Why Dynatrace Is a Top Cloud Analytics Stock for 2021

Shares of cloud observability specialist Dynatrace (DT -1.90%) have been off to the races since the company made its second public debut in 2019 (it was previously acquired and later spun off from private equity firm Thoma Bravo). The stock is up over 200% in a year and a half, including a 22% surge after the company reported on its fiscal 2021 third quarter (corresponding to the final quarter of calendar year 2020). 

At this point, Dynatrace trades for a pretty high premium but for good reason. Large organizations are rapidly migrating to the cloud, and they need the right tools to manage their next-gen IT assets. Dynatrace is quickly becoming a top name in this space, and it deserves to be on your radar.

Image source: Getty Images.

Expanding with growth of the cloud

Dynatrace reported a 28% year-over-year increase in revenue during the fiscal third quarter to $182.9 million. Within the total, subscription revenue to its cloud-based software platform increased 33% to $170.3 million. And unlike many of its competitors in the cloud analytics and monitoring space, Dynatrace is highly profitable even on an unadjusted basis. Net income increased to $18.4 million during the period, compared to just $1.8 million a year ago. 

Through the first nine months of fiscal 2021, Dynatrace has been putting up respectable numbers, and the company expects total revenue and subscription revenue to grow at a similar rate in the current period as they did in the third quarter.

Data source: Dynatrace. 

The company thinks its total addressable market will grow to some $50 billion in the next couple years as cloud observability (infrastructure software to aid in automating, securing, and fixing data center issues, and the cloud software working within those data centers) becomes more important. There are lots of competitors out there, so it may look like a crowded space. But between Dynatrace and its peers Splunk, Datadog, and Elastic, trailing 12-month revenue for the four companies totaled just under $4 billion. Suffice it to say there is plenty of room for many winners in this fast-growing market in the years ahead. 

One reason behind the huge market opportunity is the fact many organizations developed their legacy IT software tools in-house. Dynatrace is focused on the top 2,000 largest global companies, and CEO John Van Siclen told me last year that one of the biggest challenges his company faces is hiring enough people to have conversations with all of these potential customers -- not stepping on the toes of competitors. As maximizing growth is the name of the game right now and Dynatrace generates plenty of free cash flow, it has ample room to remain aggressive as it initiates dialogue with these large organizations. And as these companies rapidly migrate to cloud-based operations (replacing legacy IT software in the process), they'll need help automating and simplifying complex cloud computing infrastructure. 

Not so unreasonable a price tag

Dynatrace is growing, has plenty of room to expand, and plays in a fast-growing cloud computing industry that is accelerating because of the pandemic. But what about its valuation? Shares trade for over 23 times and 92 times trailing 12-month sales and free cash flow, respectively. That's premium pricing but not totally unreasonable given the company's double-digit growth and fast-expanding industry. Datadog and Elastic trade for higher price-to-sales multiples, though they are also growing faster than Dynatrace is. However, the latter is unique in the industry as it's already highly profitable and still growing its subscription revenue over 30%. 

There is another drawback to Dynatrace, however. As part of its spinoff from Thoma Bravo back in 2019, it was saddled with debt that many of its closest peers don't have to worry about. However, debt was $451 million at the end of the last quarter (down from $510 million at the start of the current fiscal year). And along the way, Dynatrace has also increased its cash and equivalents on hand to $300 million (up from $213 million at the start of the fiscal year). Clearly, the company is strengthening its balance sheet while maintaining its pace of expansion.

I don't think this is the best bargain among growing cloud computing companies, but Dynatrace has earned its premium. It plays an important role for big businesses trying to make digital transformations; it's picking up new customers; and it's expanding relationships with existing ones as it increases the functionality of its software. At the very least, I think this cloud company belongs on investors' watch lists in 2021.