Oof, this quarter wrapped a big bow on this very ugly year as my prediction last quarter turned out to be wrong, go figure. We ended up retesting the lows and then some and my portfolio currently sits within earshot of that mark. Needless to say, I am ready for this year to be behind us.
I did not make any major changes to my portfolio this quarter aside from selling out of my small Upstart position back in October. I finally realized things were going to continue to get worse for the company before they get better and decided to let go. The stock is down more than 25% since I sold so it is a good reminder than a stock that is down 98% can always go lower. This was another painful lesson as I should have sold out long ago but I will chalk this up as another expensive learning experience. I still believe in the company but will be watching from the sidelines until things improve.
My YTD results:
Jan: -22.8%
Feb: -16.9%
Mar: -22.9%
Apr: -39.3%
May: -51.1%
Jun: -55.5%
Jul: -51.6%
Aug: -45.9%
Sep: -51.7%
Oct: -54.1%
Nov: -59.8%
My current portfolio:
The Trade Desk: 16.5%
Snowflake: 16.1%
Datadog: 15.8%
Cloudflare: 14.1%
Bill: 13.5%
Crowdstrike: 9.8%
SentinelOne: 7.4%
Options: 3.9%
Cash: 2.9%
*The options all consist of Cloudflare and SentinelOne LEAPs, so you can think of their allocations a couple percent higher. Please, no comments on this since it is OT.
Earnings Thoughts:
It is clear cracks starting to show this quarter and the macro environment is making its impact felt. I walked away feeling more disappointed with this set of results versus any other quarterly earnings that I can recall. The scary part is, I think it will likely get worse before it gets better. But with that being said, here are my thoughts for my seven companies:
The Trade Desk: This position has become my largest since it has held up a bit better this year (it is ‘only’ down 45%) and because I have owned it for over three years so it has just gradually worked its way to the top spot. It feels odd to say I am letting my winners run considering it is 53% below its 52 week high but you get the idea. While it is the slowest grower in my portfolio, I sleep well at night with this as my #1 holding thanks to its incredible track record, leadership, and profitability.
I thought their quarter was strong, all things considered. While their competitors in the ad space such as Meta and Roku are struggling, they keep chugging along. Ultimately, The Trade Desk is going to grow revenues and adjusted EPS by 30%+ this year, which I find to be quite impressive given the advertising environment. The stock also currently trades at a TTM P/E of 42 - I remember when stocks used to trade at 42 times sales!
This quote from the CEO, Jeff Green, on the CC really sums it up for me:
“I believe that through the first nine months of the year, we have gained more market share, grabbed more land than at any point in our history.”
As a result, I expect the floodgates might open when the economy turns around. Who knows when that will be, but I am happy to hang on to TTD until that happens because I think they will be heavily rewarded thanks to their position within CTV.
Lastly, I want to point anyone interested in TTD to read Mekong’s post from a couple weeks ago. He explained why he is so bullish on the company more eloquently than I ever could - Mekong22 November 2022 Portfolio Update.
Snowflake: I gave Snowflake the MVP ball for their performance last quarter and they backed it up with another strong set of results. Here are a few things that stuck out to me:
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A record adjusted operating margin of 8%
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Total customer growth remained strong, as they added 484 new customers which is up from 434 a year ago. Given that Snowflake is targeting bigger customers, this is a good sign, especially considering they added a record number of global 2000 customers
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They added 41 new $1M customers, which is up from 32 a year ago. Given the fact most IT budgets are shrinking, I am happy to see customers continue to expand their use of Snowflake
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NRR remained at an astronomical level at 165%
The overall bullishness of management also stands out to me. Compared to other earnings calls, Snowflake really sticks out in this regard. The fact that management felt confident enough to provide this kind of guidance for next year is amazing to me -
“For the full fiscal year 2024, we expect product revenue growth of approximately 47% and non-GAAP adjusted free cash flow margin of 23% and continued expansion of operating margin.”
Of course, whether or not they hit this guidance is another question but I trust management would not share this unless they felt extremely confident they will at least hit this mark. Considering next quarter Snowflake will likely end up with product revenue growth in the mid 50’s, it is quite stunning that management is essentially telling us there will not be much more, if any, deceleration over the next year. If this turns out to be the case, I expect the stock will do very well next year.
My one gripe with the quarter would be the weak guidance for next quarter. As I alluded to above, a typical beat would mean revenue growth would fall to about 55% YoY, which is a massive drop from the 100%+ growth from just a few quarters ago. This would also mean QoQ growth of ~6.5%, which would be their slowest by a long shot.
I likely would be slamming the panic button over this quarterly guidance if management had not shared their expectations for next year. Ultimately, I think this boils down to whether or not you trust management to make good on this guidance. This is becoming a gamble on Snowflake’s growth durability. As of right now, I believe they will execute and achieve this, but if Snowflake makes a trend of growing 6.5% sequentially, I’d expect the stock will be cut in half. A lot will be riding on the full year guidance they officially share next quarter.
