We're 'Stretching' Our Target by $30 for This AI Cloud Holding
But following an earnings pop and overbought levels, we're also making this key move.
You've reached your free article limit
You've read 0 of 1 free Pro articles.
Elastic NV ESTC just released a beat-and-raise earnings report that showed the company continues to win customers while extracting larger subscription dollars per customer -- and improving margins. Driving the strong report is the adoption of its cloud, search, and security offerings as well as its AI, including search AI, mixed with tight expense control. That’s a winning recipe, and as we explain below, we have reason to suspect the company’s raised outlook skews conservative.
It's also why we're boosting our price target to $135 from $105 amid the strong post-earnings pop in the shares.
But we are also downgrading the shares to a "Two" rating from "One" for two reasons. First is the distance to our new price target, which offers just under 15% upside. Second, that same post-earnings move has landed the shares squarely in overbought territory and in keeping with a "Two" rating, which means the smarter move is to wait for a pullback before committing fresh capital to the shares.
Near-term, we’ll enjoy the strong move in the shares, but past a certain point, we may look to lock in a slice of the pronounced gain in the portfolio’s position, which has an average cost basis of $81.82. That would be the prudent thing to do.
Elastic’s Quarter
For its most recent quarter, Elastic delivered earnings per share of $0.59, which was considerably better than the $0.38 market consensus. That strong upside was achieved through a combination of stronger revenue growth, thanks to double-digit cloud and subscription growth. A significant increase in profitability helped, too, and resulted in the company’s operating margin hitting 17.6% compared with 13.3% in the year-ago quarter. While gross margins continued to trend higher as cloud became a larger part of the overall revenue mix, it’s the tight rein on operating expenses and the nature of its software business model that is dropping more to the company’s bottom line. It’s that combination that led Elastic’s bottom line to grow 59% year over year to $0.59 per share.
What we like about the company’s software business model is the high degree of operating leverage attached to incremental revenue. Augmenting that is higher pricing tied to AI features, something we’ve seen with ServiceNow NOW. On the earnings call, Elastic shared that it now has over 1,550 customers on Elastic Cloud, using GenAI use cases with over 240 of them spending $100,000 or more annually. To put some context around those figures, in the July quarter they stood at over 1,300 and ~200 customers, respectively.
Those figures point to Elastic’s total customer count continuing to grow sequentially but there were two other metrics that that stood out more to us. The first is subscription revenue per customer, which stood at $17,153 in the October quarter, up from $15,024 in the year-ago one and $16,398 in the July quarter This tells us Elastic is growing its reach within each customer, and it also helps explains the second item we noticed -- the strong move up in deferred revenue as well as remaining performance obligations. Both of those figures offer nice visibility, and they also explain how Elastic was able to lift its fiscal guidance as much as it did – more on that below.
Exiting October, the company had $1.2 billion in cash and equivalents on its balance sheet, roughly $11.60 in cash per share or $6.10 in net cash per share once we factor in its long-term debt. The key here is that for the first six months of its current fiscal year, Elastic generated more than $90 million in cash flow from operations and as it further scales its revenue, we see that continuing given the company’s subscription-heavy business model. For the most recent, October-ending quarter, subscription revenue generated 93.3% of overall revenue, on par with the prior quarter.
Elastic’s Outlook
Above we touched on the company’s continued customer wins and its winning more dollars per customer, which led to nice gains in deferred revenue and remaining performance obligations. Against those figures, Elastic guided the current quarter to earnings per share of $0.46-$0.48 compared to the market forecast of $0.40. It also lifted its fiscal year EPS outlook to $1.68-$1.72 from $1.52-$1.56, which implies EPS of $0.28-0.32 for its April-ending, 2025 quarter. As we look at these EPS figures for the current quarter and the April one, they imply continued strong year-over-year growth.
Our suspicion is those figures are conservative, owing to management’s operating margin guidance for the next two quarters being softer than the 14.2% posted in the first half of the fiscal year. Some of that could be chalked up to Elastic’s investment in bringing more AI capabilities to market across its search, security, and cloud offerings. Because we are still in the early inning of AI adoption and all indications are companies are poised to spend more on AI in 2025 than this year, that investment makes sense as it should help drive subscription revenue per customer even higher down the road while helping expand the overall customer base. To the extent that margin guidance is conservative, it would mean even more profits falling to Elastic’s bottom line, which is certainly not a bad thing given our position in the shares.
The Pro Portfolio is long NOW, ESTC.
