Key Points
- Zoom Video Communications had a strong quarter and increased guidance; profitability and cash flow are robust.
- Growth in large customers helps sustain single-digit growth and outperformance.
- The stock is trading near its bottom and set for the next move.
- 5 stocks we prefer over Zoom Video Communications
Tech start-ups like Zoom Video Communications Inc. NASDAQ: ZM have had a difficult year, but the situation is rapidly evolving. Zoom, similar to others, reported a stronger-than-expected third quarter, displaying overall strength and resilience in enterprise business. It’s proof of the ongoing shift to digital and deepening penetration of services that has sustained the business services industry for years.
With the outlook for tech and tech-centric business services now encompassing AI, these trends are anticipated to persist and support businesses like Zoom. As it turns out, Zoom provides utility for companies at scale and has proven to be an effective tool for communications and cost savings. AI-powered tools such as Companion are among the 45 new releases and product offerings issued during the quarter, and they are resonating with users. Successes with companies like Dropbox Inc. NASDAQ: DBX, Virgin, and Amynta Group attest to that.
Zoom Video Communications exceeds expectations and raises guidance
Zoom Video Communications had a strong quarter with outperformance on the top and bottom lines. The company reported $1.14 billion in net revenue, a 3.6% increase compared to last year. This represents modest growth but is 180 basis points better than expected and bolstered by improved profitability. The top-line growth was supported by a 7.5% rise in Enterprise business driven by a 13.5% trailing-12-month increase in large customers.
The margin news is even better. The company expanded the margin at the gross and operating levels to significantly improve the bottom line. GAAP operating margin came in at 14.9%, adjusted at 39.3%, resulting in a 66% increase in free cash flow. Free cash flow reached $453 million, further enhancing the already strong financial position, with adjusted earnings of $1.29. The $1.29 represents a 20% increase compared to last year and is 2000 basis points better than expected.
The best news is the guidance. The company foresees its momentum carrying into Q4 and raised the outlook for revenue and earnings. The new ranges exceed the high end of the previous range and are well above the consensus figures at the time of the release. Analysts have started to revise their estimates for Q4, and the outlook for next year is positive. Consensus figures indicate steady top-line growth near 3% but a decline in earnings, an unlikely event given the trends.
Valuation is no longer a concern for Zoom Video Communications
Valuation used to be a concern for Zoom, but not anymore. The 90% drop in share prices has the stock trading at 14x its earnings, with consistently strong earnings and an upward guidance. This aligns with analysts’ sentiment, indicating the stock is at the lower end of its price range.
Analysts’ sentiment has remained steady at Hold over the past year, but the price target dropped significantly earlier in 2023. However, the consensus target has stabilized since the Q2 earnings release, suggesting a 25% upside for the stock. More significantly, the low price target of $60 is in line with the lower end of the existing trading range where support is strong. Unless there is an unforeseen change in sentiment, the market should continue to consolidate within its range, if not move higher.
The technical outlook: Zoom Video Communications
Zoom Video Communications hit bottom in May and confirmed the bottom recently but remains stuck in a trading range. The floor is around $60, the ceiling around $72.50, and the market is unlikely to break out soon without another catalyst.
Analysts could be a catalyst if they start to raise their targets or upgrade sentiment, but there is no evidence yet. As it stands, the post-release activity is uncertain and suggests a pullback to firm support levels. In this scenario, the market might find support at the 30-day moving average. If not, it could retreat to the $60 level, where at least a temporary bounce should occur.
Before you consider Zoom Video Communications, you’ll want to hear this.
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