CompoundingCed's Aug 2022 review

This month’s review is later than usual as I wanted to wait for the last of my companies to report (GTLB and ZS) before gathering my thoughts. Overall it was a pretty good earnings season, with S, GTLB, ZS, GLBE and NET posting solid results. DDOG, MNDY and MDB’s guidances revealed potential weakness going forward as the companies grapple with an uncertain macro economy.

I am now in 23% cash. At this stage, it feels like the market is finally responding positively to good earnings (MELI, NET, TSLA etc.) and prices are holding (for now). It seems like the economy has not seen the worst of it, but there’s also no way to know if the stock market has bottomed or if there’s some way down to go. I’m happy with my 77% allocation and will look to add opportunistically.

Areas of Improvement for 2022
I keep this section to serve as a reminder to myself. After reviewing my 2021 portfolio return and decisions, the area where I didn’t do well was in portfolio allocation. My mistakes in 2021 were:

• Allocating too little capital to fundamentally stronger companies. (For e.g. I only had 2.4% in DDOG at one point)
• Adding to fundamentally weaker companies that had grown more attractive because their prices fell. (For e.g. I added to FUBO a few times as prices fell)
• Initiating try-out positions with too high allocation. (I would typically start with 5% allocation, which on hindsight seems too high.)

YTD Returns

Jan 2022	-21.4%
Feb 2022	-24.6%
Mar 2022        -22.8%
Apr 2022        -37.9%
May 2022        -51.5%
Jun 2022        -51.2%
Jul 2022        -46.7%
Aug 2022        -44.2%

Monthly Activity: I trimmed about 1% allocation off DDOG and Monday each. More thoughts on these in the individual stock discussion.

These are my current holdings at the end of the month. I have 9 holdings in total. They are grouped into high allocation (>10%), medium allocation (5-10%) and low allocation (0.1-5%), broadly reflecting my conviction levels.

Company	      Jul 2022 Aug 2022
DDOG	       16.9%   15.8%
Tesla**	       14.8%   13.1%

SentinelOne	9.1%   9.6%
Gitlab	        9.0%   9.0%
MongoDB	        7.8%   7.7%
Monday	        7.3%   7.1%
ZScaler		6.0%   5.9%
GLBE		4.3%   5.7%

Cloudflare	2.3%   2.7%

Cash	       22.1%  23.4%

__**Discussion of this company is OT for the board. I am including it for completeness. Please contact me off board if you wish to discuss this company.__

Portfolio Commentary
I work on the basis of 10-20 stocks. While I see others on the board have a concentrated portfolio to great effect, I’m not comfortable with allocating too much capital to a handful of companies. Chris shared a truism with me that concentration in a portfolio is a function of one’s stock picking skills. I don’t think I’m there yet, hence a greater diversification is prudent. Moreover, I currently don’t have a handful of companies that are executing so perfectly that I feel comfortable allocating >15% to each (I wish I do, though), hence I will have to spread my allocation out.

Having said that, I’m currently down to 9 positions and a high cash position, which is a rare situation I find myself in. It’s been a few months since I’ve found new companies to invest in. There are a couple of previously-owned companies that I may initiate positions in (MELI and CRWD).

High Allocation Companies (10-15%)

DDOG continued to perform in Q2. Revenue growth was 74% YoY and non-GAAP operating margin improved from 13.2% in the same period a year ago to 20.8%. FCF margin declined from 18% in the same period a year ago to 15%. Total customer growth was steady at 29% while customer (>$100k ARR) growth was stronger at 50%. Customers that are using >4 products and >6 products accelerated again. Customers using >2 products declined from 81% the previous quarter to 79% in Q2. The company said this was due to more customers landing with >2 products from the get go, so I’m not too bothered with that metric.

The company did warn that “our larger spending customers continue to grow but at a rate that was lower than historical levels.” and “This effect was more pronounced in certain industries, particularly in consumer discretionary, which includes e-commerce and food and delivery customers and affected more specifically our products with a strong volume-based component such as log management and APM suite.