Datadog: Well, after walking away disappointed with their results last quarter, Datadog did little to make me feel any better this go round. In fact, I would say this is the worst performance I have seen from Datadog aside from Q2 2020 when covid struck.
What I liked:
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Adjusted operating margin and FCF remained strong
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NER remained above the 130% threshold
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Customers continue to expand the use of their platform, as the percentage of customers using 2+, 4+ and 6+ pillars all showed solid upticks
What I disliked:
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The smallest beat since the covid quarter led to the slowest QoQ growth since the covid quarter. This is the first time QoQ growth was below 10% apart from that quarter
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The guidance indicates Q4 is also going to be challenging and likely below 10% growth QoQ, despite Q4 generally being their strongest
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OpEx grew 65% YoY, outpacing revenue growth at 61%. This is the first time this has happened in several years
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Stock based compensation continues to balloon and hit a record at 23.2% of revenues. Datadog SBC was 15.7% of revenues last year on average so they are clearly having to shell out more stock as compensation to make up for the depressed share price
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They added only 1,000 customers, which is less than 1,100 from a year ago
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They added only 180 customers with ARR > $100K, which is less than 230 from a year ago
Obviously, there is a lot more I disliked than I liked, but that is par for the course this quarter. Consequentially, I have trimmed about 10% of my DDOG position. I don’t plan on trimming anymore because I do believe these are temporary headwinds they are facing. Given the fact they are consumption based, it is not too surprising to see this kind of deceleration. In my opinion, they offer a best of breed solution and are well position to see growth rates pick up once things improve with the economy.
Cloudflare: The trend was snapped! After posting YoY revenue growth between 50-55% the last eight quarters, Cloudflare finally stumbled along with the rest of the pack. Honestly, from a quantitive standpoint, there was not a whole lot to like from this report. The one bright spot was the record adjusted operating margin of 6%. Problem is, management has warned us to temper our expectations here as they plan to keep this near breakeven to pursue growth.
What I disliked:
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The smallest beat I have on record led to the slowest QoQ growth at 8.2%
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FCF was negative yet again, meaning they must have achieve a solid positive FCF figure in Q4 to meet their guidance made earlier in the year
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They added only 4,197 customers, which is less than 5,655 from a year ago
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They added only 159 customers > $100K, which is less than 172 from a year ago
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DBNRR fell for the second straight quarter to 124%
The market reached a similar conclusion and Cloudflare promptly fell ~20% following this report. While this report was a disappointment, one piece of big news was shared on the earnings call. Management was proud to share that “we’re confident we’re on the path to organically achieve $5 billion in annualized revenue over the next five years.”
Unfortunately, this prediction was not enough to salvage the stock price but it is a rather bold claim. In order for Cloudflare to achieve this, they will need to compound revenue by at least 30%+ for the next few years. The reason I say this is bold, is because they are barely above that mark today! Based off next quarter’s guidance, growth is likely to end up in the low to mid 40’s. In other words, it does not give them much room for deceleration over the coming years if they are going to hit this mark.
Given the innovation machine that they are, I believe Cloudflare will pull this off which is why hold a 14% position. With that being said, if they continue to put in performances like this one, my trust will slowly start to evaporate. Until then, I will chalk this weaker report up to the macro impacts and keep believing in their ability to execute.
Bill: I thought Bill had one of the stronger reports in my portfolio but I will admit, they are more difficult for me to size up due to all their recent acquisitions. What I do know, is Bill increased revenue nearly 15% sequentially, which is well above any other holding in my portfolio. Assuming a similar size beat next quarter, Bill is poised to grow at about the same rate which I expect will once again be faster than any other holding. The problem is, Bill is all over the place with their beat history so it is difficult to bank on this.
Apart from the rapid revenue growth, there were a few things that stuck out to me:
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Adjusted gross margin hit a record of 86%
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Adjusted operating margin hit a record of 4%, making good on managements promise from last quarter of transitioning towards profitability
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They added a record number of Bill customers, 14,200 in total
While Bill is decelerating from their insane growth last year, they are still putting up growth numbers that would make just about any other company jealous. If management had not been so ‘prudent’ on the earnings call, I bet the stock price would sit a bit higher. Regardless, I view the opportunity to add at these prices a gift and have been acting accordingly. Let’s hope they can keep up the strong performance in the face of this tough environment.
Crowdstrike: Major oof here, as Kurtz and team laid an egg, in my opinion. To add insult to injury, I added slightly ahead of the earnings release thinking they would impress based upon the strong Palo Alto report and the idea that cybersecurity was more ‘recession proof.’ Well, that turned out to be a mistake and I have since sold what I added. Aside from customers continuing to expand their usage of the platform, I did not find a lot to like. On the contrary, I found a lot to dislike:
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The smallest beat on record led to the slowest QoQ growth at 8.5% (notice a trend here?). Considering Crowdstrike had never beat guidance than less than 4% (which coincidentally was last quarter), this 1.5% beat indicates to me that management was caught off guard with this quarters weakness
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ARR was a mess across the board - the slowest QoQ growth at 9.3%, a decrease sequentially in net new ARR from $218M to $198M (the first time ever from a Q2 to Q3), and guidance that new new ARR would also decrease sequentially again next quarter. This would also be a first and even more concerning given Q4 is generally their strongest
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They added only 1,460 customers, which is less than 1,607 from a year ago. This is more concerning considering Crowdstrike is trying to move down market
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They failed to raise their full year guidance for the first time ever
The stock got crushed following this report and rightfully so, in my opinion. I am sure most had high hopes for Crowdstrike like myself and they turned in a very uncharacteristic report.
