2023 has been a big year for many tech stocks as they have rallied back toward their previous highs. Cloud and AI-powered software company Dynatrace (DT 1.07%) was no exception -- at least, not until after its latest earnings update. The company just started a new fiscal year, and its Q1 financial results were impressive. Yet the stock plunged after the report was published. Is now a buying opportunity?
Dynatrace: A top leader in cloud app monitoring
Dynatrace is an infrastructure software provider, specifically geared toward large multinational companies that are migrating to and using complex cloud-based applications. Basically, Dynatrace helps these organizations monitor their apps and data, and uses AI to find performance issues, and recommend and automate fixes.
Sound familiar? This branch of the infrastructure software industry includes top names like Datadog and Splunk. It's notable, though, that market research firm Gartner recently named Dynatrace as the leader among its peer group for application performance monitoring and observability.
I've whittled my investments in this realm of cloud software down to just Dynatrace over the years because of its balance between generating growth and profitability -- in contrast to many other smaller software outfits in this space that have struggled to operate in the black.
DT Revenue (TTM) data by YCharts.
Dynatrace just got its fiscal 2024 off on the right foot, too. For its fiscal Q1, which ended June 30, revenue increased 25% year over year to $333 million. Its GAAP (generally accepted accounting principles) operating profit margin increased to 10% versus 7% in the prior-year period, resulting in earnings per share going from $0.01 in Q1 fiscal 2023 to $0.13 this last quarter. Free cash flow was down 9% to $124 million, but was still a healthy 37% of revenue. https://ir.dynatrace.com/news-events/press-releases/detail/304/dynatrace-reports-first-quarter-of-fiscal-year-2024
Earnings were good, so what's eating Dynatrace stock?
Shares of Dynatrace fell despite the solid quarter due to management's outlook -- specifically, that the outlook remained (mostly) unchanged from three months ago in spite of the surge in cloud-based AI activity this year. Management said revenue should increase by 21% to 22% in fiscal 2024 (versus guidance for growth of 20% to 21% before), and reiterated its forecast for the full-year free-cash-flow margin to be about 22%.
CFO James Benson said Dynatrace's customers have been cutting costs due to the recession they expected in 2023, and remain a bit cautious on the economy. Benson struck a balanced tone on the earnings call and said Dynatrace "had a solid start to the year, but it is still early in our fiscal year, and we do not want to get ahead of ourselves." Prudence is OK by me.
The market likely wasn't happy with that view, given Dynatrace's rich valuation. Shares trade for about 45 times expected fiscal 2024 free cash flow. A more dramatic upgrade to the outlook seems to have been the consensus expectation.
Dynatrace did announce new AI tools to help automate cloud monitoring in the last quarter, as well as application development debugging. And though macro conditions may be weighing on cash flows a bit in the near term, the company's earnings are ramping up quickly as revenue continues to grow at a fairly consistent pace. The stock certainly isn't "cheap," but its valuation most certainly isn't unreasonable either if Dynatrace can keep going like it has been in recent years.
In the wake of the market's post-earnings selloff of Dynatrace, I'm a buyer of this top dog in the cloud app monitoring and cloud observability space, which keeps profitably capitalizing on computing secular growth trends.
