Investment Thesis

Elastic (NYSE:ESTC) delivered a middle-of-the-road earnings update and the stock got hit hard at negative 25%.

What led to the sell-off wasn’t so much the fact that Elastic pulled in its revenue guidance by a hair, as much as it was the realization that investors are being asked to pay a large premium on a stock that is delivering mid-teen growth rates.

All in all, I strongly believe that there are much better bargains around, and that investors would do well to avoid buying this dip.

Rapid Recap

I hadn’t followed Elastic since January of this year, when I concluded with,

My earlier skepticism about Elastic’s prospects has proven to be misguided, as the company has demonstrated substantial improvements in profitability. The shift to a bullish outlook is supported by the anticipation of a meaningful increase in underlying profitability, approximately 65% year-over-year, reaching around $230 million in fiscal 2025.

Turns out that my estimate was too aggressive. After all, in the best case, Elastic may ultimately deliver around $220 million of non-GAAP operating profits in fiscal 2025.

In sum, I now revise my rating to a hold.

Elastic’s Near-Term Prospects

Elastic specializes in providing a platform for search-powered solutions, enabling organizations to quickly find and analyze vast amounts of data.

Their platform is widely used for various applications, including search, and observability.

Elastic continues to out its strong growth in cloud revenue, which was up 30% y/y. However, the market finally realises that for Elastic’s cloud revenues to be up 30% y/y, this must mean that its on-premise business is being cannibalized.

Nevertheless, Elastic has now more than 1,300 customers using Elastic Cloud for AI-related use cases.

Elastic’s focus on expanding its customer base and deepening its relationship with existing customers, especially those spending over $100K annually, positions it well for stable growth.

And yet, Elastic faces challenges too. The company recently underwent significant sales segmentation changes aimed at better targeting large enterprise and mid-market customers. However, these changes disrupted the sales process, particularly in the Americas, leading to slower deal closures and a shortfall in customer commitments for the quarter.

Additionally, tighter customer budgets, particularly in Europe, have delayed some deals, contributing to the mixed performance.

Moreover, Elastic is struggling to compete in a highly competitive sector, where the challenges of maintaining growth and expanding market share are significant. Despite management’s effort, Elastic faces competition from industry giants like Splunk (owned by Cisco (CSCO)), which is no pushover when it comes to key technological product offerings. Splunk’s robust and mature platform, combined with its strong customer base, makes it difficult for Elastic to carve out a larger piece of the market.

Given this balanced background, let’s now discuss its fundamentals.

Elastic Pulls in its Guidance a Sliver

Elastic had previously guided to grow its topline by 16% y/y in fiscal 2025. Now, its guidance has been pulled in so that its topline will most likely grow by 15% y/y, or thereabouts.

Meanwhile, consider that it’s entirely possible that before fiscal 2025 is out, Elastic will have managed to figure out how to grow its revenues by 16% y/y, which was its original guidance.

Again, what the market demands from tech companies is a stream of positive news together with a company’s quarterly earnings. The market demands beats on the topline and then at a minimum reaffirming of their revenue guidance, and ideally raising of a company’s guidance.

What investors do not want to see under any conditions is guidance being pulled in. By however small an amount.

All that being said, when you think about Elastic’s valuation, things soon make more sense.

ESTC Stock Valuation — 49x Forward non-GAAP EPS

Before discussing its valuation, let’s in the first instance discuss a bullish aspect. Elastic carries approximately $500 million of net cash, including marketable securities. This means that post sell-off, more than 6% of Elastic’s balance sheet is made up of cash. That’s clearly a bullish consideration and will go a long way towards providing a floor on its share price.

However, the crux of the matter here is that even after the sell-off in its share price, Elastic is still being priced at 49x forward non-GAAP EPS. And that is excessive for a company which is decidedly growing its revenues in the midteens.

Case in point, at approximately 35x forward non-GAAP EPS, there are plenty of sector leaders one could buy. For instance, ServiceNow (NOW) comes to mind.

Furthermore, yesterday, I discussed CrowdStrike (CRWD). And I don’t bring up CrowdStrike as a competitor to Elastic. But to highlight, that for investors eager to pay around 49x forward non-GAAP EPS, they may as well go with CrowdStrike, since at least that is the sector market leader and it’s growing at nearly twice the rate of Elastic.

All in all, I believe it’s going to take quite some time for Elastic to grow in its valuation.

The Bottom Line

Elastic’s current valuation at 49x forward non-GAAP EPS is already high, especially for a company growing its revenues at a mid-teen rate. This premium is difficult to justify when considering the intense competition it faces, particularly from strong rivals like Splunk.

Although Elastic has shown growth, the challenges in maintaining its market share and recent disruptions in its sales process raise concerns.

Given these factors, I now rate the stock as a hold. In this case, it seems that Elastic is stretched to its limit.