With that in mind, guidance for Q3 was lowered, at 53% YoY growth. The company also guided for margins to be impacted 100bps in Q3 due to increased spending and 400bps in Q4 due to the Dash user conference.

With the possible weakness in mind, I sold off a 1% allocation but this continues to be a high conviction holding.

**Discussion of this company is OT for the board. I am including the write-up for completeness. Please contact me off board if you wish to discuss this company.

Capital intensive. Highly competitive. Eccentric founder-CEO. There are many reasons to justify why an investment in Tesla would be silly. Yet, the company’s stock was up over 300 times at the end 2021 from its IPO price. It must be doing something right.

There are signs that the EV industry is at the beginning of technology S-curve adoption where growth can accelerate exponentially. Over the next few years, Gigafactories in Shanghai (Q1 2022: it has applied for at least a doubling of already-built capacity), Berlin and Texas are expected to come online and meet the demand.

Tesla’s products enjoy a fanatical cult-like following, similar to Apple’s iPhones (another company in a capital intensive, highly competitive industry, and with an eccentric founder). Growth optionalities include subscription from Full Self Driving and its future autonomous ride-hailing network.

The company grew at hyper growth rates in 2021 and is guiding for 50% CAGR over the next few years. Q2 results were weaker than expected due to shut downs in Shanghai. Revenue grew 42% YoY and -10% QoQ, non-GAAP operating profit improved to 16.7% (from 14.9% in Q1 2021) and FCF margin declined to 3.7% (from 5.1% in Q1 2021).

In spite of the weaker Q2, the company painted a strong picture for 2H. “We are positioned for a record-breaking second half of the year. We’re quite excited about this.” Shanghai is back to full production and Tesla recently completed an upgrade in production capacity in the factory. Texas and Berlin continue to ramp up nicely.

There was also a good example of how great companies can emerge stronger from crises in innovative ways. “And so one of the ways that we’ve been able to address supply chain issues on the chip front is by rewriting of software to be able to use different chips or, in some cases, achieve dual use of a single chip, which is even better. And actually, quite frankly, the chip shortage has served as a forcing function for us to reduce the number of chips in the car. Yes, it turns out we had more chips than we needed.

As long as the company continues executing as it has, I’m happy to keep a reasonably high-conviction allocation. There are a couple of reasons why I find it hard to make TSLA an outsized position. First, selling a physical product at scale means more complications than selling software. (Yet, successfully doing so means higher barriers to entry for the competition.) Second, at $1T market cap, it could be harder for the company to double or triple compared to other SaaS companies (but I don’t rule it out).

My write-up for the company is here…

Medium Allocation Companies (5-10%)

SentinelOne’s AI-powered Singularity platform seems sufficiently differentiated and superior (as per Gartner Peer Insights and MITRE ATT&CK assessments) compared with other cybersecurity offerings. In the latest MITRE evaluation, S1 outperformed the competition again. Out of the 30 vendors evaluated, S1 achieved 100% prevention, 100% detection, the highest analytic coverage (108/109) with zero detection delays, demonstrating the platform’s ability to autonomously combat the most sophisticated threat actors.

Q2 results were a very strong beat. Revenue grew 124% YoY (110% guidance) and 31% QoQ (including Attivo numbers), while operating margin improved from -98% a year ago to -57%. Including contribution from Attivo (a recent acquisition), revenue growth for 2022 is expected to be in the triple digits and improvement in operating margins is expected. Customer growth is also strong, with large customers (>$100k ARR) growing 117% YoY and 28% QoQ.

This is a high conviction company. The significant beat in Q2 was “driven from the organic business”, according to management. This is a company where I’d be happy to increase my allocation.

This is the latest addition to the portfolio. Gitlab’s platform is built on Git, an open-source VCS (Version Control System) application. A VCS is a collaborative tool that records the changes made to source codes over time and stores the information in a repository. This allows team members to see who has made what changes, when. If something goes wrong, they can easily revert the project back to an earlier state.

