Owners of Hortonworks (NASDAQ:HDP) stock are not having a good month.
After surging in anticipation of its earnings release last week, Hortonworks stock took a big hit once the news actually came out. Revenue surged 46% year over year, but Hortonworks reported a $1.12-per-share loss on that revenue (worse than in the year-ago quarter, and also worse than analysts had predicted).
Result: Hortonworks stock shed 28% of its market cap post-earnings, and is still down about 22% from its pre-earnings price today.
Regardless, one analyst sees hope for Hortonworks recovering all of those losses -- and more -- doubling in value and rising to $20 a share. Here are three things you need to know about this morning's upgrade.
1. Big prospects for big data
Despite the big Q2 loss, analysts at NYC-based Rosenblatt Securities are optimistic that Hortonworks will turn profitable...eventually. As quoted on StreetInsider.com this morning, Rosenblatt sees Hortonworks' focus on "big data/analytics and the migration to open source" as making up two of "the most significant waves in the tech sector today."
The analyst predicts "growth of nearly 50% for the next several years" in Hortonworks' version of the Hadoop data-crunching software, and cites the company's 72% subscription growth as evidence that the company "is on the right near and long term path" to capitalizing on that potential.
2. Big prospects, but no profits
Why isn't Hortonworks' revenue growth translating into profits? Last week, management pointed to its success in signing customers to multiyear-long subscription plans as one reason, explaining that it takes "a longer time, obviously," to recognize revenue and record profits from these deals.
3. But the profits may come eventually
Rosenblatt agrees that "the company's subscription model impairs GAAP earnings." Nonetheless, the analyst argues that "growth in both OCF and EBITDA points to a strong path to profitability." Currently, investors are frightened by the company's reduction in guidance (revenue projections cut from $49 million for Q3 to $45 million, and from $190 million to $177 million for the year). But Rosenblatt sees profit margin growing "sequentially," and argues that as revenue rises over time, those fatter profit margins will turn the company GAAP-profitable over time.
Indeed, most analysts cited on S&P Global Market Intelligence see revenue growing strongly at Hortonworks over the next few years. Even if the latest estimates look a bit light, they still imply revenue growth of 45% this year over 2015 levels. And if an investor can wait as long as 2020, S&P Global data show Hortonworks revenue more than trebling to $578 million.
The most important thing: Not revenue, but profits
Summing up, Rosenblatt declares that Hortonworks is a buy because the stock costs less than two times this years' revenue, and that revenue is growing strongly. But what about the profits?
Hortonworks' profit margins have varied widely over the years. But over the past 12 months, for example, Hortonworks achieved a gross profit margin of 58%. Should that be maintained and applied to $578 million in projected 2020 revenue, that would work out to about $355 million in gross profits in 2020 -- more than enough profit to cover the company's current operating costs of $315 million.
Problem is, operating costs will not likely hold steady as Hortonworks grows its revenue. In fact, the growth rate in operating costs over the past 12 months was 28%, about even with the growth in revenue -- 27%. So if expenses continue to rise in tandem with sales over the next few years, then by 2020, they'll more than eat up any extra gross profits that Hortonworks can produce, and leave the company still operating at a loss.
Long story short? Anything is possible over time. If you look out four or five years, assume not just steady profit margins but significant growth in profitability, a resumption of strong sales growth, and perhaps a moderation of the rate of cost-growth as well -- then yes, it's possible Hortonworks will earn a profit at some point in time, in the distant future.
But I still don't see it happening anytime soon. Rosenblatt has jumped the gun in recommending Hortonworks today.
Fool contributor Rich Smith does not own shares of, nor is he short, any company named above. You can find him on Motley Fool CAPS, publicly pontificating under the handle TMFDitty, where he currently ranks No. 308 out of more than 75,000 rated members.
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