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Workday Looks Like One of the Better Growth Picks for the Current Environment

Published 12/09/2022, 09:00 AM
Updated 07/09/2023, 06:31 AM
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  • Workday has a compelling qualitative story, with a dominant human capital management platform and a promising effort in financial planning
  • Valuation looks high on an absolute basis but more reasonable in context
  • Investors willing to take on the risks in large-cap software should have WDAY on their shopping lists
  • Workday (NASDAQ:WDAY) stock looks attractive for reasons that echo those of many other large-cap software names. 

    Growth has been and continues to be impressive: Workday is guiding revenue to increase 22% year-over-year in fiscal 2023 (ending January). There’s room for the top line to grow nicely for years to come, between the acquisition of new customers and a steadily expanding portfolio of offerings across multiple use cases.

    Meanwhile, WDAY is down more than 40% from its highs, which has brought valuation in. Based on guidance, the stock trades at a little over 7x this year’s revenue (backing out net cash on the balance sheet). 

    Using Wall Street consensus, WDAY is valued at about 33x next year’s adjusted earnings per share (again, backing out net cash).

    As always, there are risks. Valuation is not quite what it seems, and an uneven macro environment does threaten near-term performance. But the argument for WDAY is that the risks are essentially the same seen across the enterprise software sector. The potential rewards, however, are not the same.

    The Risks First

    There’s a reasonable argument to avoid names like WDAY at the moment. Yes, large-cap software stocks have sold off — but valuation concerns persist. A 7x revenue multiple sounds “cheap” after a few years in which investors often were willing to pay 15x or 20x for growth. But in a normalized interest rate environment, it’s hardly a steal by definition.

    More importantly, what matters to shareholders is profit, not revenue. And on that front, WDAY has another huge concern, one echoed across the space. Guidance for fiscal 2023 implies an adjusted operating profit of $1.07 billion — but that figure excludes stock-based compensation. 

    Year-to-date, stock-based comp has totaled $933 million. In other words, when accounting for dilution, Workday isn’t necessarily profitable. 

    To be fair, that $933 million is an accounting figure, so the story isn’t quite as bad as those numbers suggest. Still, as we discussed with Salesforce.com (NYSE:CRM), the original ‘cloud’ stock, the impact of stock-based comp is one that investors ignored in a bull market and began to focus on in recent months. And with good reason: dilution matters, and at the very least, means a stock like WDAY is not as ‘cheap’ as a 33x forward price-to-earnings multiple would suggest.

    Then, of course, there’s the macro environment. Workday itself said after Q3 that sales cycles were lengthening; other software companies have seen the same trend. Customers are more carefully watching their expenses, which means it’s taking longer to get often smaller deals. 

    The combination of slowing growth and still-high valuations might mean the sector has another leg down ahead.

    The Case for WDAY

    Those risks are real. But there are reasons to take on those risks. Stock-based comp is going to normalize going forward. The current macroeconomic cycle, like all such cycles, will pass. Many investors are willing to take the long view here and buy quality software names — and for those investors, Workday will be attractive.

    One core reason is the combination of stability and growth. Workday has already established itself in human capital management, where its platform is a leader. In enterprise resource planning, at its 2022 Analyst Day, the company claimed market share leadership. Workday has 19% of the market, against 15% for SAP (NYSE:SAP) and 12% for Oracle (NYSE:ORCL).

    Those two end markets provide a strong base for sticky, profitable, recurring revenue. But unlike many large-cap peers, Workday has a large number of add-ons to drive growth. The platform includes planning, analytics, sourcing, payroll, talent management, and more. 

    In fact, according to Investor Day, the average new customer now is buying nine different products when signing up against four just a few years earlier. 

    Those products have value no matter the macro environment. And so there’s a strong case that Workday can power through. And while there are valuation questions, the company expects profit margins to improve next year on the way to a target of $10 billion in revenue and 25% operating margins.

    This is a company that can grow into its current valuation even if the macro picture is unfavorable going forward. That’s the bull case for WDAY here, and it’s a bull case growth investors should find attractive.

    Disclosure: As of this writing, Vince Martin has no positions in any securities mentioned.

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