The company’s shift in focus should be good for investors.
Shares of Workday (WDAY 0.79%) shot higher last week after the software-as-a-service (SaaS) company’s fiscal 2025 second-quarter results topped analysts’ estimates. Nonetheless, the company’s stock is still down about 5% year to date.
Workday, which provides financial and human capital management software, lowered its guidance in May due to weak headcount growth for its customers, as well as an increasing length of deal cycles. Let’s see if the company is back on track and if now is a good time to buy the stock.
Solid results and updated outlook
In addition to providing earnings results and offering full-year guidance, Workday also adjusted its medium-term outlook, saying it expects less revenue growth but higher operating margins in the coming years.
On the earnings call, Workday said that for fiscal 2026 and 2027, it is forecasting subscription revenue growth of around 15% and adjusted operating margins of around 30%. The last time the company discussed this outlook — during its Sept. 2023 analyst day — it predicted subscription revenue growth of between 17% to 19% with adjusted operating margins of 25%.
The improved sentiment reflects the fact the company believes the current IT spending environment has become the “new normal.” However, it will continue to look for acquisitions to help bolster growth. At the same time, Workday will try to become more efficient, including through the use of artificial intelligence (AI) to improve its internal processes.
For fiscal Q2, which ended July 31, Workday’s revenue jumped 16.7% year over year to $2.09 billion as subscription revenue rose 17.2% to $1.90 billion. Adjusted earnings per share (EPS) increased 22% to $1.75. Those results topped the analysts’ consensus estimates, which called for $2.07 billion in revenue and EPS of $1.65.
The company saw its 12-month subscription revenue backlog rise 16.1% to $6.80 billion, while its total subscription revenue backlog climbed 20.9% to $21.58 billion.
It continues to lean into partnerships and announced a new one with Equifax. Its Employment Verification Connector for Equifax will allow customers to more easily transmit data for employment verification requests. It also formed a partnership with Salesforce in the quarter to help accelerate employee onboarding and enable continuous financial planning.
Workday ended the quarter with $7.37 billion in cash and marketable securities after buying back 1.4 million of its shares at a cost of $309 million in the quarter. It generated operating cash flow of $571 million and free cash flow of $516 million.
For its fiscal 2025, it now expects subscription revenue to grow approximately 17% to between $7.700 billion to $7.725 billion with an adjusted operating margin of 25.25%. Revenue guidance was unchanged from its prior revision, although its adjusted operating margin guidance was a slight improvement from its earlier outlook of 25%.
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Is the stock a buy?
Workday’s business has become more mature, and with that, the company is looking to better balance its growth and profitability. That’s not a bad thing, but it may continue to lead to a shift in the company’s shareholder base to more GARP-oriented (growth at a reasonable price) investors.
Workday trades at a forward price-to-sales (P/S) ratio of 7.2 and a forward price-to-earnings (P/E) ratio of 31.5 based on analysts’ fiscal 2026 estimates. Given the company’s projected mid-teens percentage revenue growth, those look like reasonable valuations for the stock.
Data by YCharts.
However, the key for investors will be the company’s operating margin expansion, which should lead to earnings growth that’s much stronger than revenue growth. That would make the stock more attractive from a valuation perspective and help lead to upside in its price in the years ahead.
Meanwhile, given the cash on its balance sheet and free cash flow generation, the company will have ample financial capacity to make any attractive tuck-in acquisitions it might find while continuing to buy back stock.
As such, interested investors can comfortably buy this stock as Workday takes an approach that balances the top and bottom lines.
Geoffrey Seiler has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Salesforce and Workday. The Motley Fool has a disclosure policy.
