October 30, 2020

New Relic: Stock Is Cheap, But Growth Rates Leave Much To Be Desired (NYSE:NEWR)

Investment Thesis

New Relic (NEWR) trades for 5x forward sales.

On the surface, New Relic appears to be very cheaply valued. However, the further we dig, the more challenging it becomes to find this investment attractive.

New Relic was historically growing very fast, into a rapidly expanding market. However, right now, even though the market continues to expand, New Relic is being left behind, with its unattractive dollar-based new expansion rate.

It will be difficult to attract new shareholder holders to this stock. Here’s why:

Compelling Business Prospects

New Relic is an Application Performance Monitoring (”APM”). It allows customers to collect and analyze vast quantities of data flowing through and about their software.

New Relic is well-positioned to benefit from companies’ ongoing secular shift on their digital journeys.

As companies are forced to digitalize and adopt cloud technologies in order to remain nimble, New Relic supports these customers by maintaining uptime and stability.

Source: Fiscal Q4 2020 Investor Presentation

Developers have demanding customers that require a rewarding online experience every time they engage with their brand, either through browsers or on mobile devices.

To this end, the visibility into their software provided by the New Relic One Platform to analyze their applications and infrastructure creates the foundation for best-in-class digital experiences.

Source: Shareholder Letter Fiscal Q1 2021

Developers look to build attractive application experiences and through New Relic suite of products. Consequently, not only to monitor in real-time but to go beyond simply notifying teams when an issue occurs and to guide them towards what caused the issue and why.

Growth Rates Leave Much to be Desired

Source: author’s calculations, **company guidance

Moving on, above we can see the undeniable trend that New Relic’s growth rates are slowing down at a steady and consistent clip.

If last year New Relic was a high growth story clocking in 30% y/y growth rates, right now New Relic just finished Q1 2021 with 15% y/y growth rates — a marked difference.

What’s more, the company is guiding for 12% y/y growth rates for the quarter ahead.

Even if we assume that New Relic is being conservative to allow for an easy beat next quarter, and we further conjecture that New Relic’s Q2 2021 revenue growth rates reach 13% to 14% y/y revenue growth rates, we are still left with a company that has seen its growth rates halving over a period of 12 months.

Moreover, right now, as many companies are supposedly benefiting from COVID and companies accelerating their digital journeys, that’s clearly not benefitting New Relic.

As an aside, as far as SaaS businesses go, it’s highly surprising that New Relic is not able to offer investors full-year guidance. After all, one of the advantages of having a SaaS business model is to offer shareholders the predictability which investors badly crave.

Why is New Relic’s Revenue Growth Rates Slowing Down?

Source: Q1 2021 Press Release

As a rough proxy for how attractive customers find New Relic’s platforms we can cast our eyes on the table above where we see New Relic’s ability to report high Dollar-Based Net Expansion Rates.

With this important metric in mind, we can see that during Q1 2021 the figure came down from 109% in the same period a year ago, to flat 100% in Q1 2021.

During the earnings call, management talked about COVID and the weaker economy playing a role and leading to its slightly underperforming.

Having said that, if we compare this set of results with New Relic’s close peer, Datadog’s (DDOG) recently reported a dollar-based net retention rate of over 130%.

This could mean that Datadog is taking market share away from New Relic, or that New Relic is having challenges in delivering strong execution in this highly very fertile environment.

Valuation — Investors Turn Skeptical

While investors are not being asked to pay a high multiple for New Relic, at just 5x trailing sales, this puts the stock in the bargain basement compared with many high flying Wall Street darling SaaS stocks, with many of its peers trading for north of 25x times trailing sales.

For example, Datadog is being priced at 47x trailing sales, which puts New Relic’s 5x trailing sales in the absurdly cheap territory.

However, despite being cheap, it’s not entirely without justification.

In the past, I would have contended that any cheap stock, that it would only be a matter of time before investors would come to reappraise the stock at a higher multiple.

However, the longer I invest, the more experience I gain, and the more I question those previous assertions of mine.

Yes, stocks do mean reverse. Yes, value investing does work. But low valuation stocks don’t always bounce back or at least in a timely manner.

Source: SA Premium

Consider this, analysts estimate that New Relic is likely to report Q3 2021 and Q4 2021 at very close to 10% y/y growth rates. I believe this poses a problem for investors.

Firstly, if those estimates are even close to accurate, that would imply a continued deceleration from the growth rates New Relic has recently reported.

Secondly, investors will give a company guiding for close to 20% growth rates plenty of room for ”investing for growth strategy” and to remain GAAP unprofitable for a prolonged period of time.

However, once a company is reporting close to 10% y/y growth rates, investors will start to demand a clear path towards strong profitability.

The Bottom Line

New Relic still has the shine from last year when it was growing at high 20s revenue growth rates. Consequently, for that sort of company a multiple of 5x sales is a bargain opportunity.

However, it appears to be the case that New Relic may actually be eyeing up low teens growth rates in the near-term, and given that New Relic remains GAAP unprofitable, I fail to see much of a bargain opportunity here for new shareholders.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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