With the Covid-19 pandemic necessitating social distancing, Zoom (ZM) stock surged by over 700% in the first 10 months of 2020. The stock upside was associated with robust growth in revenue and cash flows.
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However, after peaking in October 2020, ZM stock has been in a gradual downtrend. For year-to-date 2021, the stock has declined by 21.5%.
I remain bearish on Zoom even after the correction. The stock still seems expensive and with the world gradually returning to normalcy, growth might be a concern.
Talking about valuations, ZM stock still trades at a forward price-to-earnings ratio of 54.71. If earnings growth disappoints, the stock still seems expensive. (See Analysts’ Top Stocks on TipRanks)
Growth Likely to Decelerate
There are several reasons to believe that Zoom is likely to witness relatively weak earnings growth in 2022.
According to McKinsey research, once a country has weathered a wave of Delta-driven cases, it can gradually transition towards normalcy. Scientists in most countries are also looking at the beginning of an end to the COVID-19 pandemic. Of course, this is good news for the world.
It’s also worth noting that most major employers are targeting the re-opening of their offices in the first quarter of 2022. With a high vaccination rate in developed countries, this seems very likely. Recent news that Pfizer’s (PFE) antiviral pill is 89% effective in high-risk cases adds to the confidence.
The key point here is that as people return to offices, the demand for online video and conferencing is likely to decline. It certainly does not imply revenue de-growth for Zoom. However, the markets would look at the earnings and cash flow upside potential in the coming years.
In all probability, there will be disappointment on that front.
An important point to note is that Zoom reported Q2 2021 earnings on August 30. The company reported 54% revenue growth on a year-on-year basis. Since that result announcement, ZM stock has fallen by nearly 25%.
Clearly, the markets are discounting the future and it does not seem that the markets are very optimistic.
Potential Acquisitions Can Boost Growth
For Q3 2021, Zoom reported operating cash flow of $468 million. This would imply an annualized cash flow of nearly $2.0 billion. Additionally, Zoom reported cash and equivalents of $5.1 billion as of July 2021.
Therefore, Zoom has a strong balance sheet and even if revenue stagnates, the company is positioned for healthy free cash flows.
I would not be surprised if Zoom pursues acquisition-driven growth. As a matter of fact, the company was pursuing a merger agreement with Five9 (FIVN). The merger agreement was terminated in September 2021. It remains to be seen if Zoom can utilize the cash buffer to boost growth through the inorganic route.
At the same time, innovation is likely to be another key factor. In June 2021, Zoom launched phone appliances for the hybrid workforce. With the world increasingly looking at hybrid workplaces, these solutions can ensure steady client growth.
Wall Street’s Take
According to TipRanks’ analyst rating consensus, ZM stock comes in as a Moderate Buy, with 12 Buys and nine Holds assigned in the past three months.
The average Zoom price target is $346.38 per share, implying 30.86% upside potential from current levels.
Bottom Line
For Q2 2022, Zoom reported 50% revenue growth from its Americas segment. Growth in EMEA and APAC was 60% and 66%, respectively. Zoom has ample scope for growth in international markets, and that can be a potential cash flow driver.
However, for now, the headwinds seem to be more dominant, particularly as the stock is trading at a forward price-to-earnings-ratio of over 50.
It would therefore make sense to remain cautiously optimistic. Even after the correction, it seems unlikely that ZM stock has bottomed out.
Disclosure: At the time of publication, Faisal Humayun did not have a position in any of the securities mentioned in this article.
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