Strong market headwinds from the war in Ukraine, rising inflation and the risk of a recession have pushed Freshworks Inc. (FRSH) shares down over the past 12 months, having fallen nearly 70%.
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Adding another net loss to the likely ongoing turmoil, the company and analysts are expecting a difficult year ahead.
Perhaps this stock will be more attractive in the future. Until then, it still has to provide some evidence for investment, such as switching to net profit as soon as possible
About Freshworks
Freshworks develops modern customer relationship management (CRM) software for e-commerce. The company offers its technology as an “as-a-service product” that supports companies worldwide in dealing with their customers and employees.
Freshworks has a globally distributed team serving more than 50,000 customers. The company’s headquarters are in San Mateo, California.
On TipRanks, FRSH scores an 8 out of 10 on the Smart Score spectrum. This indicates a high potential for the stock to outperform the broader market.
Q1 2022: Revenue Growth but With a Loss
Total revenue of $114.6 million for the first quarter of 2022 represented a 42% jump year-over-year thanks to an increase in the number of top-spending customers (in terms of annual recurring revenue (ARR)) and following the addition of new entries to the portfolio of customers.
In terms of revenue, the company beat the analyst consensus as estimates on Wall Street averaged $108.24 million.
Total operating expenses also increased significantly in the first quarter of 2022, meaning revenue growth wasn’t enough to stave off negative net income.
As such, the operation generated an adjusted loss of $0.6 million, flat year-over-year, while the net loss on a diluted stock basis was $0.01 for the first quarter of 2022 versus a net loss of $0.02 in the quarter of the previous year.
Additionally, cash outflow of $1.4 million from operations in the first quarter of 2022, compared to a $4.8 million inflow from operations in the first quarter of 2021.
While the ARR has increased by 300 basis points year-over-year.
Balance Sheet Remains Fresh
As of March 31, 2022, Freshworks had nearly $1.2 billion in cash and short-term securities. About 50% of this amount was exposed to the financial market turmoil, which remains high due to major macroeconomic and geopolitical issues around the world.
This exposure has been steadily increasing since Q3 2021 and has now more than quadrupled, which doesn’t seem prudent given the current uncertainty surrounding current and likely future markets.
Meanwhile, prompt cash is down more than 19% from the last quarter of 2021, and has halved from Q3 2021.
As such, quick and potential cash resources can’t offer financial support to operations for more than just a few years.
However, the balance sheet is acceptable from a financial strength standpoint as evidenced by an Altman Z score of 6.40.
Essentially, the ratio measures the likelihood that the company will be unable to continue in business and will be shut down due to bankruptcy.
Freshworks does not face a bankruptcy risk as any Altman Z-Score above 2.9 indicates safe zones. A ratio below 1.79 would instead indicate trouble spots and a high risk of bankruptcy.
But if the value of the ratio is between 1.8 and 3, the company is in a grey area, which still implies a risk of bankruptcy, albeit small.
Despite the Growing Environment, Freshworks Will Yield a Loss
As more companies around the world use CRM software to improve customer retention and increase sales, the Customer Relationship Management market is set to grow rapidly over the next few years.
Despite Mordor Intelligence estimating a 15% annual growth rate in CRM software for the coming years, thus favorable market conditions, Freshworks still sees an adjusted net loss of $0.18 to $0.16 in 2022, compared to the median estimate of analysts at -$0.16.
Analysts are projecting another $0.10 per share adjusted net loss in 2023.
Should the net loss recur, the impact on the balance sheet could be felt by shareholders this time. Moreover, if the market continues to face severe headwinds, the magnitude of the negative effect on the stock prices could increase significantly.
Wall Street’s Take
In the past three months, eleven Wall Street analysts have issued a 12-month price target for FRSH. The stock has a Moderate Buy consensus rating based on seven Buys and four Holds.
The average Freshworks price target is $24.18, implying a 58.25% upside potential.
Valuation
After falling sharply by almost 70% over the past 12 months, the stock is currently trading at significantly lower valuations than it has been in that period, as shown in the stats below.
The uphill climb separating the stock price from the median (about $31.94) of the 52-week range of $10.51 to $53.36, is very steep.
Furthermore, this stock price is only slightly above the price of the 50-day moving average of $14.69, and represents a 40% discount from the price of the 200-day moving average at $24.77.
Various headwinds pushed the share price down with force. Since these were caused by issues that will long fuel investor risk aversion, it is reasonable to expect lower stock prices going forward.
Estimating how much this challenge can still affect the share price and to what extent, is not an easy task. Technically, there appears to be room for more setbacks before bottoming out. The 14-day Relative Strength Indicator (RSI) contributes to the formation of this idea.
The stock has a 14-day RSI of 58, which suggests that the stock price is far from oversold despite the plunge over the past 12 months. The indicator ranges between 30 and 70. A reading of around 30 means the stock is oversold, while a reading of 70 means the stock has approached the overbought level.
Based on growth estimates released by both the company and analysts, who are still forecasting net losses for at least the next two years, these price levels and likely the next ones, albeit low, will hardly be indicative of cheap stock.
Conclusion
The stock has significant growth potential as it develops software that enables other companies to achieve customer retention and revenue growth.
The company appears to be attracting new clients, but it will take some more work before the portfolio shows a positive return.
Operational activities consume monetary resources, which, however, are not available in unlimited amounts and are getting increasingly subject to market volatility. In addition, market conditions are likely to remain unfavourable in the coming months.
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