Why Veeva Systems Deserves Its Premium Valuation

The U.S.-China trade war torpedoed many growth stocks this year, yet shares of Veeva Systems (VEEV 1.39%) sidestepped the carnage and surged 80% in 2019. Investors are still paying a premium for the stock, which hovers near an all-time high and trades at nearly 70 times earnings.

Let's see why the bulls love Veeva and whether the stock still has room to run.

What does Veeva do?

Cloud services company Veeva was co-founded by Peter Gassner, Salesforce's (CRM 0.82%) former SVP of technology. Its core customer relationship management (CRM) platform runs on the Salesforce1 app development platform, and its other services are tethered to Salesforce's marketing and service clouds.

Image source: Getty Images.

Unlike Salesforce, which offers its CRM services to a wide range of industries, Veeva only offers services to life science companies to help them manage customer relationships, track industry regulations, clinical trials, prescribing habits, and other data.

Veeva enjoys a first-mover advantage in this market, where growing competition among drugmakers has boosted demand for real-time, cloud-based data. That's why its growing list of more than 775 customers includes pharma giants like GSK, AstraZeneca, and Novartis.

Veeva locks in these customers with an expanding ecosystem of additional services, including a data warehouse, employee training tools, and an AI service that analyzes a customer's CRM data. The stickiness of that ecosystem widens Veeva's moat against any potential competitors -- but the company faces no meaningful rivals yet.

How fast is Veeva growing?

Veeva's revenue, operating income, and net income all rose at double-digit rates over the past year.

Data source: Veeva Systems quarterly reports. *Non-GAAP (adjusted) basis.

During the second quarter, Veeva's subscription services revenue rose 28% annually and accounted for 81% of its top line. That segment's adjusted gross margin expanded 260 basis points annually to 86.1%, indicating that the company's first-mover advantage still gives it tremendous pricing power.

The remaining 19% of Veeva's revenue came from its professional services segment, which provides IT services and training for its customers. The unit's revenue climbed 24% annually during the quarter, but its adjusted margin contracted 60 basis points annually to 30.9%.

Image source: Getty Images.

That decline wasn't surprising, since Veeva is willing to accept lower gross margins at its professional services unit to keep users locked into its higher-margin subscriptions. The dip also didn't impact Veeva's total adjusted gross margin, which expanded 230 basis points to 75.9%, or its adjusted operating margin, which jumped 330 basis points to 38.8%.

Unlike many cloud service companies -- which struggle to squeeze out a profit due to the costs of running servers, securing new customers, and offering competitive prices -- Veeva remains firmly profitable by both GAAP (reported) and non-GAAP (adjusted) metrics.

A rock-solid outlook

For the third quarter, Veeva expects its revenue to grow by 22%, its adjusted operating income by 22%-23%, and for its adjusted net earnings by 20%-22%. For the full year, it expects its revenue to go up 23%-24%, for its adjusted operating income to climb 31%-32%, and for its adjusted earnings to grow 29%-31%.

Veeva's forward P/E ratio is much higher than its earnings growth rate, but the bulls argue that premium is justified for five reasons: its business is immune to the trade war, demand for its services will keep rising, its ecosystem is sticky, it lacks meaningful competitors, and it generates consistent and profitable growth. Veeva is also a lucrative takeover target for bigger CRM companies (like Salesforce) that want to dominate the life sciences CRM market with a single purchase.

I previously warned investors to be cautious with Veeva, but it's still a promising growth stock for investors with an appetite for more risk. Therefore, Veeva deserves its premium valuation, though investors should be ready to ride out the near-term volatility and be ready to buy more shares if it pulls back.