It has been relatively rare for small and mid-cap growth stocks to exceed expectations and rally this earnings season. Smartsheet (NYSE:SMAR) was a welcome outlier: this high-quality project management and workflow software company, in my view, has been long overdue for a rally. After reporting Q1 results, the stock shot up more than 10%.
And yet, in spite of this post-earnings rally, the stock remains down high single digits for the year; which, in my view, creates a perfect buying opportunity for investors as Smartsheet looks to rebound.
Buy Smartsheet stock on strong results and an overhaul of its pricing plans
I last wrote a bullish opinion on Smartsheet in March, when the stock was trading at ~$38. Since then, the company has posted strong Q1 results that showed barely any deceleration in revenue growth, alongside a sharp increase in operating margin targets for the year. In addition to that, Smartsheet's board has also initiated a $150 million share buyback program, which at current share prices covers just shy of 3% of the company's outstanding market value. While not an incredibly large buyback program, it's a clear signal that management believes Smartsheet to be undervalued. With all of these factors in mind, I'm renewing my buy call on Smartsheet.
It's worth noting as well that Smartsheet is planning an overhaul of its pricing model, designed to encourage organizations to bring in more users but at a lower per-user rate. This is an extension of Smartsheet's "land and expand" strategy, wherein it strives to sign up certain power-users and departments, with an eye toward expanding more broadly within a company.
Per CEO Mark Mader's remarks on the Q1 earnings call regarding the new pricing model, which is due to roll out on June 24th to new customers:
To unlock greater value for our customers and Smartsheet, I am pleased to share that on June 24th, we will be rolling out a new pricing and packaging model. We anticipate it being modestly accretive in the near term and meaningfully accretive in the longer term.
The new model provides broader access to Smartsheet features to more users and organizations who will be able to access the entire feature set offered by a plan, while providing increased control and greater transparency to administrators. In aggregate, the new model pairs a greater number of licensed users with a lower price per user on business and enterprise plans.
New customers will onboard with this model starting on June 24th, while existing annual customers will transition in calendar year 2025. We anticipate this new pricing and packaging model will be foundational for our long-term durable growth."
Beyond these nearer-term drivers, here's a refresher as to my long-term bull case for Smartsheet:
- Companies continue to look for ways to streamline processes and drive efficiencies. Since the start of 2023, companies have put a laser eye to budgets and focused more on headcount and efficiency. That is Smartsheet's ultimate goal: making sure projects are moving smoothly, and that resources are used to capacity.
- Remote work and distributed teams are gaining in prominence. With the continued popularity of a remote/hybrid work model, remote teams need a centralized tool to coordinate, and tools like Smartsheet are perfect conduits to that - especially true for distributed teams, where people are in different locations and some are in-person while others are remote.
- Smartsheet is moving upmarket and reducing its reliance on SMB. As Smartsheet has proven its utility and flexed its muscles as a more prominent public company, the company has been able to sign larger deals. Though the company is currently exposed to SMB weakness, in the long run it will have a more stable enterprise customer base. The company has nearly 2,000 customers that generate more than $100,000 in ARR. The average customer is also upgrading their relationship with Smartsheet: net revenue retention rates are clocking in around 120%, which exceeds most other SaaS stocks.
- Horizontal software and broad use cases. "Horizontal" is a term for a software company that is broadly applicable to virtually any industry and virtually any team or function within a company, making it addressable market-wide. Its new pricing model, designed to onboard more users in an organization, is a testament to the broad use cases that Smartsheet supports.
- High gross margins. Smartsheet's 80%+ pro forma gross margins are among the highest in the software industry, and enable the company to achieve significant operating leverage as it scales.
Stay long here and ride the Smartsheet rally upward.
Smartsheet Q1 earnings highlights
Let's now go through Smartsheet's latest quarterly results in greater detail. The Q1 earnings summary is shown below:
Smartsheet's revenue grew 20% y/y to $263.0 million, ahead of Wall Street's expectations of $258.2 million (+17% y/y) by a three-point margin. Growth also showed barely any deceleration from 21% y/y growth in Q4.
One thing to watch out for, however: dollar-based net retention rates have been in a continual decline. Net retention in Q1 dropped to 1114%, down 9 points y/y and 2 points sequentially from Q4.
Note that Smartsheet's new pricing model will hopefully combat this. If Smartsheet is successful in increasing depth within an organization and encouraging greater signups, seat-based expansion will lead to an uptick in dollar-based net retention rates (and revenue overall).
The company has also excelled in profitability, which it attributed to a keen management of opex, ensuring limits on layers of management growth and being conscious of talent locations to minimize cost. As a result, pro forma operating income nearly double dy/y to $42.1 million, representing a 16% pro forma operating margin: up 6 points y/y.
We note as well that while Smartsheet only raised its revenue guidance for the year by ~$3 million at the midpoint (still representing a 16-17% y/y revenue growth range), it did materially lift its pro forma operating margin guidance to a 14-15% margin, up from 12-13% in the prior outlook.
We could even make a case that this operating margin may be light, if the company achieved a 16% margin in Q1 before any "land and expand" benefits of potentially greater user adoption from the new pricing model are factored in.
SMAR stock - Valuation, risks, and key takeaways
At post-earnings share prices near $42, Smartsheet trades at a market cap of $5.85 billion. After we net off the $669.5 million of cash (against zero debt) on Smartsheet's latest balance sheet, the company's resulting enterprise value is $5.18 billion. This puts the stock at a 4.6x EV/FY25 revenue multiple. Considering Smartsheet was within inches of achieving the "Rule of 40" in Q1 (21% revenue growth plus 16% pro forma operating margins), I think there's plenty of room for upside from a valuation standpoint.
There are risks, of course. Smartsheet is in a particularly competitive space within enterprise software, competing against the likes of Asana (ASAN) and Atlassian's (TEAM) Jira, the latter of which is a much larger and better-funded company. In addition, Smartsheet's decision to update its pricing model and bring in provisional users/lower per-user costs could fail to generate the anticipated adoption and have the impact of lowering ARPUs.
Still, with a strong Q1 under its belt, a strong outlook for profitability, and a very modest valuation, I'm inclined to believe in much more upside than downside. Stay long here.
Gary Alexander
With combined experience of covering technology companies on Wall Street and working in Silicon Valley, and serving as an outside adviser to several seed-round startups, Gary Alexander has exposure to many of the themes shaping the industry today. He has been a regular contributor on Seeking Alpha since 2017. He has been quoted in many web publications and his articles are syndicated to company pages in popular trading apps like Robinhood.
Analyst’s Disclosure: I/we have a beneficial long position in the shares of SMAR either through stock ownership, options, or other derivatives. 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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