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Is Splunk Stock a Buy?

By Robert Izquierdo – Jun 10, 2020 at 12:30PM

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This data company experienced a recent rise in stock price amidst slower growth. Find out if it’s still worth buying.

Data company Splunk, Inc. (SPLK 0.39%) reported results for its fiscal first quarter ended April 30. Its stock rose after the earnings news, hitting a 52-week high of $192.75 on June 3.

Given the stock price rise in recent weeks, does it make sense to invest in Splunk? A deep dive into the company can deliver an answer.

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Image source: Getty Images.

Company strengths

Splunk plays in the big data arena. Big data is the term describing the large amounts of data a company collects, usually exceeding the organization's ability to extract insights from that data. Businesses must turn to providers such as Splunk to ingest, analyze, and make sense of the data.

Big data is big business for Splunk and others operating in this industry. Forecasts predict its market size to reach $103 billion by 2027 from $49 billion last year.

And Splunk has captured its share of clients in the space. At the end of the company's fiscal first quarter, more than 90 businesses in the Fortune 100 used Splunk.

The company is transitioning its products to a cloud-based platform with a software-as-a-service (SaaS) subscription pricing model. This approach allows Splunk to generate revenue on a recurring basis, charging its enterprise customers fees to manage and analyze data. SaaS also reduces the seasonal buying fluctuations inherent in its previous model, where clients purchased a perpetual software license for an upfront cost.

Splunk's move away from perpetual licensing caused license revenue to drop 27% year over year in the first quarter to $148.4 million. However, cloud services revenue increased 81% to $112.2 million, where it's poised to soon eclipse licensing revenue.

Splunk's capabilities allow it to do business in growing areas such as IT systems monitoring and security. Technology infrastructures require customer data to be protected yet accessible, and also that IT teams can react quickly to address incident management. Research firm Gartner ranked Splunk first in market share for security information event management, which uses data analysis to identify security threats in real time, and tops in market share for performance analysis, which uses tools such as artificial intelligence.

In addition, Splunk possesses a solid balance sheet. Its $1.77 billion in cash, cash equivalents, and investments at the end of Q1 are expected to cover business needs for the next year. Its total assets were $5.2 billion compared to total liabilities of $3.4 billion.

Continued growth in a pandemic

Splunk's business experienced double-digit growth in fiscal year 2020, but that streak ended with its 2021 first-quarter results. Splunk's first-quarter revenue rose 2% year over year to $434 million. Last year's first-quarter revenue grew 36% year over year.

The sudden deceleration in the Q1 revenue growth rate is understandable. The novel coronavirus pandemic caused a global economic downturn, and Splunk pulled its full-year guidance as a result.

Even so, Splunk's offerings are well-positioned for continued growth. The company announced a partnership with Alphabet's Google Cloud product in May, making Splunk's cloud solution available to Google Cloud customers along with future plans to integrate with Google Cloud's security services. Splunk has performed some strategic acquisitions, such as SignalFx in October, that strengthened Splunk's monitoring solutions. It also expects fiscal second-quarter revenue to grow year over year to $520 million from $517 million.

Splunk uses annual recurring revenue (ARR) to represent the value of its customer contracts. Its Q1 2021 ARR of $1.78 billion was up from Q4's $1.68 billion and the third quarter's $1.44 billion, illustrating the company's ongoing growth trend.

The bottom line

The combination of the big data industry's growth along with Splunk's ability to capture its share of the market means Splunk has continued revenue upside ahead. While the company operated at a net loss of $305.6 million in the first quarter, it's common for technology stocks to operate at a loss. Splunk's free cash flow increased year over year to $31.3 million from $20.1 million, which is a good sign, especially when coupled with its solid balance sheet.

Revenue over the next few quarters will reflect the pandemic's economic impact, so it's not a good gauge of Splunk's long-term potential. Instead, continued growth in ARR confirms that Splunk's shift to a SaaS model is working. The lower upfront SaaS costs enable more businesses to adopt Splunk's solutions, and once invested, the switching costs are high, locking in that recurring revenue stream.

These factors position Splunk for continued success. I noted earlier this year that Splunk was poised to deliver results for investors, and even with its recent price jump, the stock is still a buy.

Robert Izquierdo owns shares of Splunk. The Motley Fool owns shares of and recommends Splunk. The Motley Fool has a disclosure policy.

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