Git is critical for teams because without it, teams have to store different versions of the source code in different folders. This is a huge problem, especially if different people have to work on the same project. They would have to send different versions around via email and then manually merge the projects. Git reduces costs by enhancing productivity, consolidating different tools and eliminating integrations. It also enhances operational efficiency through reducing security and compliance risk.

Gitlab (and Github – owned by MSFT) provides Git services such as command-line interfaces (CLI) for advanced developers, web-based interface for new programmers, web-based repositories, wiki support, bug tracking, feature requests and task management. Revenues are subscription based, on annual or multi-year contracts.

While Github has a larger marketshare than Gitlab, their largest competitor is DIY DevOps, which are in-house point solutions developed by individual companies for their own internal use. Gitlab estimates that itself and its largest competitors still have less than 5% of the market overall.

Gitlab achieved 74% revenue growth YoY in Q1, with 89% gross profit margin and improving non-GAAP operating profit margin of -27% (vs -42% in the same period a year ago). Customer (>$5k ARR) growth was 61% YoY and Customer (>$100k ARR) growth was 55% YoY.

The company shared during the call that according to a Forrester study commissioned by Gitlab, “our customers saw a 407% return on investment within 3 years of deployment of our DevOps platform.” and “Despite the volatility in the macroeconomic environment in the second quarter, we have not seen any impact to our business. The current environment is not slowing down customer decisions, nor elongating our sales cycles. Buying cycles have actually sped up across the business, and we continue to see strong win rates.

I am looking to increase my allocation to the company.

MongoDB’s NoSQL database architecture puts it in a strong leadership position with little real competition from legacy relational databases. Growth was given a shot in the arm when Atlas, its cloud-based database-as-a-service offering started reaccelerating revenue growth in Q1 2022 (i.e. in Year 2021). Atlas revenues are now large enough to meaningfully move the needle for the company. Total revenue growth has accelerated in the past 5 quarters and the company should do well as long as Atlas growth holds up.

The company posted a good Q2. Revenue growth came in at 53% YoY and operating profit margin improved from -6% in the same period a year ago to -4%. Customer growth continued to be strong at 28% YoY. Atlas revenue came in at 73% YoY growth and is now 64% of total revenue.

The company shared that it was experiencing slower growth in the self-serve segment (US and Europe), mid-market segment (US and Europe) and enterprise segment (Europe) The root cause was slower growth in usage of its underlying applications. Q3 and Q4 would also be tougher quarters to lap due to strong performance last year.

I am happy to keep this a mid-size position.

As the work-from-home trend seems here to stay, will be a beneficiary. The space seems to be quite competitive with players like Asana, Smartsheet, Atlassian, etc. Having said that, it is worth noting that, according to the company, their largest competitor is still “email, and spreadsheet, and PowerPoint.” and “On 70% of the deals we see literally no competition.”.

In May, the company launched Work OS with 4 new products: Monday projects, Monday dev, Monday marketer and Monday sales CRM. This will see it further differentiate itself with other work software companies.

Prior to Q4 earnings, I thought it was likely they would turn Non-GAAP Operating Margin profitable in 2022. I’ve since had to reset those expectations based on the company’s 2022 guide. The company expects to be investing more heavily in 2022 to keep up hyper growth. With the resumption of conferences, travel and accelerated hiring, operating margin is expected to worsen.

Monday was a high conviction position prior to Q4 earnings but I don’t think I can say the same now. Q1 and Q2 showed some rather rapid deceleration in revenue growth while the guide for Q3 is for even slower growth. From 91% revenue growth in Q4, Q1 saw 84% growth and Q2 saw 75% revenue growth. The guide for Q3 is 58% revenue growth, which is the slowest guide they’ve issued since IPO.

Q2 operating margin improved to -12% (compared to -14% in the same period a year back). Enterprise customers (>$50k ARR) grew 147% YoY and 21% QoQ.

