Splunk Stock Surges on Better-Than-Expected Results

Splunk NASDAQ: SPLK reported its earnings for its fiscal fourth-quarter yesterday after the bell; the analytics-software company beat on both the top and bottom lines. Shares went up more than 5% in after-hours trading.

“Just three years ago, we set out to radically transform Splunk to better help our customers put data at the heart of their own organizations and strategy,” said Doug Merritt, Splunk’s CEO. “I’ve been incredibly proud of our progress through our transformation, and this quarter’s performance is no exception.”

Merritt is referring to Splunk’s transformation from on-premises software implementations to a cloud-based software business. Splunk is not only transforming its business – it is also recognizing its revenue differently. Under its previous model where it received multi-year licenses with large upfront payments, it recognized all of the revenue when it came in. Under the new subscription model, it is recognizing the revenue over time.

Revenue has been, and will continue to be, uneven as Splunk works out the kinks.

 Although Splunk’s revenue handily beat consensus estimates in the fourth quarter, it was actually down 6% yoy. But it’s important to focus on the annualized recurring revenue (ARR) numbers because that is a better apples-to-apples comparison:

• Cloud-based ARR was $810 million, up 83% yoy.
• Total ARR was $2.36 billion, up 41% yoy.
• Splunk had 510 customers with ARR above $1 million, up 44% yoy.

Those numbers show that Splunk is moving in the right direction. Once it fully transitions to the new business model, company-wide yoy revenue growth could look great.

Investors Are Getting Impatient Though

Splunk shares are near break-even since the beginning of 2020, which is, to put it lightly, significant underperformance relative to other software companies. Shares were above $200 as recently as December 1, but cratered after Splunk reported disappointing fiscal Q3 earnings.

The sell-off is understandable considering that Splunk is trading at 9.3x forward earnings and is not expected to turn a profit in the coming fiscal year.

But is that a mistake? Will patient Splunk investors be rewarded?

Splunk is a leader in the data monitoring industry, which is likely to experience strong growth for the foreseeable future. That 9.3x forward price-to-sales ratio will come down very quickly if the company can continue growing ARR the way it has been of late. Also, comparable companies like Datadog NASDAQ: DDOG and Elastic NYSE: ESTC are trading at much loftier valuations; their forward price-to-sales ratios are 32.9x and 20x, respectively.

There is a great chance that Splunk maintains or even grows its market share in this hot industry because the company isn’t resting on its laurels. Splunk’s Q4 earnings press release included announcements of launches and enhancements that will only improve the customer experience.

Wall Street Sees Upside

Splunk’s consensus price target is $212.44 with 26 buy ratings, 11 hold ratings, and 1 sell rating. Shares are expected to open around $150.50 tomorrow, giving them more than 40% upside from there to $212.44.

Moreover, we could see a number of upgrades and raised price targets on the heels of this earnings report. Even if shares closed half of the gap between their current price and the consensus price target, you’d have considerable upside from here.

How Should You Play Splunk?

Splunk shares look like an excellent long-term proposition. The potential revenue growth and comparable company valuations can easily justify a much higher price.

But it’s not all clear skies ahead. Splunk shares are currently in a downtrend. The price action has been decidedly bearish since the fiscal third-quarter earnings release. The 50-day moving average crossed below the 200-day moving average in January – a bearish indicator.

You’d prefer to see a nicer-looking chart, but then again, Splunk shares wouldn’t be available at such a discount if the chart was nicer.

Splunk may face a lot of resistance as it tries to climb towards $200, but it has a good chance of getting there – and it may not take all that long.