HubSpot (HUBS) specializes in helping scaling companies achieve a pleasant customer experience through its cloud-based customer relationship management platform. Additionally, the company provides education, services, and support to help customers be successful with its platform.
Its customers include other mid-market businesses companies that have between two and 2,000 employees located across more than 120 countries. I am neutral on HUBS. (See Analysts’ Top Stocks on TipRanks)
The beauty of HubSpot's business model is that its platform is that of a SaaS, which enables the company to enjoy recurring revenues from its current subscribers.
The company recently released its Q3 results, featuring another period of strong numbers. Simultaneously, however, the stock's valuation has expanded significantly over the past year, which appears to be limiting shareholders' total return potential moving forward.
Q3 Results - Another Strong Quarter
The COVID-19 pandemic presented challenges for many kinds of businesses. When it came to SaaS companies in the tech sector, things were slightly brighter as the working-from-home economy boosted demand for such services, especially in the CRM space.
Unfortunately for HubSpot, however, its focus on smaller clients resulted in more significant challenges over the past year, causing revenue growth to decline to as low as 24.7% in Q2 2020.
Thankfully, the ongoing global recovery has not only led to the rebound of the company's revenue growth trajectory, but HubSpot's continuous product development and successful upselling have resulted in multi-year-high revenue growth levels.
In Q3, total revenues were $339.2 million, up 49% year-over-year. The company has not reported such a rapid top-line growth (apart from the previous quarter) since 2016, which is utterly impressive at its current size (>$1 billion revenue run rate).
Management's revenue guidance of $356 million to $358 million for Q4 indicates a growth of around 41%-42% year-over-year, which suggests that a significant slowdown is not going to materialize in the short term. Considering that the company has historically only beat its own estimates, revenues growth is not unlikely to touch the 45% level as well.
In my view, the CRM space as a whole will continue expanding going forward as concepts such as search engine optimization, website content management, messaging, chatbots, and marketing automation are becoming increasingly vital for businesses.
With Marketing Hub and Operations Hub, HubSpot possesses the right tools to continue to benefit in the current environment, which should translate to robust revenue growth in the medium term. However, I am concerned with the stock's current valuation levels.
The Valuation
While HubSpot's revived revenue growth story is certainly impressive, the stock seems to be trading at a premium valuation. Presently, the stock is trading at a forward price-to-sales multiple of 24.3x, which is unparalleled to its historical levels. Even when the company used to grow at a similar pace in 2015-2016, the valuation would still not even come close to these levels.
The company's gross margins have remained constant as well, close to 80%. So, it's not like future profitability levels are to be higher than previously expected, which would justify such as multiple expansion.
Considering that profitability is expected to remain at razor-thin levels over the next few years, the current valuation limits investors' future return potential. It compresseses their overall margin of safety against a potential valuation contraction to a more reasonable valuation. For this reason, I am neutral on the stock.
Wall Street’s Take
Turning to Wall Street, HubSpot has a Strong Buy consensus rating, based on 18 Buys and four Holds assigned in the past three months. At $857.70, the average HubSpot price target implies 6.9% upside potential, nonetheless.
Disclosure: At the time of publication, Nikolaos Sismanis did not have a position in any of the securities mentioned in this article.
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