Machine learning (ML) is an important sub-field of artificial intelligence (AI). While AI is designed to eventually achieve human-level intelligence, ML is often used in practical settings by helping companies achieve greater productivity from their systems and equipment.
Splunk (SPLK) is a leading provider of ML software. It has a star-studded customer list that features leading Fortune 100 organizations, and even a Formula 1 racing team.
Splunk stock remains 54% below its all-time high which was set back in 2020, but it's slowly rebounding thanks to a management shakeup, and also because the company is making progress toward achieving profitability. Here's why investors should take the opportunity to buy it while it's still beaten down.
Spunk is key to navigating a data-driven world
Artificial intelligence in all its forms has captivated the corporate sector in 2023, and a growing number of companies are looking for ways they can integrate it into their businesses. According to FactSet, management teams in 110 of the S&P 500 companies discussed AI in their recent quarterly earnings calls with investors, an 80% increase from a year ago.
Where does Splunk fit in? The company's specialty is ingesting mountains of data into its machine learning models, analyzing it in real time, and spitting actionable insights out the other side. Formula 1 team McLaren offers a great use-case example -- it deploys Splunk during each race weekend to process 1.5 terabytes of data, which is used to make real-time adjustments to its cars to unlock maximum performance.
Japanese automaker Honda uses Splunk's predictive analytics to reduce downtime at its U.S. manufacturing facility in Alabama. The plant runs on 100 different applications, and Honda used to silo data from each of them within their respective departments, so addressing production challenges became confusing and time consuming. With Splunk, management now analyzes the factory as one machine, reducing the time it takes to rectify technical issues by 70%.
Splunk also plays a key role in data security. Its Splunk Enterprise Security platform is an event management solution designed to give organizations a better understanding of their cybersecurity posture. It's particularly useful for larger, more complex companies requiring protection at scale -- Splunk's platform delivers insights on vulnerability management, each endpoint, and the network overall.
Splunk's free cash flow is surging
In April 2022, Splunk appointed Gary Steele as its new CEO. He brought a wealth of experience within large tech organizations, and he's also an expert in scaling software-as-a-service businesses. He walked into a challenging situation -- Splunk had just lost $1.3 billion on the bottom line in fiscal 2022 (ended Jan. 31, 2022), and it only had enough cash on hand to cover one more year at that rate.
He successfully turned the company's financial fortunes around in fiscal 2023 (ended Jan. 31, 2023), narrowing its net loss to just $277 million, and it even generated net income (profit) in Q4.
Splunk now focuses more on free cash flow (FCF) as its primary measure of profitability, which reflects the amount of money generated by the company's core operating activities. It delivered just $108 million in FCF in fiscal 2022, which grew a whopping 295% to $427 million under Steele's leadership in fiscal 2023.
But Splunk delivered a whopping $486 million in FCF in the recent fiscal 2024 first quarter (ended April 30) alone. It prompted the company to lift its forecasts for the full year, estimating FCF could now come in at $825 million compared to its previous guidance of $795 million.
Image source: Getty Images.
Here's how Splunk is doing it
Cost discipline is playing a major role. Splunk's total revenue grew by 11.5% year over year to $752 million in Q1, but its operating expenses shrank by 2%. More money coming in with less money going out will always result in higher free cash flow. It comes at a price -- spending less money on line items like marketing can slow down the company's revenue growth -- but the company had to prioritize getting its financial house in order in the short-term.
Splunk's revenue growth is being driven by its cloud-based platforms, which offer customers far more flexibility than its on-premise software. The proof is in the pudding; the number of customers spending at least $1 million annually on Spunk's cloud products grew by 32% in Q1, which was nearly double the pace of those with at least $1 million in total annual spend (cloud and on-premise combined). Naturally, selling cloud-based products is now a priority for the company.
Splunk ended Q1 with $3.7 billion in annual recurring revenue overall, but that's just a fraction of what it estimates is a $100 billion opportunity. And given the pace with which companies are showing interest in AI-powered tools, Splunk's addressable market could grow substantially in the coming years.
The machine learning powerhouse is positioning itself for long-term success -- not only by growing its revenue and its customer base, but by doing so responsibly, without sacrificing the health of the business. As a result, it's unlikely Splunk stock will remain 54% below its all-time high, which is an opportunity for investors who buy it now.
