Splunk (SPLK) reported another good Q4 earnings report with revenue and billings; however, shares have traded down ~10% since. Management raised 2020 guidance and remains very confident in the long-term outlook of the company.

SPLK was not immune to the massive tech sell-off in October-December, with the shares down over 30% from peak to trough. However, SPLK was very resilient since the beginning of the year, with the shares up nearly 50% before earnings. At this point, the brief 10% decline in share price could be for two reasons. First, investors may believe F2020 guidance seems about right and the stock currently prices in that upside. And second, investors could be taking some money off the table after the strong run in the past few months.

Splunk is a great long-term play on big data and the transition to the cloud with the company showing continued strong demand trends this past quarter. Although the stock has rebounded quite nicely the past few months, it remains down ~10% after earnings, despite reporting a strong Q4 and raising FY20 guidance.

Data by YCharts

For most of 2018, Splunk was in extreme rally mode, rising nearly 50% at one point, reaching its all-time highs. The months of October/November/December were challenging for most of the market, and the tech sector was no exception. The stock was down over 30% from the all-time highs before beginning another rally phase in late November. The phantom recovery was met with a challenging December. However, since the start of the year, the stock was up nearly 50% but has since declined ~10% after a strong earnings.

Q4 Earnings and Guidance

Q4 revenue grew 35% y/y to $622.1 million, decelerating from the 40% y/y growth in Q3. Revenue was significantly ahead of consensus estimates for $563 million. Software revenue also performed pretty well, growing 42% y/y for the quarter, a deceleration from 49% growth last quarter, however, on a much tougher comparable.

Source: Company Presentation

Software revenue growth, which includes cloud and license grew over 40% for the quarter, including a strong performance of license which was well above consensus expectations. As this revenue continues to grow well above the overall company growth, cloud will begin to represent a larger share of revenue – this could become a large driver of future growth as more enterprises continually look to transition to the cloud.

Billings also performed nicely in the quarter, with total billings of $798 million, over 10% ahead of consensus estimates for $725 million. Billings growth of 29% for the quarter was largely due to new and existing customers expanding their use cases and utilization of cloud and on-premise solutions.

Source: Company Presentation

Operating margin of 26.8% was slightly ahead of consensus estimates. The slight expansion in operating margin makes sense as SPLK saw their revenue decelerate slightly. As Splunk’s revenue naturally decelerates, we should begin to see operating margin improve and the company become more profitable. At these margins, Splunk remains ahead of other faster growing software names, which typically have breakeven to negative operating margins as the companies chase after top-line growth.

Q4 EPS of $0.93 came in well ahead of consensus estimates of $0.76 largely due to the significant revenue beat and slight margin beat.

Source: Company Presentation

Management also provided guidance for Q1 and FY20.

For Q1, management sees revenue growing to $395 million, which would put the company over a $2.25 billion run-rate. In addition, management sees operating margin to be -8%. Typically, FQ1 revenue and operating margins are seasonally lower, with both of these guidance metrics similar to consensus estimates.

For FY20, management is now expecting revenue of $2.20 billion, up from their previous guidance of $2.15 billion. The slight raise here implies ~22% revenue growth for the year, a massive deceleration from the 38% revenue growth in FY19. I believe management continues to be conservative in their guidance as this sets them up for a beat and raise potential year.

Operating margin guidance remained the same at 14%, which was similar to consensus estimates. Shares were weak following the earnings report and guidance largely due to investors expecting a bit more revenue growth considering margins were left unchanged. With revenues expecting to decelerate ~16% from last year, investors would typically expect operating margins to expand, thus, rendering a more profitable company. However, this was not the case for SPLK which has caused some investors to fear the lack of operating margin leverage.

Valuation

Splunk’s valuation has bounced around quite frequently over the past few months, similar to many other tech names. However, Splunk is a very solid, long-term investment given management’s confidence in the underlying business trends and very strong revenue growth rate. It put out an updated preliminary revenue guidance for FY20, which implies revenue growth of ~22%, decelerating from the 38% growth in FY19. Operating margins are guided to ~14%, which was left unchanged from previous guidance.

I believe management continues to remain conservative with its guidance, as it should be. Coming off a 38% revenue growth year, it is challenging to imagine this type of success is likely to continue over time, especially as the company eclipses a $2 billion revenue run-rate. The law of large numbers eventually settles in and revenue naturally will decelerate.

However, I do believe management’s guidance is quite conservative. At ~22% growth rate through FY20, this would imply a 16% deceleration. I believe revenue will end up growing ~30-35% in FY20 as Splunk is likely to beat and raise each quarter.

The main question for FY20 is whether the 14% operating margin remains intact. Investors are likely to focus on this metric, as well as free cash flow, a bit more in the upcoming year than the past year. If revenue growth does decelerate to 22%, I would anticipate operating margins to expand well above 14% in order for the stock to have a strong year. If operating margins remain flattish and revenue growth does decelerate this much, I believe the stock could be in a hold pattern for a little bit.

With the stock currently trading at ~$120, the company has a market cap of $18.2 billion. Netting out the $1.9 billion of cash and $1.6 billion of debt, the company has an enterprise value of ~$18 billion. Using management’s $2.2 billion FY20 revenue number, we get a FY20 revenue multiple of 8.2x, which seems to price in a decent amount of beat and raise potential.

For my personal analysis, I assume revenue ends up growing closer to 30% during the year, bringing FY20 revenue to ~$2.35 billion and lowering the revenue multiple to 7.7x, a bit more reasonable for this price. As long as the company continues to grew revenue at a decent clip and is able to provide upside to profitability, I believe the stock should perform pretty well throughout the year.

Risks to SPLK include revenue growth decelerating to the lower 20s with operating margins not expanding during the year. Typically when a software company begins to see revenue growth decelerate, operating margins and profitability expand. If this does not turn out to be the case for SPLK, investors could punish the name over the next few quarters.

For now, I would be cautious around building up a position with the stock trading around $120. If we start to see the stock fall closer to $110, this would provide a great buying opportunity.

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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2019-03-09