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Hypergrowth stocks — a value?

 

Are some hypergrowth tech stocks a "value" after selling off for over month? Tech analyst and newsletter author Bert Hochfeld says "yes" and shares four stocks he believes are trading at compelling prices. 

Make friends with the bear.  Image by Rain Carnation from Pixabay

Many hypergrowth tech stocks have dropped sharply during the recent sell-off, but Bert Hochfeld notes that many have cratered (and still are today) in spite of exceptional growth in revenues, customers, and future guidences — nothing inherent to the companies, just a matter of the stock market re-pricing risk and investors shifting around funds. While the share-price action is certainly painful for shareholders, it offers an opportunity to establish positions in hypergrowth companies and/or add to positions in some excellent names.

I realize that within the cohort of subscribers, there are those who have differing risk preferences and time horizons. I continue to believe that the opportunities available from investing in the IT sector are substantial and now greatly underappreciated. While this has been an extremely distressing period, this has happened before, and I expect that the pattern will change once again to reflect a set of more rational expectations. I believe that valuations now reflect the sum of all fears and are substantially removed from reality and my investment stance is predicated on that belief.  ~ Bert Hochfeld, Some thoughts about the panic!

Stocks that Bert thinks are trading at levels that don't reflect their worth include four that he's written about recently: Elastic (ESTC), Asana (ASAN), Twilio (TWLO) and Upstart (UPST).

The following analyses are excerpted from Bert's subscription newsletter, Ticker Tocker. 

The best of times and the worst of stock prices: Reviewing the quarters of Asana and Elastic

Elastic-Yes Virginia, that was a strong quarter Elastic Reported

The fact is, that contrary to much I have seen written, and the woeful reaction of the shares, Elastic did have a strong quarter and there were no real spots to mar its performance. The shares are now down by 34% over the past month. The combination of a beat and raise quarter, coupled with the share price implosion has brought the EV/S ratio as I project it down to 10.6X. That is a discount of about 1/3rd compared to the average valuation for the company’s growth cohort. One thing that has happened in this panic environment for high-growth names is that the predictive value of the EV/S ratio has diminished. It is a mark of irrationality. Typically, the EV/S ratio accounts for about 60% of the valuation of a typical software name. Currently, that ratio is 49% in looking at the names I follow and for which I have made estimates. That suggests that different factors are animating valuation differences. I have invested in, and recommended Elastic for years now, ever since it fell from its post-IPO spike. The company continues to achieve the kind of progress that I find attractive. The quarter did not reflect any signs of current or coming weakness. I continue to recommend the shares and will continue with the large weighting the company has in my high-growth portfolio. If Elastic were not my largest single holding at this point, I would increase the weighting it has in the high-growth portfolio.

[...]

While I don’t normally do this in a quarterly update, again based on the share price implosion of the past month, it might be good to recount some of this company’s growth drivers and differentiators. Elastic can be a somewhat complicated company to understand, but I will try to simplify a view of its markets and demand drivers. Overall, the company has a TAM of $70 billion, because it addresses many different markets with its offerings. The company’s core technology is its high performance search engine. Users do many different things with high performance search, and these are things that cannot be done except by having the speed of Elasticsearch as part of an application. Some of the use cases can seem unrelated to search per se, but that is what makes the business opportunity so substantial. The company has used its search capabilities to build out a successful offering in the observability sector where it can compete against DataDog and Dynatrace. In addition, the company offers an alternative in what is known as the SIEM sector-that basically is a way of seeing how specific events impact the performance of a computer network-where the principal competitor is Splunk..  Finally, the company is in the process of building out a cyber-security offering, where its technology competes against companies such as Zscaler and other cloud based, zero trust offerings. At this point, enterprise search is still the largest component of Elastic’s business, although observability is growing rapidly. Part of the reason why Elastic has been successful is that many of its users appreciate a platform approach where they can combine search, observability/SIEM and now security in a single offering. As Elastic enhances one particular capability, that improvement resonates across the entire stack.

I believe that the concept of a platform approach to the acquisition of enterprise software has been somewhat misunderstood and underappreciated by investors and some analysts. While I don’t suggest that Elastic necessarily has a “better” observability solution than either DT or DDOG, I do suggest that there is plenty of opportunity for all of these vendors, and that Elastic has and will continue to achieve success in this space because of its platform approach. Using an Elastic Cloud based solution has proven to be a way of lowering risk for some customers, and that has been a significant demand driver.

From a product perspective, the company continues to develop tight integrations with the cloud hyper-scalers. In addition, the company is developing native integrations with many other software offerings. Overall, part of the growth story for this company is the amount of data that comes into the Elastic platform. The more integrations the company develops, the easier it is for users to onboard data, and the faster Elastic will grow.

[...]

