UiPath stock: Cautious path to Q2 earnings (NYSE: PATH)

UiPath(NYSE: PATH) released its first quarter results in early June and since then the stock has risen more than 5%, although it remains down nearly 60% year-to-date.

Turnover remains very healthy, growing more than 30% per year and consistently exceeding expectations. However, profitability remains challenging, with the company posting a non-GAAP operating loss of $11 million in the first quarter, including a free cash flow loss of $54 million.

At a time when investors are placing more emphasis on profitability, UiPath may continue to have negative sentiment on the stock.

With the company reporting earnings at the end of August, I think management may need to take a more cautious tone on the outlook. The macroeconomic environment continues to remain challenging and with the strengthening US dollar, foreign currencies could become a bigger headwind. UiPath earns 50% of its revenue in international currencies, so the stronger USD negatively impacts its international revenue.

On top of that, investors continue to focus on profitable companies that might fare better in a possible recession. While UiPath may continue to see strong demand, their profitability remains a bit of a concern.

The valuation is also currently 7.5x FY23 revenue, which is still quite expensive given the current challenging macro environment. Even in a bullish FY24 revenue scenario, the valuation is still around 5.5x, which isn’t cheap.

For now, I’m cautious about the company heading into second-quarter results, with the possibility that management will lower its guidance expectations. Although I have believed in the company for a long time, there seems to be some risk to the profits.

Company presentation

UiPath provides an automation platform that uses computer vision and AI to create software robots. These robots will mimic human behavior and perform repetitive tasks, automating this process. Essentially, UiPath uses software to help businesses automate simple tasks that employees would otherwise perform, making the business more efficient.

While Microsoft (MSFT) is UiPath’s biggest competitor, UiPath has consistently been named a leader in robotic process automation by Gartner.

Even though UiPath is smaller in size, they still compete well with Microsoft, Automation Anywhere, and SS&C Blue Prism. The market remains competitive as companies seek to automate certain processes and the global pandemic has certainly accelerated the pace of digitization.

Financial analysis

Although the company announced its results in early June, we are still several weeks away from another update from the company.

During their FQ1, the company increased revenue by 32% year-on-year to $245 million, which exceeded expectations by $20 million, implying an 8% increase in revenue. The company’s non-GAAP gross margin remained strong at 85%, although down slightly from 88% a year earlier. Higher inflation in salaries and expenses has certainly had an impact on the company’s gross margins, although investors will likely continue to see gross margins around that 85% level.

In addition, non-GAAP operating loss in the quarter was $11 million, nearly $30 million lower than the $16 million profit a year ago. The main driver was the $50 million increase in sales and marketing expenses. Given the significant growth in the market and the company’s steady revenue growth of over 30%, it’s no surprise that they are investing heavily in sales and marketing.

And these benefits are paying off. During the quarter, ARR reached $977 million, representing a 50% year-on-year increase and reflecting net new ARR of $52 million. Additionally, the net dollar retention rate was 138%, clearly demonstrating the desire of UiPath customers to spend more with the company over time.

For the upcoming FQ2, the company forecasts revenue of $229-231 million and an ARR of $1,040-1,042 million. However, the non-GAAP operating loss of $55-60 million was a dark spot on the outlook for the next quarter.

For the full year, revenue is expected to be $1,085-1,090 million and ARR is expected to be $1,220-1,225 million. Non-GAAP operating profit is expected to be $10-15 million, reflecting a 1-2% margin.

Given the current difficult macroeconomic environment and currency headwinds that are becoming more challenging given the strength of the US dollar, the Company may be forced to revise its guidance downwards. On the company’s FQ1 earnings call, management addressed some of these headwinds.

One of UiPath’s strengths is our global presence which gives us diverse perspectives and access to talent. We set our prices in local currency and with more than 50% of our business conducted outside of North America, our results are subject to exchange rate volatility. We recognize that macroeconomic and geopolitical issues are impacting global markets and that the strengthening US dollar continues to create a headwind for our business. As we did in March, the guidance we provide this afternoon takes into account the current operating environment and includes a currency headwind offset by growing business momentum.

These difficult macroeconomic factors have continued over the past few months and could continue through the end of the year. Thus, it would not be surprising to see the company revise down its expectations for the full year given the headwind in currencies and a more difficult macroeconomic environment.

Evaluation

The stock has fallen almost 60% since the start of the year, as investors turned away from high-value, unprofitable companies. However, since the company reported earnings, the stock has risen more than 5%.

The biggest concern with UiPath remains cost effectiveness. With a non-GAAP adjusted free cash flow loss of $54 million, investors can continue to hold that against the company in the current environment. With fears of a potential recession and continued rising interest rates, investors have turned to more stable and profitable companies.

The company has a current market capitalization of approximately $10 billion and with $1.8 billion in net cash, the enterprise value currently stands at approximately $8.2 billion.

UiPath’s full-year revenue forecast of $1,085-1,090 million implies a FY23 revenue multiple of approximately 7.5x. With the stock previously trading at forward earnings multiples well over 10x, it doesn’t seem likely that we’ll return to an environment where investors are willing to pay that much for growth stocks.

Yes, revenue growth could remain very strong over the next few years, but profitability is becoming increasingly important as we potentially enter a recession.

Even though we see FY24 revenue hitting $1,500 million, which would be above consensus expectations of $1,390 million (per Yahoo Finance), the implied FY24 revenue multiple of 5, 5x is still an expense for a business whose profitability is barely breaking even.

For now, I remain cautious about the name heading into their Q2 earnings report, as we may see management become more cautious about its outlook given the challenging macro landscape.