New Relic Q2 Earnings: The Rally Is Just Beginning (NYSE:NEWR)

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As bearish clouds begin to fade, many investors like myself are gearing up for a rebound, but in a cautious manner. I’m still keeping some cash on the sidelines in case a renewed macro scare pulls the market down further, but with the rest of my capital I’m gearing more and more of my investments in beaten-down, value-oriented tech stocks.

New Relic (NYSE:NEWR), in particular, is a very attractive opportunity that has been on a solid win streak since August. The infrastructure monitoring software company, which preceded its now better-known rival Datadog (DDOG), has seen success since revamping its product lineup and sales strategy in 2020. Balancing both growth and margin expansion alongside a very sticky and upsell-prone customer base, New Relic has consistently now turned out solid results against muted expectations. In early August, the company released fiscal Q1 results (New Relic has a March year-end, which is atypical of many SaaS names), which prompted a fresh ride higher for the stock.

In spite of this recent win streak, New Relic stock is still down more than 35% year to date, and its valuation is yet another signal that the stock has room to drift further upward.

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NEWR data by YCharts

The bull case still remains vibrant at ~4x revenue

Since I last wrote on New Relic in May, the stock has rallied more than 40%. In spite of this, I remain quite bullish on New Relic’s prospects, owing to its string of strong results plus a still-accommodating valuation. There are a number of growth drivers that New Relic has under its belt, including and especially a recent expanded partnership with Microsoft Azure that puts New Relic directly on the Azure marketplace and positions it well to cross-sell with the second-largest public cloud vendor. From a sales execution perspective, New Relic’s updated sales playbook has also led to an acceleration in new paid account adoption; which, as a reminder, is especially powerful given New Relic’s “land and expand” playbook and net retention rates approaching 120%.

For investors who are newer to New Relic, here’s a refresher on what I believe to be the key bullish drivers for the name:

  • New Relic’s new, simplified sales approach has driven re-invigorated growth rates. Much of New Relic’s growth stagnation came from the fact that its product stack was very difficult to comprehend, especially at a time when companies like Datadog were stealing the limelight. “New Relic One” was rolled out in 2020 specifically to address this problem, in addition to dramatically reducing the company’s product count into just three main platforms, as well as rolling out a free tier with the hope of “landing and expanding” new customers. So far, the strategy has proven effective at maintaining robust ~20% y/y revenue growth.
  • Consumption-based revenue model is a growth tailwind for New Relic. Other consumption-based software companies, like Twilio (TWLO) and Snowflake (SNOW), are able to drive superior growth and notch premium valuations. It also allows New Relic to derive value out of the smaller customers that may start on New Relic’s free tier and eventually move up to greater data volumes. Over recent quarters, New Relic’s net revenue retention rates have actually been increasing, indicating increased success at upselling to the existing customer base.
  • Aligned to the “big data” trend. Data volumes are exploding, both more generally and for New Relic specifically as well. As more and more companies embrace unlocking the potential of data, New Relic’s overall market size and customer traction will continue to grow.
  • Continued innovation. In early 2022, the company released a brand-new infrastructure monitoring product called CodeStream, which it previewed at the annual AWS re: Invent event in late 2021. According to the company, customers are loving the “modernized” monitoring experience, which allows, among other features, for users to go back in time and map out when incidents occurred and the cascading impacts of these events over time.

In spite of these strengths and strong recent quarterly execution, New Relic remains a value stock. At current share prices near $67, New Relic trades at a market cap of $4.52 billion. After we net off the $867.3 million of cash and $498.3 million of debt on New Relic’s most recent balance sheet, the company’s resulting enterprise value is $4.15 billion.

For the current fiscal year FY23 (the year for New Relic ending in March 2023), the company has guided to revenue in a range of $920-$930 million, representing an impressive 17-18% y/y growth rate:

New Relic Q1 results

New Relic Q1 results (New Relic Q1 earnings release)

Against the midpoint of this view, New Relic trades at just 4.5x EV/FY23 revenue – a bargain for a mid-teens grower that is approaching a breakeven pro forma operating margin and generating positive free cash flow.

The bottom line here: in my view, New Relic’s win streak so far is largely an expression of how little confidence investors had in the stock previously, and how undervalued it was to begin with. Continued beat-and-raise quarters plus a still-modest valuation leave plenty of steam for this rally to keep going. Buy New Relic on the upswing and keep riding it higher.

Q1 results

Let’s now go through New Relic’s latest Q1 results, released on August 4, in greater detail. The Q1 earnings summary is shown below:

New Relic Q1 results

New Relic Q1 results (New Relic Q1 earnings release)

New Relic grew revenue in Q1 at a 20% y/y pace to $216.5 million, beating Wall Street’s expectations of $213.1 million (+18% y/y) by a two-point margin. We note as well that New Relic’s growth accelerated slightly versus 19% y/y growth in Q4.

The company also added 300 net-new active customer accounts in the quarter, more than 200 in Q4. Net revenue retention rates – a measure of how successful New Relic is at both retaining its customer base and upselling them (or increasing their usage) – is also a highly positive story, hitting 120% in the quarter (up one point from 119% in Q4).

New Relic Q1 key metrics

New Relic Q1 key metrics (New Relic Q1 earnings release)

Here’s some helpful anecdotal commentary from CEO Bill Staples on the company’s go-to-market performance, including a comment on the fact that New Relic so far has been un-impacted by tightening macro conditions, taken from his prepared remarks on the Q1 earnings call:

Additionally, while we have not yet seen meaningful impact from the macro environment in our business results, we recognize the uncertainty of the current economic climate and believe these steps advantage us regardless of what the future holds. We’re confident we can achieve this from actions fully within our control.

We’ve also begun delivering on our third priority of accelerated account growth. Total active customer accounts are up nearly 300 in Q1, net of churn compared to a cumulative net increase of 700 accounts across the three fiscal quarters preceding it. I’m really pleased that we’ve added 1,000 paying customers to our base over the last year net of churn.

As we shared at the Analyst Day in May, churn has been steadily declining since introducing the platform and our Q1 churn number was 6%, a slight increase over Q4 as a result of a few deals that slipped into July and was in line with our internal forecast.

Account growth acceleration is due to continued improvements in our product-led growth funnel and the new inside sales program. It’s also encouraging to see that our number of active customer accounts with revenue greater than $100,000 grew by 38, double the number of additions we had in Q1 last year. So not only are we adding more paying customers, but they’re graduating to higher levels of spend faster as well.”

New Relic’s wins weren’t just limited to growth, however. The company has consistently improved pro forma gross margins for the third straight quarter, hitting 73% in Q1 (up four points from 69% in the year-ago Q1):

New Relic Q1 gross margin trends

New Relic Q1 gross margin trends (New Relic Q1 earnings deck)

Similarly, pro forma operating margins hit a near-breakeven -8%, up one point from -9% in 1Q22. The company also had a strong kickoff to the year in free cash flow, which hit $38.3 million (an 18% margin) – substantially higher than $4.8 million in the year-ago quarter.

New Relic Q1 FCF

New Relic Q1 FCF (New Relic Q1 earnings release)

Key takeaways

As a smaller-cap tech stock that has needed to claw its way out of the “penalty bucket”, New Relic has fallen off most mainstream investors’ radar. That’s a shame, as New Relic offers the perfect combination of growth, margin/profitability expansion, and value that I think makes it the perfect investment opportunity in a rebounding but volatile market. If you haven’t already, build a stake here.

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