ServiceNow's (NOW -4.98%) stock price jumped 9% on Jan. 27 after the cloud-based enterprise services provider posted its fourth-quarter earnings. On a generally accepted accounting principles (GAAP) basis, its revenue rose 29% year over year to $1.61 billion. Its net income increased 53% to $26 million, or $0.13 per share.
On a non-GAAP basis, its revenue grew 30% to $1.63 billion, which beat analysts' expectations by $30 million. Its net income rose 26% to $296 million, or $1.46 per diluted share, and beat estimates by three cents.
ServiceNow's headline numbers looked healthy, but should investors still buy this high-growth cloud stock as rising inflation and higher interest rates spark a rotation toward more conservative investments?
Image source: Getty Images.
What does ServiceNow do?
ServiceNow provides a wide range of cloud-based services that streamline digital workflows for IT professionals, employees, creators, and customers.
ServiceNow served only 602 customers back in 2010, but it ended 2021 with more than 7,400 customers -- including about 80% of the Fortune 500. Within that total, 1,359 customers had an annual contract value of more than $1 million -- which represented 25% growth from a year earlier.
How fast is ServiceNow growing?
ServiceNow mainly gauges its growth in terms of its subscription revenue, subscription billings, current remaining performance obligations (cRPO), and total remaining performance obligations (RPO). Its RPO is calculated by adding its deferred revenue to its backlog, and it gives investors a clearer picture of its forward demand. Its "current" RPO will be recognized as revenue within the next 12 months.
All four growth metrics remained robust throughout the pandemic, since the shift toward remote work highlighted the need for streamlined digital workflows. That momentum continued throughout 2021, even as more employees physically returned to work. The company also ended the fourth quarter with a renewal rate of 99% -- which remained unchanged from a year earlier.
|
Growth* (YOY) |
FY 2020 |
FY 2021 |
|---|---|---|
|
Subscription revenue |
31% |
28% |
|
Subscription billings |
31% |
28% |
|
cRPO |
30% |
32% |
|
RPO |
31% |
32% |
Source: ServiceNow. YOY = Year over year. *Constant currency terms.
For 2022, ServiceNow expects its subscription revenue to rise 28% on a constant currency basis. It also expects to generate more than $15 billion in annual revenue by 2026 -- which would represent a compound annual growth rate (CAGR) of at least 20.9% from its $5.81 billion in non-GAAP revenue in 2021.
During the conference call, ServiceNow's CEO Bill McDermott said the company doesn't "depend on M&A for growth," that its "organic growth machine is in full flight," and that its "pipeline is stronger than ever." McDermott also said that as "rising interest rates challenge others," ServiceNow's business can still "flourish in any economic environment."
Stable margins and GAAP profits
In the past, the bears often dismissed ServiceNow as just another high-growth cloud company with no profits. However, that all changed at the end of 2019 when it turned firmly profitable on a GAAP basis for the full year.
ServiceNow also remained profitable by GAAP measures in 2020 and 2021, while its subscription gross margins held steady on a GAAP basis.
|
Period |
FY 2019 |
FY 2020 |
FY 2021 |
|---|---|---|---|
|
Revenue |
$3.46 billion |
$4.51 billion |
$5.90 billion |
|
Gross margin |
83% |
83% |
82% |
|
Net income |
$627 million |
$119 million |
$230 million |
Source: ServiceNow. GAAP basis.
ServiceNow's GAAP profits are still a bit bumpy, due to its ongoing investments in its own ecosystem and smaller acquisitions, but its stable gross margins indicate it still has plenty of pricing power in its niche market.
But can ServiceNow maintain its premium valuation?
ServiceNow's business looks healthy, but its stock currently trades at 67 times forward earnings and 14 times this year's sales. Those valuations aren't outrageous, but they're still uncomfortably high in a market that seems allergic to pricier growth stocks.
Analysts expect ServiceNow's non-GAAP revenue and earnings to grow 25% and 21%, respectively, this year. Zendesk (ZEN), which also integrates workflow automation tools into its cloud-based customer relationship management (CRM) service, is expected to generate comparable top- and bottom-line growth as ServiceNow this year -- but it trades at 107 times forward earnings and eight times this year's sales.
ServiceNow might be cheaper than Zendesk, which isn't profitable by GAAP measures yet, in terms of its earnings. But in terms of its sales, by which most cloud software stocks are valued, it looks more expensive.
However, ServiceNow's rock-solid growth rates, stable margins, improving profitability, and clear plans for the future all justify that higher valuation. Therefore, I believe ServiceNow is still one of the few growth stocks that investors can consider accumulating in this choppy market.
