Investment Thesis

Workday (WDAY) is an old school SaaS stock. Although Workday should be benefiting from the present cloud migration, its guidance doesn’t reflect that side of the story.

The stock appears to be fully priced relative to its near term potential, as it already trades for more than 11x forward sales, even though its revenue growth rates are clearly decelerating with each passing quarter, while at the same time its multiple remains elevated — particularly compared with its peers.

On balance, investors can find better investment opportunities elsewhere. Particularly since the market has opened up slightly these past several weeks.

Workday to undergo routine maintenance | Penn State University

The Bull Case For Workday

Workday is the category-defining leader platform for finance and human resources. Workday’s applications are aimed at facilitating financial management and human capital management (”HCM”).

The most attractive reasons to be bullish Workday include this cloud SaaS business having very strong visibility. Investors have a clear understanding of its progress and are willing to pay a large multiple for a lack of downstream surprises (more on valuation later).

Workday’s application streamlines financial processes for organizations through a single platform, as well as offering large global enterprises a human resources platform to manage their workforce.

Furthermore, given that it’s aimed predominantly at enterprise customers, in the event of a slowing of the economy due to small businesses closing down their doors, Workday should be relatively immune. What’s more, Workday sees market dynamics improving towards the back end of fiscal 2021 and early fiscal 2022.

Hence, given the acceleration of digitalization seen throughout the world and companies’ migration towards the cloud, we should expect this to provide Workday with very fertile ground and positive tailwinds to continue growing rapidly.

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Yet, rhetoric aside, Workday’s hard numbers don’t appear to be backing up that story.

Revenue Growth Rates Are Trending Steadily Lower

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

Workday’s guidance appears to point towards a dramatic deceleration in revenue growth rates. If this time last year, during fiscal Q2 2020 Workday was a plus 30% y/y revenue growth rates company, this year’s 20% y/y growth rates comes across as a rapid deceleration in comparison.

What’s more, looking ahead for the rest of fiscal 2021, Workday’s revenue growth rates don’t appear to regain much vitality.

As a sanity check, please consider what analysts expect from Workday over the next several quarters:

Source: SA Premium Tools

Bulls would claim that management is lowballing estimates to allow for easy beats. And that’s obviously taking place. After all, Workday is a SaaS company and they have a very strong idea of what the next 90 days look like, and possibly even what the next year looks like.

In short, SaaS companies don’t miss estimates unless something goes dramatically wrong.

However, Workday did highlight the loss of contract, where a customer was forced to prepay the remaining balance of the contract. This amounted to $6 million pull forward from several years’ worth of contract which all fell into Q2 2021.

Moving on, after adding back its heavy stock-based compensation, Workday is guiding for fiscal 2021 non-GAAP operating profits to reach approximately 18%. This means that despite heavily investing in its top-line growth strategy, its non-GAAP operating income should reach slightly under $775 million. Readers should note that due to COVID, Workday has reduced travel, marketing, and event spending.

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On the plus side, unlike many cloud SaaS peers, Workday is able to convert its revenues into cash flows at a high rate. During H1 2021, its revenues converted into cash flows from operations at approximately 20%. Put simply, this means that Workday’s non-GAAP operating income is largely in line with its cash flows from operations.

Thus, on the one hand, investors can feel reassured that Workday’s revenues are converting into cash at a high percentage. On the other hand, investors should remember that this figure doesn’t take into account Workday’s consistent real estate project capital infusions. However, most likely due to COVID, Workday states that for the remainder of fiscal 2021 it would not make further investments into real estate projects.

Nonetheless, at this valuation, Workday’s margin of safety is non-existent.

Valuation — Difficult to Find Upside Potential

Workday’s fiscal 2021 revenues are pointing towards $4.3 billion — this is at the high-end of its revenue target. This leaves Workday trading for just over 11x sales.

This is in no way an exuberant valuation in and of itself, particularly amongst SaaS stocks. However, given the market reaction the last several weeks, it appears that investors are now starting to question whether it is truly worthwhile to pay a large premium for just about any stock in the SaaS space.

Yext (YEXT) has similar growth rates and guidance to Workday, yet Yext trades for approximately 5x forward sales. Meanwhile, Salesforce (CRM), which trades for 10x forward sales, and practically the same multiple as Workday, yet Salesforce is still guiding for solid 20% growth rates over the next several quarters.

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The Bottom Line

For now, investors are going to struggle to see meaningful upside potential from Workday. Even if there’s a strong thrust by companies to continue to accelerate their digitalization and move to the cloud, that line of the narrative is already being priced in here.

For more upside potential, Workday needs to positively surprise investors, that it can re-ignite its growth rates and return to being a high growth rate company, but given its full-year guidance, even if one assumes 1% to 2% top-line beats, Workday is still not likely to return towards being a 20% CAGR stock. There are better investment opportunities elsewhere, with less risk.

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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.



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