monday.com: Impressive Q4 Highlights 2023 Potential

It hasn't been a great year to be a software investor. The wider software market has been struggling since the start of 2022, even as large enterprises have leaned into digital transformation. We are seeing large increases of CTO's and CIO's investing in data, cybersecurity and productivity software like monday.com (NASDAQ:MNDY). The need to get efficiency out of any technology costs has been at the forefront the past year as companies are scrutinizing spend more closely than the early pandemic days. monday.com provides a highly scalable and efficient work operating system. While the company has had strong growth, a solid platform to scale and strong marketing, the valuation is still very high compared to non-software stocks. 70% of companies utilizing the software are not tech companies showing the importance of the ease of use and customizable platform. Productivity software for business has become a very crowded area with Asana (ASAN) and Smartsheet (SMAR), other good examples of successful public companies in the space. monday has potential to be the biggest of the three, and any pullback should be analyzed carefully for long term growth investors.

monday's flexibility allowing many different management styles and it's intuitive dashboards provide powerful project management tools. The low and no code building blocks allowing immense customizability for organizations mirrors that of Alteryx (AYX) in the productivity space. The recently added work OS suite allows a single unified workspace to give considerable reach and allow organizations to reduce overall complexity. Power is not the most important thing in scaling a piece of software but rather how easy it is for someone to utilize effectively. The apps marketplace has helped by adding additional capabilities built outside and integrated seamlessly with the Work OS. At 217 applications and 61 that are monetized the potential for additional integrations is high. Covid-19 has really pushed many organizations that were not investing heavily in productivity and digital transformation to adopt more of these next generation tools. They continue to add these capabilities or risk being left behind as data explodes in the enterprise. monday also plans on adding monday DB in 2024, a schemaless database to provide enterprises with even more flexibility.

Co-CEO Roy Mann noted on the Q4 call,

"where monday DB comes in, it takes that magic in a scalable way and allows to build like way bigger applications on top of us. And that opens up the door for larger installment – like different use cases that requires millions of – it opens the door for larger customers, in many ways. But again, it's like an infrastructure to move us to the next level."

These consistent innovations are a strong product road map and are the main reasons MNDY can win in the category over time. Digging into the Q4 results is another step to determine whether monday makes up for its higher risk profile in this market.

Q4 Results

Recently MNDY's quarterly earnings have been impressive, with the most recent Q4 results up there with the best growth stories in software. Many metrics point to very strong growth in the years ahead, but the strongest may be the incredible 86% y/y growth in customers over $50,000 in annual recurring revenue. This number is already up to 1474 in just a few short years. This shows enterprises are really leaning into the MNDY platform utilizing the software to create a unified workspace and boost productivity. MNDY pointed out on the Q4 conference call competition is reducing marketing spend, allowing monday to gain accelerated market share. At the enterprise level net retention was still over 135% which is an elite level of growth among that most important cohort. monday saw an impressive level of revenue growth of 57% up to $149.9 million in the quarter. Keep in mind this also had a 3% foreign exchange headwind, with a normalized growth rate at 60% at this scale is best in class. This is with only a 15.5% increase in marketing over Q4 of 2021 showing a strong go to market and scaling in their model. Efficiency in marketing spend tends to be one of the metrics that demonstrates long term sustainable growth rates. Gross Margin is at the top of the range for software companies at 88.4% for Q4 but that number could drift down over time as the company scales its operations. Even so a long term operating margin of 25% is certainly possible considering the marketing efficiency.

Operating income was negative $10.1 million which is impressive considering the level of growth MNDY has achieved of late. This negative operating margin of -6.7% is actually among the stronger GAAP operating margins among the small to mid-cap software stocks in 2023. This can be attributed to the stronger than average gross margins, good marketing leverage and reasonable G&A expense growth over the past 2 years. Research expenses will step up several % in 2023 and 2024 as called about by management on the conference call to 20% of revenue. Marketing will also increase in 2023 as more in person events become normalized again but MNDY has done a great job growing revenue on a reasonable marketing budget. Look for them to continue to lean into growth as much as possible with a large cash hoard on the balance sheet able to handle moderate losses each quarter. The balance sheet is in great shape with $885m in cash on hand which should be able to fuel growth and acquisitions until the company is able to achieve profitability in the future. Analysts think that will be achievable by 2026, but recent focus on profitability in the sector means it is likely a push will be made for GAAP profitability sooner. Free cash flow for monday has been erratic, but should stay positive from here on out. Q4 free cash flow was $29.7 million, a record high both in absolute terms and as a percentage of revenue. Initial guidance for 2023 is for 33-34% revenue growth which was $30m above wall street consensus leading to a nice 10% gain after earnings.

Valuation

monday had an excessive valuation at the peak of the software bubble of 2021 after its IPO, at 60x Sales in the middle of 2021. However, now that has reached a reasonable level of 14.12x on a trailing basis and 10x forward. This is with having a lower enterprise value with significant cash on hand. Compared to some of the more profitable companies in the space you are still paying a premium for growth rather than GAAP profitability. This means very high volatility is to be expected, especially on earnings reports where a slight miss could mean a large drawdown. MNDY's beta is currently at 2.26, making it more than twice as volatile as the S&P 500. This issue is not for the faint of heart, with software stocks continuing to be penalized for cash burn and high interest rates. The positive side is valuations in the application software space are now the lowest since 2017 when these stocks broke out in a big way. This gives some confidence that the worst is over for the space, even if revenues have a much harder time growing in 2023 and beyond. Valuations have contracted enough that as interest rates potentially ease in 2024, these companies' cost of capital will likely once again decrease to 3-4% longer term. Technically the stock looks good, with it bottoming in November and rebounding on heavy volume. The stock has now doubled from those 52 week lows of 73.58, and money flow has continued strength the past 3 months.

Verdict

monday.com has good potential and better unit economics than many of its other unprofitable software peers. Worries about the macroeconomic environment will continue to weigh on the stock in the short term. Also, the crowded space it plays in creates potential risk down the road that growth will not be easy to come by after 2023. Nonetheless MNDY is a top tier software name, with both strong growth and a continued track record of earnings beats. While others have reduced guidance in recent months, MNDY had significantly above expectations guidance for Q4. The continued momentum in 2023 should lead to outperformance against software peers, but know the stock is of a very high risk level. Competition and a crowded space creates a lot of uncertainty looking out a few years. If you can stomach the risk however, long term investors would be wise to buy MNDY under $150/share and add to core positions on pullbacks.