Zoom Video Communications (ZM 1.46%) is growing its enterprise business at a healthy clip. Yet those gains are being tempered by losses in other parts of its portfolio. That was the main takeaway from the video communications company's latest earnings report, which in late November came with a modest downgrade to management's full-year fiscal 2023 outlook (fiscal 2023 ends Jan. 31, 2023).
As the fiscal year winds down, investors have at least one big reason to like the stock today. But there's also a red flag to keep a close eye on.
The green flag: Financial strength
Zoom is taking a financial hit as pandemic-related demand spikes reverse themselves. Profitability slumped, with operating income landing at $375 million over the last nine months compared to $812 million a year earlier.
Yet Zoom is still generating positive earnings, setting it apart from many other growth stocks that benefited disproportionately from the pandemic's lockdown phases.
ZM operating margin (TTM); data by YCharts. TTM = trailing 12 months.
This success makes Zoom less exposed to earnings pressure from rising interest rates. It also gives the management team plenty of resources it can direct toward building out the communication platform. A steadily expanding portfolio is Zoom's surest path toward increasing average contract sizes over time.
The red flag: Economic weakness
The main reason Wall Street has been punishing Zoom's shares is the company's weakening growth outlook. Management reduced its fourth-quarter fiscal 2023 forecast in late November after sales rose just 7%. CEO Eric Yuan said in a conference call with investors that enterprises are becoming more cautious about signing up for big new software-as-a-service deals. That pressure would accelerate into the next fiscal year if a recession develops.
For now, though, Zoom is getting all of its growth from the corporate division that caters to increasingly large clients. Contracts with annual spending of over $100,000 rose 31% this past quarter, even as Zoom's customer-focused business shrank. The portfolio will keep tilting toward the enterprise segment in the coming years, executives predict.
That shift is both a challenge and an opportunity. It means Zoom has a less diverse revenue base, with essentially all of its growth coming from businesses rather than consumers. But it also means Zoom has an engaged customer base that it can market toward as it expands its service portfolio. That's the main motivation behind new features like its mail and calendar integrations, and Zoom's recent acquisition of Solvvy, the conversational artificial intelligence and automation platform.
Looking ahead
Its strong cash position means Zoom can continue making bold moves to build out its platform, which will lay the groundwork for faster growth whenever the industry hits its next upswing. Yes, the next few quarters might be rocky -- especially if major economies around the world begin contracting. But Zoom has the financial strength to survive such a slump.
The bigger question is whether the company can build a big enough service portfolio to reaccelerate growth without relying on its consumer-focused products. Watch key metrics like contract sizes, renewal rates, and enterprise customer additions for signs of success here through 2023.
