Avalara: Clear Long

While the stock remains up around 30% for the year, Avalara (AVLR) has not moved too much over the past few weeks since reporting earnings. The company reported a good start to the year considering the looming uncertainties around the global pandemic.

Q1 revenue grew 31% and while above expectations, decelerated from the 40% growth last quarter. Overall metrics showed some level of slowdown, likely resulting from companies starting to feel pressure from the global pandemic in the latter half of the quarter.

Management also lowered their full year guidance to $455-465 million, which now represents 19-22% growth compared to 2019. I believe guidance remains a little conservative as management likely did not want to lower guidance twice in the year. In addition, the company could see Q2 revenue growth be the low point of the year with continued acceleration for the remaining quarters.

Data by YCharts

The only big challenge I have with this name is valuation, which now stands at ~14x 2021 revenue. Even though the company’s growth prospects of 20% revenue growth and operating margin expansion over the next several quarters sounds nice, valuation places a limit to how high the stock can go. Given the company is currently trading near all-time highs, I am hesitant to put new money to work right now.

With the stock up 30% so far this year, investors should not shy away from the name. While there has not been much movement over the past few weeks, I believe this reflects the already strong price return this year rather than disappointment from the recent earnings report.

Over the long term, revenue growth will continue to be in the 15% range and margins will start to expand into new levels of profitability. For now, I am waiting for a pullback in price in order to become more constructive around the name as valuation is a bit too high right now.

Q1 Earnings and Guidance

Revenue during the quarter grew an impressive 31% to $111.4 million, which was above expectations for ~$108 million. While growth during Q1 remained strong, it did show ~9 points of deceleration compared to the 40% growth seen last quarter. Net revenue retention also decreased to 109%, compared to 111% last quarter as companies are likely more hesitant to spend a lot of capital given the uncertain global economic environment.

Source: Company Presentation

Subscription revenue continues to represent nearly 95% of total revenue and grew 35% during the quarter to $78.2 million and seemed to be above consensus expectations. The subscription revenue stream continues to drive the company's overall growth, and investors place a high revenue multiple for valuation given the stickiness and recurring nature of this revenue.

Billings growth also remained a little bit challenged, growing only 21% to $116.7 million, up from the $96.4 million in the year ago period and actually down slightly from the $121 million last quarter. It was only two quarters ago when billings grew 38% and investors will keep a close eye on this metric over the next several quarters to better gauge longer-term growth trajectory.

Source: Company Presentation

Given the company’s highly recurring software subscription model, gross margins tend to be relatively high. During the quarter gross margins came in at 71%, which was pretty similar to the 72% gross margins seen in the year ago period. Gross margins may be under pressure as the company continues to expand their operations internationally.

Non-GAAP operating margin of -7.3% was down from the year ago period’s non-GAAP operating margin of -3.1%. As the company continues to expand internationally and invest more into R&D and S&M, the company’s operating margins are likely to remain under pressure. In addition, the headwinds resulting from the global pandemic likely had some impact on operating margins. Nevertheless, the company’s stronger than expected revenue led to an EPS loss of only -$0.05, which was better than expectations for a loss of -$0.11.

Source: Company Presentation

For Q2, the company is expecting revenue of $109-111 million and non-GAAP operating loss of -$8-9 million, which would represent a non-GAAP operating margin of -7.7% at the midpoint.

For the full year, management lowered their revenue to $455-465 million (down from $470-474 million), which now represents 19-22% growth for the year. This would imply a rather significant deceleration for the remainder of the year considering Q1 revenue grew 31%. However, the company could see revenue decelerate to a low point in Q2 given the global economy has largely been shut down over the past few months, which could be followed by continued improvement through the remainder of the year. Management may also be somewhat more conservative on their guidance given the $10 million revenue guidance band (as opposed to only $4 million to start the year) in addition to not wanting to miss revenue guidance and lower again. By keep the bar low, the company has flexibility in terms of beat and raise potential.

Valuation

Since reporting earnings a few weeks ago, the stock has not moved a whole ton. Considering the stock remains up around 30% year to date, I think investors were satisfied with Q1 earnings and the updated guidance, but felt no bullish reason as to why the stock to reach new all-time highs. Yes, the quarter was good considering the economic uncertainty, but for now, I think investors are waiting for the next quarter results and updated guidance before pushing the stock higher.

Data by YCharts

While management lowered their 2020 revenue guidance to $455-465 million, or 19-22% growth for the year, I believe investors will assume some level of conservatism as well as revenue growth remaining strong in 2021.

With a current market cap of ~$8.0 billion and net cash of ~$450 million, the company has a current enterprise value of ~$7.55 billion. Assuming revenue comes in at the midpoint of management’s newly revised 2020 guidance of $455-465 million, this would result in a 2020 revenue multiple of ~16.4x. However, considering we are already almost half way through 2020, we can start to look at 2021 for a better understanding of current valuation. Assuming another 20% revenue growth in 2021, this would result in 2021 revenue of ~$550 million with valuation ~13.7x 2021 revenue, not unreasonable for a fast-growth company.

While I believe the company's fundamentals remain healthy and the growth opportunity remains prominent, I am hesitant to put new money to work in the name given the stock remains near all-time highs and there is some level of uncertainty over the next few quarters. The stock may have some downside risk if the global economic environment remains uncertain due to the pandemic, however, if management’s newly updated revenue guidance proves to be conservative and the company continues on their 20% revenue growth over the next several quarters, the stock could continue to rise.

Over the longer term, I believe Avalara will continue to lead the way in tax automation, as it has rapidly expanded its customer base and has the potential for operating margins to expand over the next several years as they scale.

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.