Like many other technology companies, Atlassian (TEAM -9.56%) sold off in 2022 due to rising interest rates, slowing growth, and uncertainty about the future, leading some investors to become more risk-averse. That in turn put pressure on the valuations of many technology stocks.
Although many people don't expect economic conditions to improve much in 2023, some analysts forecast rebounding economic growth in 2024. Bullish investors seeing some light at the end of the tunnel have pushed Atlassian's stock price up 26% year to date in anticipation of a better economy next year.
If you are an aggressive growth investor willing to bet on improving economic growth next year, Atlassian could be a good investment at current prices. Here's why.
The demand for customized software drives its revenue growth
Atlassian is a company that specializes in software creation and helping organizations foster collaboration between developers and other teams involved in making software. The company designed its products to support software development groups in planning, tracking, and delivering software.
One of its primary revenue growth drivers is the rising demand among businesses for customized software. Companies striving to gain a competitive edge need unique solutions that set them apart. Custom software can give businesses an advantage over competitors.
Despite this slow growth period, Atlassian is outpacing the growth of the overall software industry. It expects to end its fiscal year 2023 with 25% revenue growth over the previous year's results. According to CSI Markets, the average revenue growth of the software industry will be only approximately 15% by the end of the June quarter.
As the demand for custom software increases, Atlassian's products become increasingly valuable to companies. Overall, the increasing demand for custom software is a significant growth driver for Atlassian. As this trend continues, Atlassian is positioned to continue to outgrow the overall software industry.
Cloud growth
Cloud growth is the second most significant secular trend driving Atlassian's revenue growth. In October 2020, it began transitioning to a more cloud-first company by starting the process of eliminating one of its on-premise products, Server, by February 2024. On-premise software is software installed and run on computers or servers located on the premises of the organization using the software. In contrast, cloud-based software is hosted on a remote server and accessed over the Internet.
Although it will continue to support another on-premise product, Data Center, Atlassian now prioritizes the development of its Atlassian Cloud platform. Its cloud-based version will provide many features not found in the on-premise product. The company only sees Data Center as a temporary solution for customers who cannot immediately transition to its Atlassian Cloud product due to company policies or require a longer transition period.
Atlassian decided to prioritize the cloud for several reasons. First, the cloud is the future of software delivery. More businesses are moving their applications to it, and Atlassian wants to be at the forefront of this trend.
Second, cloud services offer many advantages over on-premise software. Cloud-based applications are more scalable, more reliable, and easier to manage and update, making them a better choice for businesses of all sizes.
Third, Atlassian believes that the its cloud services will allow it to innovate faster. By moving to the cloud, Atlassian will be able to focus on developing new features and functionality for its products rather than on maintaining on-premise versions of its products.
Its cloud-based products have grown like a weed. In fiscal 2022, annual Atlassian Cloud revenue grew 64% year-over-year and increased from 46% of total revenue in fiscal 2021 to 54% in fiscal 2022.
Slowing cloud growth is a risk
This terrible economic environment started hurting cloud growth in late calendar year 2022 into 2023. And there is a substantial risk that slowing cloud growth could hurt Atlassian over the next few quarters.
Cloud computing is a cyclical industry that is susceptible to economic downturns. When the economy is weak, businesses are less likely to invest in new software, which can lead to slower growth in cloud computing. Consequently, companies are more likely to focus on cutting costs during a recession, and investing in new software is something management teams often see as a luxury they can cut.
You can already see a sharp deceleration in Atlassian's cloud growth, as the company reported fiscal third-quarter 2023 revenue growth of 34% year over year compared to 60% in the previous year. Since the possibility of further weakening of the economy is still on the table, its cloud revenue could slow further.
However, Atlassian is also positioned to weather the storm. The company has a strong track record of innovation. According to Stack Overflow's 2023 survey of developers, two of the company's top tools, Jira and Confluence, are two of the most popular collaboration tools among developers. It constantly develops new products and features, which could help Atlassian attract new customers and maintain its growth even during a recession. Additionally, Atlassian has a strong balance sheet with a lot of cash, meaning that the company is well positioned to weather a slowdown in the economy.
The company sells at a price-to-sales (P/S) ratio of 12.4, expensive compared to the software industry's three-year average P/S ratio of 10.4 but well below its median P/S ratio of 19.7 over the past 10 years.
If you are willing to undergo the risk of a short-term drop in stock price due to a possible recession because you believe the economy will recover in 2024, you may want to buy the stock at current prices. Additionally, should the stock price drop due to the economy worsening, it is an excellent option to consider buying on the dip.
