Investment Thesis
Smartsheet (NYSE:SMAR) delivered an overall positive report, and its stock jumped 12% premarket.
But I find myself less enthusiastic. Here's the thing, I've seen this type of setup before many times. The company is working off small numbers and has a couple of good quarters, and it appears that the stock is off to the races.
Ultimately, I question whether paying around 31x forward non-GAAP operating profits is all that enticing. On the other hand, the earnings report was strong enough that it doesn't make sense to be bearish on this stock either.
Rapid Recap
In my previous bearish analysis, I said:
This is how I see SMAR: you have a stock that carries a punchy valuation at 34x forward non-GAAP EPS, facing decelerating growth rates, and where the underlying profitability of the business has for the most part maxed out and gone as far as it can go, for now.
With so many bargains in the market right now, I'm issuing a sell rating on SMAR.
With the benefit of hindsight, it didn't make sense to issue a sell rating on SMAR, I should have kept it neutral.
But in the market, it never matters what you should have done, it matters what you did.
Smartsheet's Near-Term Prospects
Smartsheet provides a platform for collaborative work management, functioning as a digital workspace where teams can plan, track, manage projects together, and communicate.
Smartsheet is a bit like Asana (ASAN) but with much better financials. While Asana also focuses on project management and team collaboration, it emphasizes a more user-friendly interface.
Although both platforms aim to improve project management, Smartsheet offers more spreadsheet-like features for complex project tracking, whereas Asana strives for ease of use for task management.
The main issue I've had with Smartsheet was that its billing metrics were disappointing.
As you know, billings are a leading indicator of revenue growth rates.
Above is the final time that Smartsheet reported its billings metrics. Given that billings were moving in the wrong direction, management has decided to stop reporting its billings and has asked investors to instead focus on its ARR (annual recurring revenues).
Looking ahead to fiscal 2025, this points to approximately 15%, which, as you'll soon see, is lower than Smartsheet's revenue growth rate guidance for this fiscal year. And that has the potential to, in time, become a problem - even though, for now, everything still looks reasonably solid. Let's discuss this further.
Smartsheet's Growth Rates Could Deliver 19% This Fiscal Year
Smartsheet was expected to deliver 18% y/y revenue growth rates for fiscal Q1, but ended up delivering 20% y/y revenue growth rates.
This has two implications. The first one is that it allows management to speak of its growth rates stabilizing. After all, fiscal Q1 2025 marks the 11th consecutive quarter of decelerating revenue growth rates. Stability in its growth rates is long overdue.
But more importantly, given that fiscal Q1 2025 was up against the "final" most challenging comparable quarter, and Smartsheet was able to grow by 20% y/y, this implies that for fiscal Q2 and the remainder of fiscal 2025, Smartsheet will be up against much easier comparables.
In practice, this will allow Smartsheet to easily beat the high end of its fiscal 2025 guided 17% y/y revenue growth rates. For my part, I've presumed that Smartsheet will grow by 19% y/y this fiscal year. However, I believe that even this figure may end up being too conservative. But let's go with this for now. Given this context, let's discuss its valuation.
SMAR Stock Valuation - 31x Forward Non-GAAP Operating Profits
In my previous analysis, together with its fiscal Q4 2024 results, I said:
Smartsheet saw its underlying profits jump from negative 5% non-GAAP operating margins in fiscal 2023 to 11% non-GAAP operating margins in fiscal 2024, a 1,600 basis point expansion in profitability in 12 months, see below.
Given the ease with which Smartsheet had improved its underlying profitability, investors had expected to improvement in profitability to continue in fiscal 2025.
Now, if we take the high end of Smartsheet's guided non-GAAP fiscal 2025 operating margins, investors are looking at approximately 14% to 15% improvement in underlying profitability. (emphasis added)
This implies that the majority of the low-hanging fruit has been picked over, and the operating expenses have been cut back as far they can go.
Accordingly, I stated that Smartsheet's non-GAAP fiscal 2025 operating margins would hover around 15%, and that there wouldn't be a lot of juice left to improve on its underlying profit margins this fiscal year.
Furthermore, even if Smartsheet's profits end up reaching $180 million, rather than the high end of its current guidance of $167 million, this would still only see its non-GAAP operating profits reaching 16%. And that's why I'm struggling to be too bullish on this stock.
You are eyeing up around 19% topline growth, with its operating profits to a large extent nearly maxing out. For that, having to pay around 31x forward non-GAAP operating profits feels like fairly value already.
On the other hand, we must keep in mind that Smartsheet holds about $660 million of cash and short-term investments and no debt.
Given that Smartsheet is expected to perhaps deliver another $230 million of free cash flow this year, this means that Smartsheet has ample means to make a significant needle-moving acquisition.
The Bottom Line
I believe Smartsheet's stock is fairly valued given its balanced financial outlook and recent strong performance.
Even though the stock jumped 12% premarket after a positive earnings report, I still have concerns about the high valuation of around 31x forward non-GAAP operating profits, especially with decelerating growth rates and limited potential for further profitability improvements.
However, Smartsheet's solid financials, including $660 million in cash and no debt, along with stable revenue growth rates and expected significant free cash flow, make me think its current valuation is reasonable, without being overly bullish.
Strong Investment Potential
My Marketplace highlights a portfolio of undervalued investment opportunities - stocks with rapid growth potential, driven by top quality management, while these stocks are cheaply valued.
I follow countless companies and select for you the most attractive investments. I do all the work of picking the most attractive stocks.
Investing Made EASY
As an experienced professional, I highlight the best stocks to grow your savings: stocks that deliver strong gains.
- Deep Value Returns' Marketplace continues to rapidly grow.
- Check out members' reviews.
- High-quality, actionable insightful stock picks.
- The place where value is everything.
