Workday (WDAY) has been through a rather volatile year so far, wit the stock up as much as 40% to $225 in July, now down to under $160. After their recent analyst day this past week, the stock took another big hit, trading down over 15% the following few days. While management talked about HCM growth of ~20% per year, this was known throughout the market and should not have come as a surprise to many.

International growth prospects remains very strong and management also talked about continuing their penetration in the North America market, despite being the clear market leader.

Data by YCharts

While investors have continued to love the name, it seems like valuation has kept the stock back from significantly outperforming. Shares are down over 15% since the company’s analyst day which seem to be a big overreaction to somewhat stale news. It also did not help that the entire software market was hit the past week as investors seems to shift their likings away from growth and more towards value oriented names.

I believe now is a great buying opportunity for WDAY given management reiterated their long-term operating margin guidance of ~25% and discussed the international expansion opportunity. Despite the stock having nearly $3.5 billion in revenue over the past year, revenue growth remains very healthy at ~25-30%. Even if revenue starts to decelerate more than expected, the company already has massive scale and the law of large numbers eventually has to hit in, right?

Analyst Day Recap – Large International Opportunity

WDAY has continued to post revenue growth near the 25-30% range over the past several quarters and despite management talking about HCM revenue (which makes up ~80% of subscription revenue) growth of ~20%, the company will still perform above average. WDAY has done an incredible job penetrating the market and at some point we all knew they would reach an inflection point where their revenue growth would start to decelerate, and that should not be worrisome.

The other 20% of their revenue is comprised of other fast growing areas such as ERP/Financials. WDAY’s Financials offering (known as FINS) is growing over 50% and poses a significant opportunity for WDAY to continue their above average growth rates. Despite WDAY having a 38% penetration in the G2K HCM market within North America, this penetration rate drops to only 11% when looking internationally.

Source: Company Presentation

The company’s international opportunity remains very healthy, despite the core HCM penetration starting to saturate a bit. For example, management talked about the 11% G2K penetration internationally as well as this penetration rate being only 13% in their EMEA region and <10% in APJ (excluding China/India).

In addition, overall bookings mix has become more diversified and has moved away from US-based large enterprises. Even as WDAY remains the leader in that cohort, the company’s diversification will help them continue to grow above normal rates.

Source: Company Presentation

When looking at net new ACV bookings, US large enterprises only made up 35% of FY20, down from ~57% in FY15. Smaller, more concentrated US verticals now represent ~18% and as the company continues to expand internationally (~27% of net new ACV bookings), we could see revenue growth remain healthy and diversified.

Investors seem to continue to concentrate on the US market where WDAY is likely to see revenue growth decelerate over time. Management talked about US large enterprise growth remaining an opportunity, with WDAY having 40%+ of Fortune 500 companies, compared to 25% from other cloud HR vendors. This leaves ~35% of the Fortune 500 market open for competition within the US large enterprise market.

These metrics look very different when looking internationally.

Source: Company Presentation

The opportunity internationally remains much greater for WDAY when looking at the share of Global 2000 customers. Currently, WDAY has a ~17% share of these customers, with ~13% coming from other cloud HR vendors. This mean WDAY is the clear leader even in the underpenetrated international market. With ~70% of the market remaining an opportunity and WDAY having a ~60% win rate, this could mean WDAY could have a ~59% market share if the Global 2000 customer become fully penetrated. This remains a massive area for growth that WDAY will continue to benefit from over the years.

Source: Company Presentation

Attach-on products also remains a large opportunity. Despite cloud growth slowing down, customers are increasingly using more add-on products, which improves the overall ACV for each client. WDAY estimates that ~20% of their net new ACV comes from add-on bookings, such as planning tools, analytics, training, and others. As WDAY continues to build out these modules, add-on products could continue to become an increasing amount of a customer ACV, which could offset cloud growth deceleration.

Long-term operating margin guidance was reiterated at 25%+ with the company noting that their HCM business is already producing operating margins above this range. As the Financial modules continue to grow and gain scale, these margins will eventually reach the company’s goal of 25%+.

Source: Company Presentation

Even if revenue growth disappoints and investors lose confidence in the company’s ability to grow 20%+, the strong operating margins should offset this. Software companies typically start to see margins expand once revenue growth decelerates to 25-30%. Considering WDAY is already guiding FY20 operating margins of 12.3%, investors should feel confident in the margin expansion opportunity.

Operating margin expansion will come from three key areas. First, the company will continue to post strong revenue growth. Second, gross margins will improve over time as the company gains additional scale. And third, operating efficiencies will improve over time as operating expenses such as R&D and S&M typically slow down as scale increases.

Valuation

Valuation has taken a hit over the past few weeks as investors have moved out of faster growth, higher valued software names and into more value oriented names. Some of the more expensive names in the market such as Zscaler (ZS) and Atlassian (TEAM), have seen their stock go down quite a bit from investors pulling back valuation expectations.

WDAY has seen their revenue grow 25-30% over the past several quarters and I believe 20%+ revenue growth is still the right way to view the business over the long term.

ChartData by YCharts

WDAY has a current market cap of ~$35.25 billion and with cash of $1.93 billion and debt of $1.23 billion, the company has a current enterprise value of ~$34.55 billion. Using management’s subscription revenue guidance (not total revenue) of $3.06-3.07 billion during their most recent earnings release, this implies a FY20 subscription multiple of ~11.3x. If we were to include Professional Services revenue guidance of ~$520 million, this would give us a FY20 revenue multiple of ~9.6x.

While this valuation is not cheap, WDAY is deserving of a premium valuation given above average revenue growth and the large margin expansion opportunity. If we were to assume FY20 total revenue of ~$3.6 billion were to grow a conservative 20% in FY21, this would give us FY21 revenue of ~$4.32 billion and a FY21 revenue multiple of ~8x.

I believe WDAY should be valued much higher than 8x FY21 revenue and with the stock now trading below $155, I believe it is a great opportunity to pick up some shares on sale.

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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2019-10-20