Okta, Inc: Does It’s Growth Justify Its High Valuation?
Throughout 2020, the “work-from-home” trend was one of the most powerful bullish forces in the market. The COVID-19 pandemic changed life in many ways and outside of the healthcare sector, one of the most stark differences between pre-pandemic life and post pandemic-life is the expectation of remote work. The pandemic accelerated a trend that was already growing due to technological innovation and continued internet penetration. And with many companies suffering to produce growth while much of the economy was shut down, investors piled into the stock of companies who benefited from this accelerated shift. One such company was Okta, Inc (OKTA), which saw its share price from $114/share at the end of 2019 to $254/share at the end of 2020.
However, after this 100%+ performance during 2020, Okta shares have suffered year-to-date, falling more than 10.4% throughout 2021 thus far. The company recently reported its first quarter earnings and while the results beat analyst expectations, we still haven’t seen the stock rally. On the contrary, OKTA shares fell more than 11% after the results. So, with all of that being said, we wanted to take a look at what the blue chip analysts that the Nobias algorithm tracks have had to say about the stock in recent weeks. Can this company get its 2020 mojo back? Or, do analysts believe that the 2021 weakness is set to continue? Let's find out.
Jose Najarro, a Nobias 4-star rated analyst who writes for newsbreak.com recently published an article titled, “3 Cybersecurity Growth Stocks Down Big From Recent Highs” in which he highlighted Okta as a stock that investors should add to their watch list. Najarro provided 3 reasons for a bullish stance on Okta. He began by saying, “On May 3, Okta completed an acquisition of Auth0, a leading identity platform for application teams. The acquisition strengthens and accelerates Okta's growth in the identity market.” He continued, “For Q4 FY 2021, Okta reported 40% y/y growth in revenue, 42% y/y growth in subscription revenue, 26% y/y growth in total costumers, and 33% y/y growth of costumers with Annualized Contract Value greater than $100k.” And he concluded, “Okta has strong fundamentals with positive cash flow from operations and more cash and short-term investments than debt.”
Jason Hawthorne, a Nobias rated 4-star analyst who writes for The Motley Fool, recently published a bullish article where he made the argument that OKTA shares continue to look attractive due to their operations which allow them to benefit from two major secular trends: work-from-home and cyber security. With regard to the privacy needs of employers when allowing employees to work remotely, Hawthorne said, “There aren't many better industries right now than cybersecurity. It's an estimated $162 billion market slated to grow to over $400 billion by 2028. With the shift to zero trust, Okta's Identity Cloud is perfectly positioned.”
Hawthorne notes that Okta’s business is essentially divided into two segments. “First,” he says, “companies are able to authenticate employees, contractors, and partners when they attempt to access the company's internal network in any way. This process is called workforce management.” He continues, saying, “Okta's customers can also layer in its security to provide authentication for their own customers. That's the second application, called customer identity.”
These two markets present a tremendous opportunity for the company. Hawthorne touches upon the total addressable market (TAM) that Okta stands to benefit from as it attempts to grow and take market share, explaining, “Okta's SaaS business model generates most of its revenue through multiyear subscriptions to its cloud-based offerings. Management believes the workforce identity market is roughly $30 billion and the potential of the customer identity is about $25 billion. With less than $800 million in sales in the fiscal year ending Jan. 31, the company has a huge opportunity if it can add customers and deepen the relationship with existing ones. It's knocking the ball out of the park in both areas.”
Hawthorne liked the 44% revenue growth that Okta generated in 2020 and noted that the business continues to attract significant contracts from large customers, saying, “The number of customers with an annual contract value (ACV) greater than $100,000 continued to grow at a rapid clip, while dollar-based net retention remained incredibly high. That net retention number over 100% means that growth from existing customers more than offsets any churn.” Hawthorne highlighted the success that the company had attracting new customers in Q4 of 2020, saying that “Nearly half of the customers with ACV greater than $100,000 added last quarter were new customers.” He continued, noting that the company’s growth implies that it is taking market share from “legacy vendors such as Oracle (ORCL) and IBM (IBM).”
The potential downside to the stock is its valuation. Hawthorne says that the stock is trading for roughly 35x sales. He says, “That's about as cheap as it has been since early in the pandemic, but it still isn't actually cheap.” However, he also notes that “Great businesses are never cheap.” And he concludes, “Ultimately, the valuation will work itself out over time if management keeps executing. So far, every indication is that they will. Thanks to the recent sell-off in tech stocks, this industry leader is finally on sale again. If history is any indication, it might not last long.”
