AI Expansion And Efficiency Measures Will Strengthen Future Performance

Key Takeaways

• Expansion into AI and international markets positions Workday for revenue growth by attracting customers seeking integrated AI operations and untapped market potential.
  
• Demand for AI SKUs and ecosystem investments improve margins and revenue through higher-value offerings and sustained growth in ACV and new revenue streams.
  
• Reliance on AI investments and restructuring costs may impact margins amid macro headwinds, currency fluctuations, and growing competition in the AI and cloud sectors.

Catalysts

Provides enterprise cloud applications in the United States and internationally.

• Workday's expansion into AI, particularly through its Agent System of Record and role-based agents, presents a significant opportunity to boost subscription revenue by attracting customers wanting to integrate AI more securely and efficiently into their operations.
  
• Continued strong performance in the financial services and healthcare sectors, along with new expansions in international markets and public sector wins, could drive revenue growth and improve earnings as these markets offer substantial untapped potential.
  
• Increasing demand for Workday's AI SKUs, such as Extend Pro and Recruiting Agent, which have shown robust quarter-over-quarter growth, indicates a potential uplift in average selling prices and contribution to net margins through higher-margin premium offerings.
  
• Strategic investments in the partnership ecosystem, which contributed to over 15% of net new ACV, coupled with program developments like Built on Workday, signal an opportunity for sustained growth in ACV and future revenue streams.
  
• Focus on enhancing operating efficiency through recent restructuring and targeted AI investments is expected to support margin expansion and stronger overall earnings performance in the medium to long term.

Workday Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Workday's revenue will grow by 13.0% annually over the next 3 years.
• Analysts assume that profit margins will increase from 6.2% today to 12.7% in 3 years time.
• Analysts expect earnings to reach $1.6 billion (and earnings per share of $5.47) by about April 2028, up from $526.0 million today. However, there is a considerable amount of disagreement amongst the analysts with the most bullish expecting $1.9 billion in earnings, and the most bearish expecting $818.8 million.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 66.0x on those 2028 earnings, down from 115.3x today. This future PE is greater than the current PE for the US Software industry at 29.6x.
• Analysts expect the number of shares outstanding to grow by 0.38% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 7.73%, as per the Simply Wall St company report.

Workday Future Earnings Per Share Growth

Risks

• The increasing strength of the U.S. dollar has created a headwind, potentially impacting international revenues negatively due to currency fluctuations.
  
• There is a risk that the company’s continued reliance on AI investments might not yield the projected ROI, which could affect operating margins if these investments do not translate into substantial revenue gains.
  
• The restructuring could lead to short-term disruptions and costs, such as the $75 million charge, potentially impacting financial performance and GAAP operating margins due to the associated expenses.
  
• Macro headwinds, especially in EMEA, remain a concern, as they could affect customer spending and new contracts, possibly impacting international revenue growth and overall company performance.
  
• Intensifying competition in the AI and cloud solutions space poses a significant threat, and failure to continually innovate or maintain differentiation could lead to loss of market share and revenue.

Valuation

• The analysts have a consensus price target of $305.003 for Workday based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $360.0, and the most bearish reporting a price target of just $230.0.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be $12.2 billion, earnings will come to $1.6 billion, and it would be trading on a PE ratio of 66.0x, assuming you use a discount rate of 7.7%.
• Given the current share price of $227.71, the analyst price target of $305.0 is 25.3% higher.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.