AI Investments And Competition Will Impact Future Margins In Enterprise Cloud Applications

Key Takeaways

• Workday's revenue targets may be overly ambitious due to increased competition and challenges in scaling growth sustainably.
  
• Investments in AI and government contracts pose uncertainties, potentially impacting margins and causing short-term revenue volatility.
  
• Workday's AI adoption, strategic sector expansion, and partner ecosystem strength suggest potential revenue growth and higher profit margins through innovative solutions and differentiated offerings.

Catalysts

Provides enterprise cloud applications in the United States and internationally.

• Workday's ambitious target to drive mid-teen subscription revenue growth through fiscal 2027, while expanding non-GAAP operating margins to 30%, might not be sustainable. This plan may be overly optimistic as the company faces increasing competition and the challenge of maintaining growth as its business size increases, potentially impacting future revenue growth and earnings.
  
• Investment in AI innovation and the introduction of AI-driven products, such as Recruiter Agent and Talent Optimization, comes with uncertainties related to customer adoption and monetization. This could impact net margins and earnings if these investments do not yield expected returns quickly enough.
  
• A strategic shift towards government contracts, such as those with the Defense Intelligence Agency, requires building secure platforms and delays revenue recognition due to product deliverables extending into future periods. This might lead to short-term pressure on revenue growth and earnings.
  
• International revenue growth is only 25% of total revenue, with economic headwinds and deal scrutiny persisting in regions like EMEA. Continued challenges in international markets could slow expected growth, affecting overall company revenue and earnings prospects.
  
• The transition in leadership roles, such as the appointment of Rob Enslin as President and Chief Commercial Officer, introduces potential risks related to strategic continuity and go-to-market execution. Any disruption could hinder operational efficiency, impacting net margins and future earnings.

Workday Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Workday's revenue will grow by 13.7% annually over the next 3 years.
• Analysts assume that profit margins will shrink from 19.9% today to 14.5% in 3 years time.
• Analysts expect earnings to reach $1.7 billion (and earnings per share of $5.38) by about January 2028, up from $1.6 billion today.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 67.4x on those 2028 earnings, up from 44.4x today. This future PE is greater than the current PE for the US Software industry at 43.6x.
• Analysts expect the number of shares outstanding to grow by 6.78% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 7.06%, as per the Simply Wall St company report.

Workday Future Earnings Per Share Growth

Risks

• Workday's AI innovations, such as Recruiter Agent and Talent Optimization, are experiencing significant adoption and customer willingness to pay, suggesting potential revenue growth and increased revenue from AI-related solutions.
  
• The company's strategic wins and expansion into sectors like government and healthcare indicate strong demand for Workday's full suite offerings, likely bolstering subscription revenue and backlog growth.
  
• Workday's global expansion efforts, particularly in the U.S. federal government sector and international markets, present growth opportunities that could positively impact future revenue streams.
  
• The strength of Workday's partner ecosystem and its role in sourcing new deals could contribute to new revenue opportunities and enhance their sales pipeline, positively affecting overall revenue growth.
  
• Workday's efforts to deliver innovative AI agents and secure strategic partnerships aim to provide differentiated products, which could drive higher average selling prices and profit margins in the medium to long term.

Valuation

• The analysts have a consensus price target of $296.33 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 $350.0, and the most bearish reporting a price target of just $242.0.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be $12.0 billion, earnings will come to $1.7 billion, and it would be trading on a PE ratio of 67.4x, assuming you use a discount rate of 7.1%.
• Given the current share price of $270.43, the analyst's price target of $296.33 is 8.7% higher. The relatively low difference between the current share price and the analyst consensus price target indicates that they believe on average, the company is fairly priced.
• 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.