It appears that investors were unsure of what to make of the company’s valuation coming into Q1 earnings. And, as Demitri Kalogeropoulos, a Nobias ranked 5-star analyst who also writes for The Motley Fool said in a recent piece, investors were also concerned about a recent acquisition that the company made as well. Kalogeropoulos wrote, “In early May, the digital identity management specialist closed its biggest acquisition yet -- the $6.5 billion purchase of Auth0 -- which has the potential to threaten cash returns going forward.” But, he said, those fears were “overblown” and the company’s operations remain quite strong.
During the first quarter, Kalogeropoulos notes that Okta’s “Sales landed at $251 million, which translated to a 37% increase year over year. That boost easily beat the 30% boost analysts were expecting and marked only a modest deceleration from the 43% spike Okta logged through 2020.” Kalogeropoulos mentioned that Okta’s management said that the company continues to land contracts from large enterprise clients, which continues the trend of taking market share from legacy operations that Hawthorne touched upon. Kalogeropoulos also said that “The company is also finding room to broaden its contracts by upselling into other security services.”
With specific regard to the impact of the Auth0 acquisition on the company’s growth prospects, Kalogeropoulos says that Okta management made it clear that the move will help them to maintain their high level of growth over the medium to long-term. He wrote, “That purchase should allow the company to grow sales at over 30% annually over the next five years. This year's growth will be between 45% and 47%, management said, compared to their pre-merger outlook calling for 30% gains. That target implies reaching $4 billion in annual sales by fiscal 2026.”
And, Kalogeropoulos was also bullish on the acquisition’s impact on Okta’s bottom-line as well, saying, “Okta is also planning steady improvements in free cash flow with that figure reaching at least 20% of sales five years from now. The company produced a free-cash-flow margin of 13.3% in fiscal 2021 and 6.2% the year prior.” Kalogeropoulos closed his piece with a bullish leaning, highlighting the company’s “solid momentum coming out of the pandemic”; however, he also noted that these shares may not be for everyone, saying, “Yet shareholders should still brace for volatility over the next year or so, thanks to demand swings in the industry and challenges associated with integrating Auth0 into Okta's operation.”
So, with such strong growth prospects in mind, why have Okta shares suffered throughout 2021? Well, Royston Yang, a Nobias 4-star rated analyst recently covered Okta for The Motley Fool in an article titled, “Why Okta Dived 17.5% in May” and said that investors, “May have been spooked by Okta's guidance for the full fiscal year. Three months ago, when the company released its full fiscal 2021 earnings, it had guided for a net loss per share of between $0.49 and $0.44. Okta's latest earnings release has amended this guidance to reflect a loss per share of $1.16 to $1.13, more than double the range it had estimated a while ago.” What’s more, Yang says, news recently broke that “Okta's CFO Mike Kourey has also announced his resignation, in a move that caught investors by surprise. Brett Tighe, the company's senior vice president of finance and treasury, will stand in as interim CFO while the search for a permanent replacement takes place.”
Nicholas Ward is a Senior Investment Analyst at Wide Moat Research. He has spent the last 8 years writing about the stock market at various publications, including Seeking Alpha, The Street, Forbes Real Estate Investor, Sure Dividend, The Dividend Kings, iREIT, Safe High Yield, and The Intelligent Dividend Investor.
However, these two pieces of negative news didn’t sway Yang, who remains bullish on shares, concluding his article by saying, “Notwithstanding the above news, Okta remains one of the more promising software-as-a-service stocks. The higher loss can be attributed to growing pains that are a necessary part of expanding its business and its total addressable market. The Auth0 acquisition should be viewed as a short-term pain that will result in long-term gains for investors.”
It’s clear that there is a tug-of-war going on here between the bears who believe that Okta’s valuation is too speculative and the bulls who believe that the company’s strong double digit growth prospects moving forward justify its high price-to-sales ratio. This is normally the case when we’re talking about high flying growth stocks. Yet, when looking at the recent opinions published by 4 and 5-star rated Nobias analysts, we see a clear bullish mean.
Since the beginning of May, there have been 15 opinions published by the blue chip analyst that we track. One of these opinions was “Neutral”. Just 3 came with “Sell” ratings. And, 11 of the notes included bullish opinions. Within this blue chip group of analysts, we’ve seen 3 recent price target updates. The average of these estimates is $275/share. Okta, Inc currently trades for $227.79, which implies near-term upside potential of nearly 21%.
Disclosure: Nicholas Ward has no positions in any stocks listed in this article. Nicholas Ward wrote this article for Nobias at their request with a view of giving investors a balanced perspective based on the writings of Nobias highly rated analysts and bloggers. Nobias has no business relationship with any company whose stock is mentioned in this article and does not have a position in this stock.
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