I trimmed about 1% allocation after Q2 results because I didn’t think the results were fantastic and yet the share price popped about 20%. I took the opportunity to sell into strength.

Compared to CRWD, ZS seems to have prioritised revenue growth over operating margin in the past couple years. In their Q1 2022 earnings call, they said, “we’re going to prioritize growth over operating profitability.” This probably makes sense since they are already non-GAAP and FCF profitable.

In the latest quarter, ZS posted good numbers (61% YoY and 11% QoQ) and improving operating margins (12.0% vs. 10.5% in the same period a year ago). For their FY23, they guided for operating margin expansion of 150 bps. On the current operating environment, management said, “In Q4, as we saw more deals getting scrutinized, we delivered more of these business value assessments, which helped us close many large multiyear, multiproduct pillar deals.” This sounds like their clients really like ZS’s value proposition.

I’m happy with my medium allocation for now and wouldn’t mind increasing allocation if the opportunity arises.

Low Allocation Companies (0.1-5%)

Global-e Online
GLBE facilitates cross-border e-commerce. It aims to make international transactions as seamless as domestic ones. Services include interaction with shoppers in their native languages, market-adjusted pricing, localized payment options, compliance with local consumer regulations and requirements such as customs duties and taxes, shipping services, after-sales support and returns management.

The company solves a pain point for merchants as huge upfront costs and efforts are needed to offer cross-border sales. According to Forrester, brands typically see around 30% of e-commerce traffic being international but in terms of actual sales figures, no more than 5-10% come from international shoppers.

Q1 results were decent (52% YoY revenue growth, operating margin was flattish at 12% compared to 13% in the same period a year ago, Net Dollar Retention Rate >130%). The revenue guide for Q3 (73%) and the full year (74%) was very strong.

During the call, the company shared that, “On the merchant activity front, demand for our services continues to remain strong as more and more brands around the world put direct-to-consumer and cross-border sales,” and “what differentiates us is the fact that the direct-to-consumer channel is in the focus of the merchants and is gaining share over other channels. So this channel is definitely growing and growing in a nice pace. And we believe that this is a secular trend that will stay for us for a long time as merchants prioritize this channel for a reason. They want the close relationship with the consumer, they want to have the data, and they want to enjoy the margins at the end of the day. I think this is what differentiates direct-to-consumer cross-border from the sort of general e-commerce market.

Given the more volatile nature of e-commerce revenues compared to SaaS companies, I’m happy to maintain a low-ish allocation.

Cloudflare continues to confound me. It posted another consistent set of results in Q2. Consistent, but not spectacular. Yet the share price jumped about 20% after-hours. I’m not complaining, but I don’t understand it.

Revenue growth was 54% YoY and non-GAAP operating profit margin improved from -2.6% in the same period a year back to -0.4%. Paying customer growth was 20% YoY. The company shared that is was aiming to increase their $NRR to above 130% and it planned to do so by bundling products together.

The company revealed that in Q1, their pipeline generation slowed, sales cycle extended and customers took longer to pay their bills. In Q2, those metrics stabilized but “they’re not where we throw up hooray yet.” The CEO cautioned that “while our business remains strong, I believe this is a time for prudence and caution.

The CEO then shared about their strength in Zero Trust services. “Because in a lot of cases, the kind of previous Zero Trust solution either suffered from a lack of ability to scale, real performance bottlenecks, not having the total global coverage that global companies need, and Cloudflare addresses all of those things extremely well. So I think that, that’s an opportunity for us.

It was also insightful to hear how he could use high gross margins to help their customers with pricing during tougher periods. “We try to be strategic and accommodating where we think it makes sense to build business relationship and business. But we’re using our margin to accommodate for that without any doubt.

It has gotten more expensive after the pop, I’m happy to keep my position, but I think other companies will probably give me better value at their prices. Then again, this company’s price moves continues to confound me…

Previous Updates
Jan 22:…
Feb 22:…
Mar 22:…
Apr 22:…
May 22:…
Jun 22:…
Jul 22:…