Asana-Workflow management is a hot area for users and has become a cold area for investors

Since the panic amongst some investors in the high-growth IT segment emerged, shares of Asana have imploded. They are now down by just short of 50% in the past month. With that plunge, the shares, for the first time since May, are now selling below average for the company’s growth cohort. Asana shares are not exactly cheap, but at current valuations, they have become attractive for long-term investors.

The EV/S ratio has now fallen to about 22.7X, and that is about 10% below average for the company’s growth cohort. Asana is not a profitable company at this point, and I don’t expect to see positive free cash flow metrics until the end of 2022, although in the latest quarter the company’s free cash flow burn, despite some balance sheet headwinds did start to see some positive trends as called out by the CFO. But I believe that the opportunity here is [..] that based on the quarterly numbers, management commentary, and my own proprietary field checks,  the company’s growth outlook is undimmed and its visibility has never been stronger. In the wake of the quarterly earnings report, I raised my 3 year CG

As was the case with regards to Elastic, much analyst commentary has been related to what were considered to be disappointing numbers with regards to calculated billings and bookings. I will go through the specifics of the numbers in case anyone may have missed it.

[...]

The company raised guidance, once again, and it is now forecasting full year revenues of $372 million. The prior quarter its full year revenue forecast had been $359 million, and the beat this past quarter was $6 million. So, the new revenue forecast implies that in dollar terms, anyway, growth is accelerating.

[...]

As mentioned in earlier posts, I can’t project when the mindset of investors is going to be recast into one favoring high growth names from the current panic about the future valuation of these kinds of companies. But I can definitely project that Asana has been and will remain a category leader in one of the hottest spaces in the IT space for the foreseeable future, and that it has the makings of a very strong business model with a gross margin of 91%. 

Twilio: Lots Of Moving Parts And A Disappointing Organic Growth Metric Create An Investment Opportunity

So far this year, Twilio shares are down about 7%, the outstanding share count is up 12% and revenues are likely to grow more than 60% for the full year. So, that has brought the EV/S ratio down by about 1/3rd or a bit more since the start of the year. It is that valuation compression that I think merits an investment in the shares at current prices ($312/share as of 11/9). In my view the company’s growth engine is not sputtering, and the controversy with regards to organic vs. inorganic growth is one that really is of limited importance to investors as I try to explain later in this article. The company has broadened its product footprint and in doing so it has materially enlarged its TAM-and there is no evidence that I have seen that the company is losing market share or that its strategies aren’t resonating with its thousands of developer/customers.

[...]

My positive investment thesis for this name is that the valuation compression has left it undervalued, regardless of the specific calculation of the organic growth percentage. The company has a broad and expanding set of growth opportunities beyond its core messaging technologies, and it is moving to capture those opportunities using both organic and inorganic strategies and some combination of the two. The company appears to be growing its share of the cloud based communications space, and that space has a projected CAGR in the mid-high 20% range.

[...]

I believe Twilio represents a substantial investment opportunity as it dominates a high-growth space, its TAM continues to enlarge, and it has built a business with a very efficient and frictionless go-to-market action. I see no signs that either its market share or its pricing power has been threatened and I believe that the recent release of Twilio MessagingX is likely to present a new standard in the space that will resonate with developers.

Upstart’s share price swoon (UPST); Doximity’s confirmation of its strategy (DOCS); GlobalE beats and raises but it doesn’t seem to matter (GLBE)

Upstart

At the end of the day, investors should want to see Upstart ramp its opex. For me, the reason to own this name is that it has a multi-year high growth opportunity and to achieve that opportunity it needs to make appropriate investments-and that is precisely what it is doing.

The company’s operating cash flow continued to grow in Q3. Overall, operating cash flow was $44 million. The major changes in the level of operating cash flow include net income and the purchase of loans held for sale. The company really has a minimal balance sheet exposure in terms of the loans it underwrites,  and it winds up selling most of the loans it acquires, but as it has gotten larger, it has seen some growth in the loans it has held briefly, in its portfolio. Through 9 months, the company’s free cash flow margin has been 33%. I have projected a free cash flow margin of 36% for 2022.

Overall, the company now has 31 bank partners that use Upstart to originate loans up from 25 at the end of Q2. The pipeline for new partnerships has apparently continued to grow. Upstart was able to on-board its most recent bank partner in a record time of 50 days. The company has continued to see its bank partners drop their FICO based safety rails in terms of loan approvals which enhances the value proposition this company is offering banks…

[...]

This has been a wildly successful company, helmed by visionary management, and so I have to trust that the continued emphasis on the size and potential of the auto loan market is more than a chimera. And management suggested that in the mid-term it would enter what is of course the largest loan market there is, that of home mortgages. It can be difficult to foretell when investors will choose to disentangle the wheat from the chaff here, and to re embrace the name. I intend to add to my position in the name-I consider the current valuation a substantial aberration.

For more, visit Bert at Ticker Tocker and at Seeking Alpha. Charts are from SeekingAlpha.


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