Dynatrace: Monitor This Cash Flow, Time To Reconsider This Stock (Upgrade) (NYSE:DT)

shapecharge/E+ via Getty Images Investment Thesis Dynatrace, Inc. (NYSE:DT) is currently out of favor with investors, yet its underlying fundamentals remain robust. However, this thesis isn’t flawless. Growth rates are decelerating, which weighs on the stock. Nonetheless, the company’s core business is highly profitable. What’s more, the business holds no debt, and more than 5% of its market cap is made up of cash. Buying DT at 27x this year’s non-GAAP operating profits provides investors with a compelling risk-reward. Therefore, I am upgrading my recommendation on this stock to a buy, after being neutral on this name. Rapid Recap Back in March, I said, The bull case points to the fact that Dynatrace is highly profitable with 5% of its market cap made up of cash and no debt. However, the bear case here points to the fact that its valuation isn’t providing enough margin of safety. Having to pay around 31x forward non-GAAP operating profits is already pricing in a lot of very high expectations from Dynatrace next year. Therefore, I’ve downgraded my DT rating to a hold. Author’s work on DT Looking back, Dynatrace’s stock has been terribly volatile. Very few investors would have been able to eke out any gains in this name in the past year. But I now believe that this is a good point to reconsider this name, with no biases or attachments. Essentially, if you forget the past year and look ahead to the next twelve months, I believe that getting this stock at sub $50 will look like a cheap price for DT. Why Dynatrace? Why Now? Dynatrace provides a comprehensive platform that helps businesses monitor and optimize their software applications and IT infrastructure. By collecting and analyzing data from across hybrid and multi-cloud environments, Dynatrace offers real-time insights into performance and user experience. This enables organizations to proactively identify and resolve issues and ensure their digital services run smoothly. Looking ahead, Dynatrace’s near-term prospects appear favorable. The company has demonstrated strong growth, surpassing $1.5 billion in ARR. Dynatrace continues to capitalize on the expanding observability market, benefiting from enterprises’ shift towards larger, more integrated observability architectures. However, Dynatrace faces several challenges too. Despite its strong performance, the company is navigating a competitive landscape, against the likes of New Relic (Private) and Datadog (DDOG), both of which provide observability solutions aimed at optimizing digital experiences across complex environments. Given this balanced context, let’s now discuss its fundamentals. Revenue Growth Rates Below 20% CAGR DT revenue growth rates In my previous analysis, I said, […] when it comes to forming a few of fiscal 2025 (starting next calendar month), I’ve presumed that Dynatrace will grow next year by approximately 20%. It may end up growing a couple of percentage points faster than this, but given its current ARR is growing at 21% y/y in constant currency, I find it difficult to envision its growth being dramatically different from approximately 20%-22%. Therefore, I’ve worked off the assumption that 22% CAGR will be on the cards for Dynatrace next year. As is the habit with tech companies, we often presume that management is lowballing its guidance. Consequently, we aggressively estimate that there’s more growth to come. And we end up in a cycle where we expect management to beat their guidance. However, even if I presume that Dynatrace beats the high end of its revenue guidance by 300 basis points, and grows its top line by 19% y/y on an as-reported basis, the fact remains that it is highly unlikely that Dynatrace will deliver 22% CAGR this fiscal year. Moreover, once a tech company starts to deliver sub-20% CAGR, investors start to nervously look beyond its top-line, towards its bottom line to see if there’s enough profitability on the horizon to support its valuation. And that’s a topic we explore next. DT Stock Valuation — 27x This Year’s Non-GAAP Operating Profits In my previous analysis, I said, […] as we look ahead to fiscal 2025, let’s say that Dynatrace expands its underlying profitability by a further 200 basis points relative to [its fiscal 2024 year]. This would put Dynatrace on a path towards 27% non-GAAP operating margins, which means that in the near term, that’s as profitable as Dynatrace is capable of being operated at. Therefore, approximately $460 million of non-GAAP operating profits is as good as it’s going to get in the coming year. Turns out that my estimate was roughly in the right ballpark, as Dynatrace’s high-end non-GAAP operating profits point to $467 million. However, let’s consider, once again, that management is being conservative with its profit estimates. Let’s make the case that Dynatrace’s non-GAAP operating profits actually reach $490 million. This would see its underlying profitability increasing by roughly 23% y/y. That’s clearly an alluring jump, and paying 27x non-GAAP operating profits provides investors with an attractive risk reward. After all, there are too many tech companies with no debt, growing their bottom line by close to 20% CAGR, priced at approximately 27x this year’s non-GAAP operating profits. The Bottom Line In conclusion, while Dynatrace, Inc. currently faces investor skepticism, its strong underlying fundamentals and debt-free status present a compelling case for investment. Despite decelerating growth rates, the company’s profitable core business and substantial cash holdings underscore its resilience in a competitive market. At 27x this year’s non-GAAP operating profits, DT offers an attractive risk-reward proposition. This is an excellent time to reconsider this stock.

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