Its top-line growth is slowing. However, there are some positive factors that could mitigate that.
Workday (WDAY -1.73%) has been a late summer success story on the market. Its shares have crushed the broader indexes since it reported its fiscal 2025 second-quarter results near the end of August. This, despite one crucial metric that is anticipated to come in under expectations in the current quarter.
It’s all about the subscriptions
That line item is subscription revenue — Workday management believes this will come in at a shade under $2 billion in its fiscal third quarter. While $2 billion is an easy figure to track, to a degree, it was mildly disappointing that the company doesn’t expect it to be met or exceeded.
Subscription revenue is crucial for Workday. The company offers a palette of financial and human resources software tools for businesses, providing them — as is the current fashion in tech services — via a subscription model. Happily for the company, its take from subscriptions has been growing. For example, it topped $1.9 billion for the first time in fiscal Q2 (which ended July 31) thanks to a 17% year-over-year rise.
Yet Workday investors might have to steel themselves for (slightly) more modest growth. Its sub-$2 billion guidance for the current quarter represents anticipated growth of 16%, down from the second quarter’s increase and below the 19% annual rise the company achieved in its fiscal 2024 (not to mention the nearly 23% gains of the previous fiscal year).
No investor likes to see slowing revenue growth, but the numbers that really count — profit figures — look set to rise for Workday. Management cranked up its guidance for this fiscal year’s non-GAAP (adjusted) operating margin a bit to 25.5% from the previous 25%. At the same time, they made quite a significant increase to their estimates for that metric in fiscal 2026 and 2027, to 30%. Previously, guidance for those years had also been for 25%. Those upgrades boosted hope for its future.
Major clients and high potential
Workday’s slowly descending revenue growth rate has several factors behind it. One is that numerous businesses have lately been taking a more cautious approach to IT spending due to various macroeconomic fears. These days, for example, many are worried that the worse-than-expected August employment data indicates we’ll soon experience a dent in the economy. Such concerns have a way of making company managers more reluctant to spend money.
Workday management said the company is looking for ways to expand its profit margins, which feels like the right strategy for a no-longer-young business moving past its robust revenue growth phase. It plans to more effectively harness artificial intelligence (AI), for instance, to better its internal processes, and there are surely numerous ways that tech can be leveraged to both cut costs and enhance the company’s suite of products.
If I were an investor in Workday, I wouldn’t worry about its future. The company clearly has a compelling product lineup, as evidenced by the fact that businesses as diverse and prominent as telecom giant AT&T, restaurant chain operator Shake Shack, healthcare sector veteran Abbott Laboratories, and entertainment conglomerate Comcast are clients.
Meanwhile, that subscription-heavy business model is working, as it lately produced annual cash flow of more than $1.9 billion (a nearly 50% improvement over the previous fiscal year, by the way). Its forward price-to-earnings ratio might seem a touch on the high side at 37, but remember, this business still regularly delivers double-digit percentage improvements. Collectively, analysts are modeling for a 20% leap in its per-share net income this year alone.
Sure, investors would like to see Workday join the $2 billion revenue club sooner rather than later. But I think the company is humming along quite effectively, thank you very much, and standing in front of years full of satisfying growth. I would seriously consider buying its stock.
Eric Volkman has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Abbott Laboratories and Workday. The Motley Fool recommends Comcast. The Motley Fool has a disclosure policy.