Similarly to Datadog, I am chalking this up to temporary macro headwinds and expect the company to get back to their winning ways. Their track record of success is too long to indicate the thesis just broke in one quarter. I said last quarter this is a solid 50%+ grower but this appears to be closer to 40%+. Still, to be growing at that pace, at this scale, with 15%+ operating margins and 30% FCF margins, there is a lot to like. Let’s hope this is a temporary blimp on their journey.
SentinelOne: Following Crowdstrike’s lackluster report, my expectations for SentinelOne immediately lowered. I would say they cleared the low bar, but not my much. While they did grow at an eye popping rate of 106% YoY, this number is surely going to fall drastically over the coming quarters as the sequential growth indicates they are truly growing closer to 60%. I wrote this blurb in my Q2 update a few months ago:
I own less of SentinelOne because I see it as a bit riskier than my other positions. It is far less unproven, but at a ~$8B market cap, there is a lot to like. If they can continue executing, there is a ton of upside. Ultimately, it will come down to two main things:
1. How durable is their growth? It is paramount that SentinelOne can continue to grow at a high rate.
2. Can they continue to improve the bottom line? They must continue to show operational efficiencies and drive towards positive adjusted operating income.
Well, fast forward to today and the valuation has been cut in half to $4B. Let’s see how they are doing with regards to the two main items mentioned above:
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Growth is looking a lot less durable today than it did in September. While management did provide guidance of 50% ARR growth next year, I would be surprised if they came in too far above this. To see revenue growth dropping so rapidly at this scale is a bit concerning, without a doubt.
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I would say SentinelOne is trending in the right direction with regards to profitability. Adjusted operating margins are making huge strides forwards and it is obvious management will continue to focus on this based off comments in the earnings call. Now we just need FCF to pick up the slack a bit. After all, a company growing 60% is going to get a lot less leeway in terms of cash flows versus one growing 100%.
The supporting metrics were all very ‘meh’, nothing thesis breaking but nothing to write home about either. Customer and > $100K ARR customer adds were both up very slightly YoY, although this is more than Crowdstrike, Cloudflare or Datadog can say.
ARR growth was also its slowest ever sequentially, but at least management said next quarter they expect net new ARR to increase by at least 20%. Again, Crowdstrike management shared a different story, although it is important to remember they are exponentially larger than SentinelOne. Also, it is important to keep in mind SentinelOne guided for net new ARR to be in the high 50’s this quarter and it came in at $49M. This is a pretty big miss, so it is difficult to take their guidance at face value going forward.
In total, I would say this was a weaker report, although better than the one Crowdstrike reported. It left a lot to be desired, but I would argue much of this is already priced in. The stock is trading at a very low valuation so I think there is a lot of upside even if they grow around 60% next year and make solid strides with FCF. It is my smallest position though for a reason, but I have no intentions of exiting or trimming. I want to give them at least one more quarter to get a better idea of what kind of growth we should expect going forward. At a $4B market cap, I think the risk/reward is worth seeing how it plays out for now.
Concluding Thoughts:
This was a really tough quarter, in regards to both the portfolio performance and the actual earnings results. I thought Crowdstrike and Datadog in particular had especially weak results, while Snowflake and Bill were the strongest of the bunch. Regardless, it is obvious that the macro environment is making its mark on these companies from top to bottom.
I think things with the economy are going to get worse before they get better. Generally, it takes 9-12 months for the change in the federal funds rate to impact the economy, which means we should start to feel the impacts of the rapid interest rate hikes by mid-2023. And based off the fed’s comments, it appears they are willing to drive the economy into a recession in order to bring down inflation. It seems like that is the collision course we are on for next year. Time will tell, but I am expecting bumpy roads ahead.
The good news is, the stock market is forward looking, and I think most of the damage has already been done for SaaS stocks. These businesses should be positioned the best to survive a recessionary environment given the reoccurring nature of their revenue. And when things with the economy do start to recover, I would expect there is a good chance for their revenue to accelerate (looking at you, Datadog and The Trade Desk). Personally, I know I have zero hope of ever timing the market and seeing as my portfolio is already down 60% YTD, I plan to keep riding this out and hoping for the tide to turn sooner rather than later.
Wishing you and your family a Merry Christmas and hopefully a better 2023!
Rex
Q3 2021: https://discussion.fool.com/majorfool39s-earnings-thoughts-34977…
Q4 2021: https://discussion.fool.com/majorfool39s-q4-earnings-thoughts-35…
Q1 2022: https://discussion.fool.com/majorfool39s-q1-earnings-thoughts-po…
Q2 2022: MajorFool's Q2 Earnings Thoughts & Portfolio