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Is Elastic Stock a Buy?

By Leo Sun - Apr 14, 2021 at 8:45AM

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The enterprise search provider's fundamentals are improving, but it still faces a sea of competitors.

Elastic's (ESTC -0.13%) stock price more than doubled over the past 12 months, as the Dutch enterprise search company generated stable growth throughout the pandemic. But as rising bond yields spark an investor rotation from growth to value stocks, can Elastic maintain that momentum?

What does Elastic do?

Elastic's core software platform, Elastic Slack, ingests and stores data from "any source" and in "any format," then processes that data with search, analysis, and visualization tools within "milliseconds or less."

Its technology helps Uber's app locate nearby riders and drivers, enables Match's Tinder to find potential matches, and helps Adobe's Creative Cloud users locate the right photos, fonts, or color palettes to complete their digital projects.

Four people standing in a space with the floor lit up with images of machinery

Image source: Getty Images.

Telecom giants like T-Mobile's Sprint and SoftBank use Elastic's technology to monitor their infrastructure and network performance, while universities use its services to track students and classes.

As Elastic's name implies, its tools are flexible and can be integrated into a wide range of services beyond enterprise searches, including application performance monitoring (APM) and data analytics tools.

How fast is Elastic growing?

Elastic went public in October 2018. Its revenue rose 70% to $271.7 million in fiscal 2019, which ended in April of that calendar year. However, its net loss widened from $52.7 million to $102.3 million.

In fiscal 2020, Elastic's revenue increased 57% to $427.6 million, but its net loss grew again to $167.1 million. On a non-GAAP basis, which excludes its stock-based compensation and other one-time expenses, its net loss still widened from $61 million to $73.3 million.

Elastic's non-GAAP gross margin actually expanded 70 basis points year over year to 74.7% in fiscal 2020. It mainly attributed that expansion to slightly higher margins for its professional and subscription services. But at the end of the year, Elastic warned that the ongoing expansion of its cloud-based software-as-a-service (SaaS) platform would remain a "modest headwind" for its margins in fiscal 2021.

Improving fundamentals in fiscal 2021

In the first nine months of fiscal 2021, Elastic's revenue rose 42% year over year to $430.9 million. Its subscription revenue (including its expanding cloud services) accounted for 93.5% of that total, up from 91.5% a year ago. The rest of its revenue came from its professional services.

A laptop accessing cloud services.

Image source: Getty Images.

Elastic ended the third quarter with over 13,800 subscription customers, compared to more than 10,500 a year ago. It locked in about 670 customers with annual contract values of over $100,000, up from roughly 570 customers a year earlier.

Elastic ended the period with a net retention rate of more than 130%. Its deferred revenue, which gauges the future demand for its services, grew 58% year over year in the first nine months.

Elastic's non-GAAP gross margin expanded year over year during that period, from 74.2% to 76.9%, as its stable revenue growth and retention rates offset the impact of its SaaS investments. Its net loss narrowed from $136 million to $86.1 million, while its non-GAAP net loss declined from $63.5 million to just $339,000.

Elastic expects its revenue to rise 38% for the full year. It forecasts non-GAAP gross and operating margins will expand, and its non-GAAP net loss should narrow from $0.93 per share in 2020 to just $0.16-$0.19 per share.

For fiscal 2022, analysts expect Elastic's revenue to increase 26% but project its net loss to widen as it ramps up its spending again. Based on that forecast, Elastic trades at 15 times next year's sales, which is cheaper than many hyper-growth stocks but still pricier than other tech stocks that have comparable revenue growth.

But mind the competition

Elastic has locked in a lot of big customers, but many of its core services are built with open-source software. As a result, it faces intense competition from similar open-source and proprietary platforms.

Alphabet's Google Custom Search, Oracle's Endeca, and Microsoft's FAST framework all offer similar search features, while Amazon Web Services (AWS) and other cloud platform providers integrate the open-source components of Elastic's platform into their own services without Elastic's proprietary features.

Elastic also faces a long list of competitors in the application performance monitoring, analytics, and data visualization markets. That fragmented competitive landscape could make it tough for Elastic to continue expanding, and its decelerating sales growth since its IPO reflects those challenges.

Is Elastic worth buying today?

Elastic provides an essential technology for many software platforms, its gross margin and retention rates remain high, and its financial discipline is improving.

However, it's tough to recommend buying Elastic as its core market becomes increasingly saturated with similar tools. Therefore, I believe investors should stick with other tech stocks until Elastic's valuation cools off and it further differentiates itself from its many competitors.

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