Companies like Dynatrace (DT -0.30%), whose software provides cloud infrastructure management, have been predicting for a long time that software was going to grow in complexity by an order of magnitude. Here we are in 2023, and generative AI is all the rage. Services like ChatGPT are indeed mind-bogglingly complicated to develop, requiring new hardware and massive amounts of data to be stored, moved, and processed. Dynatrace's software, which provides cloud observability and application security, remains in high demand, despite a myriad of economic worries hurting many of its customers.
After it capped off an epic year, here's why you need to keep this stock on your radar.
Is generative AI really a game changer?
Dynatrace topped its own expectations for fiscal 2023 (ending in March 2023). Total revenue jumped 25% higher year over year, or 29% when excluding negative currency-exchange rates, to $1.16 billion. Free cash flow (FCF) was $333 million, a very healthy FCF profit margin of 29%.
But enough of the numbers; what about AI? As could be expected from the CEO of a cloud software company, Dynatrace's Rick McConnell weighed in on the latest earnings call about how new generative-AI services like ChatGPT are affecting customer plans. In response to a question, McConnell said: "Generative AI, from our point of view, is really all about productivity, whether writing text or developing code, whatever it might be. And we see it over the long haul as being upwards of a 10x multiplier in software development efficiency."
The cloud has changed businesses because it means greater operational efficiency and deeper and actionable insights from data. And generative AI -- at this point usually hosted in a cloud environment (a remote data center and accessed via the web) -- is now supercharging that productivity.
But there's one problem. As McConnell also said, AI further complicates the development and delivery of software products, sometimes exponentially so. With many companies -- especially large, lumbering organizations -- still getting their arms wrapped around the cloud, this new breed of AI isn't going to make things any easier.
Thus, recent AI developments will only further emphasize Dynatrace's importance to a large cloud environment. Software that can help a large business manage the health of its IT operations, make tweaks and fixes, and keep software secure will remain in high demand in this new era of computing technology.
And Dynatrace focuses on only the largest organizations in the world. Its solutions are "old school" AI aimed at automation, but with data and software only getting bigger, this older type of artificial intelligence will be a staple.
Strength amid economic troubles
Perhaps the best indication that this company is the real deal is its financial guidance for the next year. The economy is in a slump, and some investors and pundits argue a recession is already here or looming. Even the fast-growing cloud industry has hit the skids as many customers slow down their tech plans to manage their spending amid the uncertainty.
With this as a backdrop, Dynatrace is anticipating revenue growth of 20% to 21% for fiscal 2024 (ending in March 2024). FCF profit margin is expected to be 22% -- about $308 million at the midpoint of guidance -- lower than the last year primarily due to a higher tax rate.
Given the state of the global economy and how large businesses are being extra cautious before they spend right now, I'd say that's pretty good guidance. It's also worth noting that Dynatrace sandbagged with its guidance in fiscal 2023 and handily outperformed (it had anticipated revenue growth of as much as 22% last August). Perhaps something similar will happen again in fiscal 2024.
Dynatrace's stated commitment to growing its business profitably puts the stock on the top shelf, at least in my book. Peers in the cloud infrastructure observability sector have had some difficulty striking this balance between growth and cash profits in years past.
Also, Dynatrace has a completely squeaky-clean balance sheet, having paid off the rest of its debt in the quarter ($555 million in cash and short-term investments). Given the current state of the economy, I still like Dynatrace stacked up against other top names like Splunk (SPLK) and Datadog (DDOG -1.43%).
Data by YCharts.
Dynatrace currently trades for 46 times expected fiscal 2024 FCF. It's without a doubt a premium-priced stock. Just a few months ago, the valuation was much closer to a fair price, so I'm not inclined to add to my existing position at this juncture.
But with new types of AI possibly poised to ramp up cloud complexity in the coming years, Dynatrace is a company you need to keep on your radar if you are interested in cloud computing. I for one am happy to keep holding my position in this stock for the long term.
