This cloud computing stock is starting to look like a lot |  The Motley Fool

This cloud computing stock is starting to look like a lot | The Motley Fool

The bear market of 2022 has been brutal for software stocks, and some of them are rightly punished. Rapid growth is good, but profitability matters. And many upstart cloud software companies have proven to be deficient in this department.

This is not the case for Dynatrace (DT 1.78%). The company is dedicated to profitable growth, and the financial results show it. Nonetheless, heading into the fourth quarter of 2022, stocks have sold around 45% this year as the stock is hammered with the rest of the tech market. Here’s why Dynatrace is starting to look like a bargain.

Dynatrace grows where it matters most

One of the reasons the market is stunned has to do with fears of a recession. As the risk of an economic downturn increases, many organizations are tightening their budgets. But the top brass at many cloud companies say they continue to grow because “digital transformation” remains a top priority. This makes sense, because investing in digital processes helps a business become more efficient and save resources in the long run.

It’s also the story that Dynatrace’s top team preached this year. As giant enterprises (which Dynatrace is focused on) migrate more of their operations to the cloud, they need a new set of tools to ensure these new cloud-based computing capabilities and applications run smoothly. This is where cloud observability comes in.

Dynatrace’s platform covers everything from application performance monitoring to security to technology infrastructure monitoring. And unlike many legacy software, this toolset doesn’t just notify an IT department if something is wrong. It also suggests and helps automate a fix. The volume and complexity of data is increasing as cloud adoption accelerates, so this kind of automation is critical for mega-enterprises.

But what if the growth of the cloud industry slows down? At a recent technology conference, CEO Rick McConnell pointed out that cloud hyper scalers Amazon AWS, Microsoft Azure, and Alphabet‘s Google Cloud collectively generated approximately $160 billion in revenue in the second quarter of 2022, growing 36% year-over-year. Even if this rate of increase is slowing down a bit, the cloud universe is doing very well.

And since Dynatrace generally follows the path of cloud industry expansion, it is also doing very well. Its revenue rose 34% year-over-year in its latest quarter, even as many of its large clients began to cut spending as recession worries grew.

Steady growth, high margins and improving balance sheet

For its fiscal year 2023 (the 12-month period ending in March 2023), Dynatrace expects its revenue to grow by at least 21% (or at least 26% if excluding exchange) to reach approximately 1.13 billion dollars. Along the way, the free cash flow profit margin should be around 28%, a very healthy rate for a growing company.

Admittedly, this is a slowdown compared to the recent past. Economic uncertainty and the historic appreciation of the US dollar are weighing on revenues and earnings. McConnell and company also decided earlier this year to invest some of the company’s money in expanding its sales force. Over the next two years, management sees these free cash flow margins rebound towards 30% as this investment is digested.

And thanks to its steady generation of fresh cash, Dynatrace’s balance sheet has also improved rapidly since its IPO in 2019. Once struggling with liabilities, this company is now cash and short term investment positive. term net of debt.

DT Total Long-Term Debt Chart (Quarterly)

Data by YCharts.

However, this debt repayment has not hindered the development of more tools by Dynatrace. McConnell said the infrastructure monitoring module currently generates about $100 million in sales per year, but is growing at a much faster rate than overall revenue. The most recently released Application Security module is on track to hit $100 million in annualized revenue. And a new tool in preparation for a few years now, the management of data logs (Splunkcore software capability), is almost ready to be unveiled. Based on Dynatrace’s conversations with customers, Log Management is also expected to reach $100 million in sales per year very quickly.

After being dragged down by the broader market, Dynatrace stock now trades at 32 times company value to free cash flow. It is a rare software company with rapid growth and robust free cash flow generation. I think it might be time to snack here if you’re looking for some quality cloud computing stocks to hold for the next few years.

Suzanne Frey, an executive at Alphabet, is a board member of The Motley Fool. John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a board member of The Motley Fool. Nicholas Rossolillo and his clients have positions in Alphabet (C shares), Amazon and Dynatrace, Inc. The Motley Fool has positions and recommends Alphabet (A shares), Alphabet (C shares), Amazon, Microsoft and Splunk. The Motley Fool has a disclosure policy.

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