As more business tools and applications move into the cloud, monitoring that these connections work with each other is vital. Maintaining data security is also a big deal as most of this processing happens offsite. Datadog (DDOG 4.95%) is a leader in both cloud applications, and the stock has become a popular investment.
Still, the stock is up only 20% for 2023 (still a good run) even though many of its software peers have seen their prices rise more than 50%. So, is this relative weakness a buying opportunity for Datadog stock? Let's find out.
Cloud revenue growth is slowing
Understanding when applications aren't working well together used to be a manual process; users had to contact IT to let them know something wasn't working properly. This could lead to significant downtime and, thus, lost productivity as they troubleshoot the problem. Datadog does all this automatically. In some cases, no human intervention is required.
Cloud monitoring is one of Datadog's top products. It also has a full suite of other offerings, like log management, cloud security management, and continuous testing, that fit nicely with the base product. This is a key part of the Datadog investment thesis as it must sign a user to one product and then upsell other products.
Datadog has done a spectacular job of doing so, considering that 82% of customers utilize two or more products. But the critical customers are the ones deploying even more. Customers using four or more products have risen from 37% last year to 45% this year, and those with six or more have risen from 14% to 21%.
That's a key metric to watch as any stagnation in its rise could spell disaster for Datadog. Still, Datadog's revenue growth has been slower than investors would like, as cloud spending has been tough to come by these days.
DDOG Revenue (Quarterly YoY Growth) data by YCharts. YoY = year over year.
While 25% growth is still impressive, it's not what investors are used to in the past. On its Q2 conference call, management credited the spending slowdown to customers optimizing their cloud computing spend, consistent with many others in the space. In fact, 40% of Datadog's revenue growth came from new customers who signed on in the past year.
This should unlock a significant spending tidal wave once existing customers are comfortable expanding their usage, so investors shouldn't expect its revenue growth to remain muted for long. This is critical, as Datadog still needs to improve its profitability.
Datadog is close to breaking even
Unlike many of its software peers, Datadog is on the brink of profitability. Unfortunately, the latest numbers have been moving in the wrong direction Operating expenses rose 32% in Q2, outpacing its revenue growth. As a result, Datadog's operating margin fell from a 1% loss last year to a 5% loss this year. But high interest rates saved Datadog on the bottom line. Its net interest income from its cash horde was nearly enough for Datadog to break even as it posted a $4 million net income loss.
With Datadog close to breaking even, it could easily become profitable overnight. But it is something to continue monitoring each quarter. Even though Datadog isn't profitable from a net income perspective, it is free-cash-flow (FCF) positive. In Q2, it churned out $142 million in FCF, giving it a 28% margin. This brought its trailing-12-month total to $421 million, which values the stock at an expensive 67 times FCF.
DDOG Price to Free Cash Flow data by YCharts. PS Ratio = price-to-sales ratio.
As the stock trades for about 15 times sales, it's a bit pricey on both valuation measures. But with a massive upside in cloud computing spend coming, I'd say this muted year for Datadog has presented investors with a buying opportunity. So, if you're looking for a cloud growth stock to add to your portfolio, Datadog should be a strong candidate.
