Nutanix: Powerful Tailwinds

It's rare, in this environment, to see a tech stock trading at YTD highs as investors pull back from risk-taking amid high interest rates. Nutanix (NASDAQ:NTNX) is a rare exception here: this infrastructure technology provider has soared nearly 40% year to date and continued to rally after a strong fiscal Q4 (July quarter) earnings print.

A number of factors have driven Nutanix's success this year. The company has leaned in on high-profile partnerships (including with Microsoft Azure) to counteract a softer macroeconomy. It has focused on larger accounts, landing a number of new high-profile corporate and government deals. And it has continued to focus on efficiency, delivering soaring free cash flows and pro forma full-year profitability for the first time.

I've been bullish on Nutanix since the start of the year. Of course, with the stock up so sharply over the past few months, it's a good time to re-assess the bull case in this stock and validate that the stock merits continued investment: and in light of Nutanix's incredible Q4 results, I remain bullish on this stock.

Data volumes are growing, and companies are keen to invest in the best and lowest-cost solutions to store and manage their digital assets. Even if infrastructure purchases are delayed in this macroeconomy as companies seek to slash their capex spending, the need for more sophisticated technology to handle modern data centers won't fade.

It's also worth mentioning that Nutanix is mission-critical. Unlike application software products that can be cut for budget reasons or as headcount reduces, Nutanix powers a company's technology infrastructure - it's necessary to keep the lights on.

Here is my full updated bull case on Nutanix:

• Category leader in the hybrid cloud. Though the buzzword "cloud" grabs all the media attention in the software industry these days, the reality is that many companies, especially those in complex or highly regulated industries, will never entirely move their systems into the cloud. Nutanix is a champion of the "hybrid cloud" strategy, in which some of a business's assets are in the cloud and others are in on-prem environments. For the on-prem assets, Nutanix's hyper-converged technology ensures that customers get the same performance and agility benefits that users receive in the cloud. Most companies today employ some sort of hybrid cloud strategy - meaning Nutanix products are widely applicable to all IT departments.

• Focus on hyper-converged infrastructure. For multiple years in a row, the company has been recognized as the category leader in "hyper-converged infrastructure" by Gartner, the software industry's leading analyst and reviewer. By combining storage, compute, and networking resources into a single system, Nutanix solutions help to improve efficiency and lower the operating costs of a modern data center.

• Software-first. Earlier on in Nutanix's lifespan, the company sold server devices as its primary business, with its proprietary software overlaid as a "package solution." Now, Nutanix sells only software. This has dramatically raised its margin profile while also making it more palatable for companies who only want to consume software to run on their own hardware.

• Annual recurring revenue at the forefront of Nutanix's sales focus. At the beginning of Nutanix's fiscal 2021, the company made the earth-shaking decision to incentivize its sales staff based on ACV and not TCV. In the past, Nutanix's account executives sold longer-term contracts and incentivized customers with bigger discounts because they were paid based on the value of the total deal. What's important for Nutanix and for investors, however, is how much Nutanix can rake in annually and for each customer's lifetime. So Nutanix shifted its sales compensation in line with this priority and began paying its sales teams based on ACV - and this has yielded very strong results in growing both ACV and ARR.

• Prioritizing profitability. The company hit pro forma profitability for the first time in FY23.

Stay long here: there's plenty of upside left.

Q4 download

Let's now go through Nutanix's latest quarterly results in greater detail. The Q4 earnings summary is shown below:

Nutanix's revenue grew 28% y/y to $494.2 million, beating Wall Street's expectations of $475.8 million (+23% y/y) by a respectable five-point margin. It's worth noting as well that growth accelerated sharply over 10% y/y growth in Q3.

ARR continued to grow at a similar pace, up 30% y/y to $1.56 billion. The company noted that renewals were particularly strong in the quarter, and the general availability of its NC2 product on Microsoft Azure helped to boost sales.

And though management noted that macro headwinds were largely consistent with Q3, Nutanix landed a number of large deals in the quarter. Per CEO Rajiv Ramaswami's remarks on the Q4 earnings call:

Finally, on the go-to-market front, we closed multiple large deals with major enterprise and government customers. These wins demonstrate the strategic relevance of our platform to our customers’ key transformation initiatives and the success of our focus on landing these larger, more strategic transactions. Overall, for fiscal 2023, we demonstrated consistent execution, solid top line growth, strong renewables performance, sharp improvements in profitability and free cash flow and continued progress on our longer-term strategic priorities.

Moving on, gaining sales leverage by our partners has been a priority since I joined as CEO. We said we would focus on deepening our partnerships to provide more impact in how we go to market, as well as provide more opportunities within larger accounts. This week, we made a milestone announcement on this front with a global strategic partnership with Cisco. This partnership is about combining the best of breed between our two companies."

Nutanix's count of customers generating more than $1 million in lifetime bookings grew to 2,183, adding 98 such customers in the quarter - and the most aggressive quarter for large customer adds in the trailing two-year timespan (Q4'22 came close at 94 adds).

The company also noted that contract lengths have shortened slightly: the average contract signing in FY23 had a term of 3.0 years, versus 3.2 years in FY22. But as long as the company continues to excel in renewals, these contract expiries provide a great opportunity for Nutanix to upsell its existing customer base.

Pro forma operating margins in Q4 also hit 12.9%, a substantial increase over -9.6% in the year-ago quarter: driven by keen cost management that allowed Nutanix to grow revenue double digits while growing pro forma opex at just 1% y/y. Full-year pro forma operating margins were 8.6%, a 14-point jump from -5.5% in FY22 and the first time Nutanix hit profitability from a pro forma perspective.

It's worth noting as well that free cash flow of $207.0 million in FY23 was substantially greater than just $18.5 million in FY22, and comfortably finances the company's recent decision to boost its buyback program by $350 million.

Valuation and key takeaways

At current share prices near $36, Nutanix trades at a market cap of $8.71 billion. After we net off the $1.44 billion of cash and $1.22 billion of convertible debt on Nutanix's most recent balance sheet, the company's resulting enterprise value is $8.49 billion.

Meanwhile, for the next fiscal year FY24, Wall Street analysts are expecting Nutanix to generate $2.45 billion in revenue, representing 17% y/y growth. This puts Nutanix's valuation at 3.5x EV/FY24 revenue - which still remains a modest valuation multiple for a company expected to grow revenue at a high-teens pace while seeing huge lifts in operating margin.

Stay long here and continue riding the upward trend.