Data is the new gold, and Alteryx (AYX) is a leading beneficiary from the data analytics revolution. The company is growing at full speed while also outperforming Wall Street expectations, and it has plenty of potential for sustained growth and expanded profitability in the years ahead.
Make no mistake, Alteryx is a volatile stock operating in a competitive landscape that is prone to disruption. However, as long as the business fundamentals remain intact and management keeps executing well, the stock is well-positioned for attractive returns going forward.
The Business
Data analytics is one of the most critical priorities for all kinds of businesses nowadays. Data-driven decisions are crucial in terms of leading the business in the right strategic direction and increasing efficiency across the board. Staying behind the competition in data analytics can be a fatal error in times when everyone is aggressively leveraging on the power of hard data to outperform the competition.
Alteryx provides software to make this data analysis process simpler, easier, and more efficient. The company calculates that its total addressable market is worth nearly $28 billion and over the coming years the size of such a market opportunity is expected to reach as much as $49 billion.
Alteryx has over 5,600 active customers, including 34% of the Global 2000. The net expansion rate was 132% last quarter, as customers continue to invest in the company's solutions. This speaks well about Alteryx and its ability to generate value for customers.
The company was recognized as a Gartner Peer Insights Customer Choice in 2019, which is a recognition of vendors by verified end-user professionals. The reviews from users are clearly impressive.
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Source: Alteryx
Spruce Point Capital Management recently published some quotes from their conversations with Alteryx users and industry experts. Based on these testimonies below, the company is truly outstanding in terms of the quality of its services and customer satisfaction.
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Source: Spruce Point Capital Management
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Source: Spruce Point Capital Management
Alteryx is benefitting from multiple growth engines in the years ahead. IDC calculated there would be $2 trillion spent on digital transformation in 2019 alone. Last year, the World Economic Forum found that 29% of all work is performed by machines, and this is expected to grow to 42% by the end of 2022.
By automating both simple and complex analytic tasks with the Alteryx platform, the company can significantly increase the productivity for all categories of data workers across the enterprise. Alteryx is agnostic to the shape, size, and location of data, as well as agnostic to how the data is consumed. This puts the company in a strong position to profit from the increasing demand for automation.
Another key trend is the convergence of analytic personas. Business professionals with no coding abilities are venturing into data analysis and working side by side with professionally trained data scientists. Alteryx is focused on addressing the requirements of users with a variety of skills, coding abilities, and comfort with advanced analytic capabilities.
The Numbers
Alteryx is growing at full speed, while also consistently outperforming Wall Street expectations. The financial reports for the third quarter of 2019 confirm that the company is firing on all cylinders across the board.
Revenue during the quarter amounted to $103.4 million, an increase of 64% year-over-year and representing a net expansion rate of 132%. Adjusted earnings per share amounted to $0.24, surpassing analysts' expectations by $0.15 per share.
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Source: Alteryx
Looking at the evolution of profit margins, it is important to note that Alteryx retains 90% of revenue as gross profit. Even when considering research and development and general and administrative expenses, the business is still widely profitable after including these items. The lion's share of expenses is sales and marketing, which currently accounts for 51% of revenue and keeps overall profit margins under pressure.
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Source: Alteryx
Over the long term, management is planning to take the operating margin from 1% of revenue to 35%-40%. The main drivers behind this expected increase in profitability are scale, efficiencies, and a reduced impact from sales and marketing on a growing revenue base.
When you look at the valuation in terms of ratios such as price to earnings, Alteryx would seem irrationally expensive, with a forward PE ratio around 115. However, we need to consider that current earnings are not truly reflecting the company's true underlying earnings power because sales and marketing expenses represent 50% of revenue right now.
Sales and marketing is money invested for further growth. In fact, Nike (NKE) refers to sales and marketing as "demand creation" in its financial statements. If the company is correctly assessing the profitability of those marketing investments, this money should come back to the business - and then some more - in the form of increased revenue in the years ahead.
When you think about it, Alteryx is making a gross margin of around 90% on revenue, and the company has enormous opportunities for growth. From this perspective, management is doing the right thing by prioritizing long-term growth above current profit margins.
Since current earnings are clearly not the right measure to evaluate Alteryx and other high-growth software stocks, we can take a look at the price to sales ratio and its expected evolution going forward. The table below shows revenue estimates, growth rates, and the implied forward price to sales ratios based on these assumptions.
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Source: Seeking Alpha Essential
Based on these growth expectations, Alteryx is not cheap at all, but it is still priced in line with other high growth companies in the software sector. Looking at how the price to sales ratio has evolved for Alteryx, valuation has retraced substantially in recent months, mostly because high growth software stocks, in general, have pulled back.
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Data by YCharts
Importantly, forward-looking valuation ratios are based on a particular set of expectations about the business. When the company outperforms those expectations, the stock price tends to increase. Alteryx has an impeccable track record in this area, and the company has delivered both earnings and sales numbers above Wall Street estimates in each and every quarter since its IPO in March of 2017.
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Source: Seeking Alpha Essential
Wall Street analysts are consistently running from behind and raising their revenue estimates for Alteryx. As long as this trend remains in place, better than expected performance and rising expectations for future performance would mean that Alteryx stock is ultimately cheaper than what current expectations are implying.
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Data by YCharts
It is interesting to note that Salesforce (CRM) disclosed some filings with the SEC after the Tableau (DATA) acquisition, and the fillings showed that internal financial forecasts for Tableau are materially ahead of Wall Street estimates at the time of the acquisition. I wouldn't be too surprised to learn that Alteryx also has more ambitious targets than what Wall Street is currently expecting from the company.
Managing expectations is of the utmost importance for high growth stocks in the software business, and management tends under-promise and over-deliver in comparison to market expectations. The fact that Alteryx has consistently crushed expectations since being a public company supports this idea.
Risk And Reward Going Forward
Alteryx operates in an emerging industry with enormous potential for growth, but success attracts the competition, and investors need to keep a close eye on the competitive landscape going forward.
Many analysts seem to believe that a larger player such as Microsoft (MSFT) could be a major competitive threat for Alteryx. However, it can be difficult for a tech giant to compete with the same flexibility and focus as a specialized player in a particular segment. Instead, chances are that a bigger player such as Microsoft may want to buy Alteryx, which would require a purchase price considerably above current market prices for the stock.
As long as Alteryx keeps delighting its customers with superior solutions, the company should be more than fine from a competitive point of view. But the industry is still prone to disruption, so this is a key factor to monitor when assessing a position in Alteryx.
Valuation is always a major concern for high growth companies in the software sector. The stock is not too expensive in comparison to peers, and valuation is not excessive at all based on the company's track record. As a reference, the average price target among the analysts following Alteryx is $126, which implies a healthy upside potential of over 30% from current levels.
But still, when growth expectations are high and valuation ratios are elevated, the stock can be vulnerable to the downside in case of any disappointment. Even in the absence of any company-specific factors, these kinds of stocks can be quite volatile.
That said, volatility and risk can be very different things for investors. If the business fundamentals remain strong and management continues executing well, price corrections in Alteryx should be considered an opportunity to buy an exceptional growth business at a more convenient price and with a long-term investment horizon.
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