GitLab: Strong Growth, Valuation Unattractive (NASDAQ: GTLB)

investment thesis

gitlab (Nasdaq: GTLB) went public in late 2021 and since then the share price has fallen more than 70%. Some people may be inclined to buy the plunge, but I would like to make my readers aware of this The upside potential is minimal compared to the level of risk and uncertainty. Moreover, the current harsh environment does not favor stocks that do not make profits, even if they show explosive growth. I wouldn’t buy GTLB stock at current levels, but the company will be on my radar for the next several quarters to watch how the situation develops.

company information

GitLab is a technology company that brings to market the complete DevOps platform delivered as a single application. GitLab enables teams and organizations to streamline the software development lifecycle, enhance collaboration, and accelerate software delivery. According to the most recent 10-K reportThe company has more than 30 million registered users and more than 50% of Fortune 100 companies are GitLab customers. GitLab primarily generates revenue from selling subscriptions in both self-managed and SaaS models.

The company’s fiscal year ends on January 31. Self-managed subscriptions accounted for nearly two-thirds of the company’s total sales in fiscal 2023.

Finance

GTLB went public relatively recently, so the horizon for historical financial performance is rather short, with only four full fiscal years available. The company achieved a compound annual growth rate of more than 50% in revenue, although the comp was low and easy to beat. The gross margin seems massive, close to 90%. Operating margin seems far from breakeven, but it has improved significantly over the past four years.

For me, as a potential investor, massive operating losses are a red flag, so I need to get into detail here. As you can see in the table below, SG&A expenses are huge and higher than revenues.

I don’t like that R&D expenditures are much lower than SG&A expenditures. Marketing is essential for a young company like GitLab to build word of mouth, but underinvesting in product development can be costly in the long run.

Narrowing down on its most recent quarterly earnings, the company showed revenue and earnings per share outperformance versus consensus estimates. The company has never failed to beat consensus estimates since going public, though the sample is relatively small to give a confident opinion regarding future quarters.

If we look at revenue dynamics sequentially, we can see that core growth is slowing, and there is almost no data to compare last year’s dynamics. In its most recent 10-K report, the company claims that its fiscal third and fourth quarters are typically stronger than the first two. However, we can see sequential growth slowing significantly in the past two quarters. Annual growth is also expected to slow significantly in the first quarter of fiscal 2024. The earnings announcement is relatively close and is scheduled for June 6th.

The company’s balance sheet looks strong with almost no debt and cash outstanding at about $1 billion which is well above last quarter’s cash burn rate of roughly $77 million. The current liquidity is also in good shape, so I think GitLab is unlikely to face the need to raise additional funding in the near future, which is a good sign given the current tight credit environment.

evaluation

Gitlab is a strongly growing company, so I use discounted cash flow [DCF] approach to evaluation. I’m using 10% WACC which is an approximation of GuruFocus’ estimate. I have a consensus on revenue estimates available for the nearest three fiscal years. For years beyond, I expect revenue growth of 25% for the next three years after fiscal 2020, and then I expect it to slow to 20%. I expect the company to generate a positive FCF in fiscal 2026 and assume that FCF margin will expand by two percentage points annually.

As we can see, incorporating all assumptions into the discounted cash flow model gives us a fair value of the business of approximately $6.2 billion. It indicates upside potential between 20% to 15%. If GTLB was a value stock with a sustainable dividend yield and estimated future cash flow reliably, I would invest immediately given the upside potential. But given the high degree of uncertainty around the underlying assumptions, I consider the upside unattractive.

On top of that, let me also simulate a less aggressive but very optimistic 20% revenue CAGR. Implementing a more modest revenue CAGR for years after fiscal 2027 offers only 5% upside potential, which is certainly not enough for a growth stock with a high level of uncertainty.

In general, I do not consider the current share price attractive. Furthermore, Morningstar Premium estimates the fair value of GTLB’s share price to be approximately $37.5, approximately 10% higher than the actual share price. And according to Morningstar, the level of uncertainty is also very high.

Risks to consider

The main risk that I see in the near term is the general market volatility that could be caused by the unfavorable macro environment. Apart from the AI ​​craze fueling the market this year, there are no other positive catalysts for the market. On the other hand, the war in Ukraine is still far from over, there is uncertainty about when the Fed will stop its rate hike cycle, and Democrats and Republicans are still unable to reach an agreement on the debt ceiling. All of these things look hugely unfavorable to the stock market, and growth stocks suffer the most in the general market turmoil. The S&P500 is about 10% below its all-time high, and I think the current harsh macro environment hasn’t been priced in.

The high costs of the public and general departments of the company also pose a great risk. During our latest full year results, SG&A expenses were still higher than sales. This means that the company has been fueling its rapid growth with aggressive marketing. Thus, there is significant uncertainty about the ability to sustain strong revenue growth in the event that management decides to optimize selling expenses. Also, I consider the company’s mix of SG&A and R&D expenses, which suggests that management may focus more on short-term revenue growth than long-term growth. It’s not good in the long run and risks the company’s ability to keep up with technological developments.

Finally, GTL conversion relies heavily on open-source solutions, which can have both benefits and risks. The most obvious risks of open source are security vulnerabilities, licensing issues, and potential conflicts within the open source community. This is also a risk that management must be able to manage in order to mitigate it.

minimum

Overall, I think the potential upside for GTLB stock derived from my valuation analysis is not worth investing in at current levels. Uncertainty about future growth and the timing of the break-even is murky. The company is still far from becoming profitable, and all growing companies that aren’t profitable are highly vulnerable to adverse conditions in the macro environment. Since 2023 and the next few years are expected to be challenging for the global economy, I also don’t see how the GTLB stock will grow under the current conditions. The stock is hanging on at current levels, in my opinion.