Working day (NASDAQ:WDAY) has a lot to offer, but one thing stands out above the rest. It is no longer a high-growth business. Meanwhile, investors continue to crowd into the action as they perceive the safety of Workday’s blue chip status.
Workday’s recent analyst day has investors dangling it will hit $10 billion in revenue. But Workday fails to contextualize when.
I, on the other hand, argue that paying 29 times next year’s operating profits for a company that is obviously growing at a CAGR of 20% is just too much and doesn’t provide investors with enough of a margin of safety.
No longer a high growth company
The graph above speaks for itself. We are facing a company that is clearly growing at 20% CAGR and not faster. Indeed, it has now been a good number of years since Workday was a high-growth company.
And while the bull case here is that Workday is strongly entrenched in the workplace and will be able to continue to raise prices in an inflationary environment, I wonder how much of that thesis has already been factored in.
What’s next for Workday
Workday is a solutions platform for human resources, finance and planning. Workday’s platform is used by more than half of the Fortune 500 companies. It is truly a top-notch company serving major top-notch companies.
The main problem facing Workday is succinctly summarized above. What we can see here is that the majority of its growth comes from its ability to expand and cross-sell to its customer base.
Again, you can see this from another angle. The number of products per customer continues to be the driving force here, rather than a significant increase in the number of customers.
Therefore, I argue that this means Workday is saturating its platform’s reach with potential customers.
Let’s discuss the profitability profile of Workday
The chart that follows is also from Workday’s Investor Day. This is a signal to investors that SBC spending is something Workday is aware of.
What you see highlighted above is that once Workday hits $10 billion in revenue, its SBC will moderate. Needless to say, going from $5 billion in revenue to $10 billion is a long way off.
In fact, it’s worth noting that while Workday points out to investors that its non-GAAP margins in the second quarter of 2023 reached 20%, its own GAAP margins were negative 2%. A substantial difference.
WDAY stock valuation – 29x next year’s non-GAAP earnings
Let’s make some assumptions. We know Workday is targeting around $6.2 billion in revenue this year. And if we assume that Workday continues to grow revenue at a CAGR of 20% next year, revenue is likely to reach $7.5 billion.
Then, if we assume 20% as Workday’s non-GAAP operating margins next year, highlighted in the slide above, that would bring its operating profit to about $1.5 billion.
Then, on top of that, we should be looking at a dilution of about 10% of his diluted number of outstanding shares.
In total the stock is priced at 29x not this year but Next non-GAAP operating profits for the year. A figure that comes before taxes and interest.
The problem with the Workday valuation is that it’s not entirely cheap for what’s on offer. That being said, let’s be honest, technology has seen a dramatic revaluation in multiples across the board.
And with Workday priced at 5x next year’s earnings, it’s essentially an interest rate bet at this point. If interest rates continue to rise, we should expect further compression of the multiple.
Although if interest rates positively surprise investors by stabilizing faster than many realize, there could be some multiple expansion driving up the stock.
To be clear, there’s a lot to love about Workday. It’s a stable business as it goes, which isn’t going to offer investors a lot of negative surprises.
My only assertion is that I believe the stock is already valued in the perception of “that security”.
And if we’ve learned anything in the last 18 months, it’s that even in technologyit is absolutely crucial to invest with a margin of safety.
Indeed, I will go further, I have come to believe that the market will remain choppy for longer and that in this context Iit’s even more important to have a wide margin of safety.
In 2020, one could buy a high-quality secular cultivator, and even if the price of entry was high, the stock could achieve intrinsic value. Today, I don’t think that still holds water.
Investors can no longer rest on the laurels of a centuries-old producer as compelling as Workday and expect everything to go well. Investors currently need to sharpen their pencils a little more and demand a wider margin of safety.