Investment Thesis
Workday (NASDAQ:WDAY) updated its guidance together with its fiscal Q1 2025 results. And the stock dropped 10%. That's the headline.
But in this instance, I'm inclined to believe that the market is overreacting. Particularly given that as we went into this earnings result Workday's share price was already down close to 15% from its recent highs.
Yes, Workday's backlog saw a 210 basis points deceleration from 20% growth rates previously reported in fiscal Q4 2024 to a 17.9% y/y increase now reported can also be blamed for this sell-off of more than 10%.
And yet, I don't believe that investors are likely to get WDAY a lot cheaper than 28x forward operating profits.
Therefore, I remain bullish on WDAY.
Rapid Recap:
Back in November, I said about WDAY,
I contend that paying 37x next year's free cash flows makes sense. Why? Because the company is growing at very close to 20% CAGR and it has a strong balance sheet. And finally, it makes a lot of free cash flow, or FCF, that's growing.
As you can see above, this is a stock that I've been bullish on for some time.
However, if you are familiar with my work, you should know that I'm not afraid of changing my mind if I believe that the facts changed. But in this instance, I don't believe the bull case has lost its appeal. Therefore, I reiterate my bullish stance.
Workday's Near-Term Prospects
Workday provides Human Capital Management (''HCM''), Financial Management, and planning software solutions. It helps organizations manage their workforce and financial operations by offering tools for HR, payroll, talent management, and financial planning and analysis.
Workday's platform services a diverse range of industries, including healthcare, public sector, and financial services.
Workday's earnings call highlighted strategic wins, such as the landmark deal with the Defense Intelligence Agency, which has opened up new market opportunities. This is indicative of Workday's potential to expand its total addressable market.
Moreover, Workday's focus on vertical-specific solutions allows it to continue expanding into healthcare, public sector, and financial services.
That being said, Workday faces headwinds too. Case in point, as described on the call there's been increased scrutiny and lengthening of sales cycles, particularly for large and net new deals.
This led to Workday revising its fiscal 2025 subscription revenue guidance to reflect the anticipated continuation of these challenges. Furthermore, the previous year's strong renewal activity, which boosted last year's RPO growth, has created challenging comparables against this year's growth rates.
In the next section, we continue this discussion, but add specifics to the argument.
Revenue Growth Rates Still Solid
As a growth company, generally speaking, the market will forgive many aspects of a company provided there's a steady drip of good news, whereby the company announces that it is increasing its revenue guidance higher than it previously expected. That's generally how the game unfolds.
If you are having a tough period, you may simply reiterate your outlook, hoping that next quarter you'll be able to once again upwards revise it higher.
What you do not do, under any circ*mstance, is lower your growth rates.
Given this prelude, let's look at what Workday was previously guiding for:
Previously, WDAY guided for 17% to 18% subscription growth (practically speaking, total revenues).
Now, WDAY has updated its guidance towards this:
As you can see above, the change we are referring to here is approximately $50 million over the course of a year. This led to its market cap selling off by more than $5 billion. Overreaction? Yes.
But does this sell-off make sense? Yes, also. Why?
Because, Workday was being rewarded with a premium valuation, on the expectation that it wouldn't provide investors with any negative surprises. Investors believed and bought into the thesis that these subscription revenues were highly predictable, stable, and growing.
However, if you think about it, we are still eyeing up around 17% CAGR for this year. It's just that its topline will be a smidgen slower than previously expected. Given this context, let's now discuss its valuation.
WDAY Stock Valuation -- 28x Forward Non-GAAP Operating Profits
As it stands right now, WDAY is on a path toward approximately $2.2 billion of non-GAAP operating profits.
For this figure, I've taken the 25% non-GAAP operating margin in its guidance, and estimated this figure on a go-forward basis.
This leaves WDAY priced at 28x forward non-GAAP operating profits. A figure that I earnestly believe is very much acceptable for new investors considering this stock as a fresh new entry point.
Generally speaking, I'm a strong believer that the market is nearly always right and share price movements make sense, but often only in hindsight. But in this case, I believe that this stock's reaction doesn't make sense.
The Bottom Line
Workday updated its fiscal guidance, and saw a 10% drop in its stock price. Despite this, the company's financials remain robust, priced at 28x forward non-GAAP operating profits.
Workday is expected to achieve around $2.2 billion in non-GAAP operating profits this year, reflecting a 25% operating margin. While the market reacted negatively to a slight deceleration in backlog, the company's fundamentals, including a strong balance sheet and consistent free cash flow growth, support a continued bullish outlook.
The anticipated 17% compound annual growth rate for subscription revenue underscores Workday's solid financial position and growth potential.
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