ratios. In addition to lofty earnings and cash flow multiples, WDAY shares trade at about nine times current sales.
Even with its proven ability to grow revenues over time, this multiple raises red flags. Workday’s price-to-earnings-growth ratio is also 1.5, which is higher than would normally be considered attractive from a value perspective.
Taking these varied factors into account, Workday shares don’t have a large margin of safety associated with them. This view even assumes that the company will remain profitable and continue its currently strong growth trajectory.
Investors should be aware, though, that negative earnings surprises or a return to losing money could cause share prices to sharply decline once again. As such, Workday is a potentially good growth stock, albeit one that is no slam dunk buy.
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