Investment Thesis

PagerDuty (PD) has a very compelling narrative, with this incident reporting company bringing a real-time response. Presently, this small-cap stock has fallen out of favor with investors, as investors sought rapid growth, which PagerDuty struggled to deliver.

However, it now is being priced for less than 10x its forward sales, which I believe is starting to become very attractively priced.

PagerDuty’s Revenues Are Becoming Predictable

I had been very bearish on this stock for a while, before recently declaring that the stock was fairly valued.

I’m now revisiting the name once more, in light of the changing SaaS landscape where many stocks have pressed ahead with their valuations and multiples, whereas PagerDuty has largely remained stagnant.

Source: author’s calculations; **high-end company guidance

Previously, PagerDuty was being viewed by investors as a high growth stock, and was getting priced as such. This attracted a certain type of shareholder. Now that many of those shareholders have gotten bored or moved on, it’s become an interesting opportunity.

Source: SA Premium Tools

Indeed, I make argue that analysts following the company may be overly bearish of this name, as analysts looking out over the next few quarters and are now expecting PagerDuty’s revenue growth rates to approximate 20%, which could be too gloomy on PagerDuty’s prospects.

After all, for many companies, COVID brought into question any and all need for discretionary IT spend, but we have seen across the board that many companies are having to adapt in order to survive in a new normal environment, and will have to adopt digital tools to remain relevant in a digital world.

It’s on this front where I believe that PagerDuty could regain some traction, now that the initial COVID shock is behind us and the volume of incident reporting goes in one direction only, and that is up.

What’s more, anyone following this space has heard ad nauseam that the digital acceleration of the world leaped overnight, creating a substantial opportunity for PagerDuty to provide a real-time response.

So What’s the Market Missing?

The market is not putting enough consideration behind PagerDuty’s gross profit margins being so high. Coming out of Q2 2021 its non-GAAP gross margins reached 87.4%, which is utterly astonishing and should translate into substantially higher valuation multiples for PagerDuty.

Indeed, PagerDuty’s high gross profit margins translated free cash flow at 2.7% of revenue. Having said that, PagerDuty is obviously not seeking to maximize free cash flow at this juncture, as it is steadfast on growing its land and expand strategy. Nevertheless, even in that case, PagerDuty is still free cash flow generative — and the market should reward its clear path to profitability.

Next, when it all boils down to it, investors are focusing on the fact that PagerDuty’s deferred revenue is only up 5% from the previous quarter to $101 million.

However, here I believe the market is not sufficiently mindful about is just how small PagerDuty is, where even a small number of logo wins with annual recurring revenue over $100K can have a disproportional impact on its top-line.

Valuation — Why PagerDuty Carries a Margin of Safety

As alluded to earlier, whereas the rest of the SaaS market has rallied ahead at a tremendous pace PagerDuty has been left behind. What’s more, calendar 2021 is now just around the corner, and many investors are looking out to next year and pricing in many different opportunities.

Even though PagerDuty’s fiscal year is misaligned with the calendar year, we can see that PagerDuty is very reasonably priced at just less than 10x its fiscal 2022 revenues (January 2022).

I follow many companies, and I don’t know of many SaaS companies which are free cash flow generative, growing at arguably more than 20%, and still being priced at sub 10x forward sales.

For example, Twilio (TWLO) is a crowd favorite with investors, is substantially free cash flow negative, has non-GAAP gross margins of just 55%, yet because it’s growing its top-line at 40%, but it’s being priced at more than 18x forward sales — which is double the multiple of PagerDuty.

We could also compare with DocuSign (DOCU) and see that although it’s expected to grow at mid-30%, while being priced at roughly 20x its 2021 revenues.

ChartData by YCharts

In sum, many SaaS stocks have seen remained largely range-bound these past few months as investors try to figure out what’s a bargain opportunity and what’s overvalued.

It’s on that line thinking that I see PagerDuty’s sub 10x forward sales as quite attractively valued.

The Bottom Line

There’s no question that PagerDuty is now cheaply valued on relative metrics, but the question remains on whether it will reprice higher? I believe that it will, and I believe that PagerDuty now carries a meaningful margin of safety.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any 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.



Via SeekingAlpha.com

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