All of the portfolio companies have now reported their latest quarterly results. The companies are discussed further below.
PRIOR PORTFOLIO UPDATES
PORTFOLIO PERFORMANCE
It’s now been more than one year since the portfolio peaked and then began falling. The portfolio’s 24May low was breached on 9Nov at -72.4% YTD, and at the end of November 2022 the portfolio closed down 70.2% compared to the S&P 500 down 13.1%. By comparison to the S&P 500, the portfolio has had its worst year on record. Despite the 81.8% drawdown from the 18Oct21 all-time high, the portfolio has still achieved a 29.9% CAGR since the start of 2017 (that’s a period of 5 years and 11 months).
| DATE | GauchoRico Portfolio (YTD) | S&P500 Total Return (YTD) |
|---|---|---|
| Jan22 | -31.7% | -5.2% |
| Feb22 | -32.6% | -8.0% |
| Mar22 | -35.1% | -4.6% |
| Apr22 | -49.6% | -12.9% |
| May22 | -66.5% | -12.8% |
| Jun22 | -65.8% | -20.0% |
| Jul22 | -63.6% | -12.6% |
| Aug22 | -62.3% | -16.1% |
| Sep22 | -65.3% | -23.9% |
| Oct22 | -67.4% | -17.7% |
| Nov22 | -70.2% | -13.1% |
Weekly Performance
| DATE | GauchoRico YTD | S&P500 TOTAL RETURN YTD | DELTA |
|---|---|---|---|
| 01/07/22 | -24.1% | -1.8% | -22.2% |
| 01/14/22 | -30.5% | -2.1% | -28.4% |
| 01/21/22 | -39.5% | -7.7% | -31.8% |
| 01/28/22 | -39.3% | -6.9% | -32.3% |
| 02/04/22 | -33.6% | -5.5% | -28.2% |
| 02/11/22 | -25.2% | -7.2% | -18.0% |
| 02/18/22 | -33.0% | -8.6% | -24.4% |
| 02/25/22 | -35.8% | -7.8% | -28.0% |
| 03/04/22 | -42.4% | -8.9% | -33.5% |
| 03/11/22 | -48.4% | -11.5% | -36.9% |
| 03/18/22 | -37.9% | -6.1% | -31.8% |
| 03/25/22 | -37.6% | -4.3% | -33.3% |
| 04/01/22 | -33.7% | -4.3% | -29.4% |
| 04/08/22 | -41.6% | -5.5% | -36.1% |
| 04/15/22 | -40.8% | -7.5% | -33.3% |
| 04/22/22 | -49.0% | -10.0% | -39.0% |
| 04/29/22 | -49.6% | -12.9% | -36.7% |
| 05/06/22 | -58.6% | -13.1% | -45.5% |
| 05/13/22 | -62.4% | -15.1% | -47.3% |
| 05/20/22 | -67.0% | -17.7% | -49.3% |
| 05/27/22 | -64.9% | -12.2% | -52.6% |
| 06/03/22 | -64.7% | -13.2% | -51.4% |
| 06/10/22 | -66.4% | -17.6% | -48.8% |
| 06/17/22 | -68.8% | -22.3% | -46.5% |
| 06/24/22 | -61.8% | -17.3% | -44.5% |
| 07/01/22 | -63.9% | -19.1% | -44.8% |
| 07/08/22 | -61.0% | -17.5% | -43.5% |
| 07/15/22 | -64.9% | -18.3% | -46.6% |
| 07/22/22 | -64.7% | -16.2% | -48.6% |
| 07/29/22 | -63.6% | -12.6% | -51.0% |
| 08/05/22 | -61.0% | -12.2% | -48.8% |
| 08/12/22 | -60.0% | -9.3% | -50.7% |
| 08/19/22 | -62.5% | -10.4% | -52.1% |
| 08/26/22 | -60.8% | -14.0% | -46.8% |
| 09/02/22 | -64.3% | -16.8% | -47.5% |
| 09/09/22 | -62.2% | -13.7% | -48.4% |
| 09/16/22 | -64.1% | -17.8% | -46.3% |
| 09/23/22 | -65.7% | -21.6% | -44.1% |
| 09/30/22 | -65.3% | -23.9% | -41.3% |
| 10/07/22 | -64.7% | -22.7% | -42.0% |
| 10/14/22 | -69.2% | -23.9% | -45.3% |
| 10/21/22 | -66.8% | -20.3% | -46.5% |
| 10/28/22 | -67.3% | -17.1% | -50.2% |
| 11/04/22 | -71.2% | -19.8% | -51.3% |
| 11/11/22 | -68.0% | -15.1% | -52.9% |
| 11/18/22 | -69.2% | -15.6% | -53.7% |
| 11/25/22 | -69.3% | -14.3% | -55.0% |
ALLOCATIONS
| 11/30 | 10/31 | 9/30 | 8/31 | 7/31 | 6/30 | 5/31 | 4/30 | 3/31 | 2/28 | 1/31 | 12/31/21 | |
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| SNOW | 20.1%** | 18.6%** | 16.1%** | 14.0%** | 16.9%** | 23.3%** | 21.8%** | 12.8%** | 9.8%** | |||
| CRWD | 14.7%** | 19.1%** | 18.7%** | 19.4%** | 17.0%** | 23.9%** | 23.8%** | 21.9%** | 15.4% | 8.3%* | 6.4%* | 5.9%* |
| DDOG | 14.0% | 16.8% | 17.6% | 19.1% | 28.8%** | 40.4%** | 41.4%** | 39.4% | 33.4% | 35.7% | 36.8% | 31.7%* |
| TTD | 8.7% | 5.3% | 5.3% | 2.8% | — | — | — | — | — | — | — | — |
| MELI | 6.7% | 6.0% | 5.2% | 3.3% | — | — | — | — | — | — | — | — |
| BILL | 3.8% | — | — | — | — | — | — | — | — | |||
| LNG | 3.4% | 3.1% | 2.8% | 1.7% | 0.5% | — | — | — | — | |||
| NET | 3.4% | 3.5% | 3.3% | 3.4% | 2.8% | 3.7% | 4.9% | 4.4% | 4.2% | 3.9% | 3.2% | — |
| MDB | — | — | — | 3.7% | — | — | — | — | — | — | — | — |
| UPST | — | — | — | — | — | 0.1%* | 0.2%* | 2.7%* | 3.0%* | 4.6%* | 3.5%* | 14.7%* |
| ZS | — | — | — | — | — | 4.5% | 4.7% | 22.5%* | 16.9%* | 16.2%* | 12.6%* | 4.3%* |
| S | — | — | — | — | — | — | 6.8% | 6.3% | 4.9% | 5.1% | — | — |
| MNDY | — | — | — | — | — | — | — | 3.5%^ | 9.4%^ | 9.1%^ | 26.0%^ | 27.5%^ |
| AFRM | — | — | — | — | — | — | — | — | — | — | 3.8% | 7.4% |
| Cash | 25.2% | 27.7% | 31.6% | 33.2% | 34.1% | 4.0% | -3.7% | -7.3% | 6.2% | 2.3% | -5.6% | -4.0% |
The allocation details described below are as of the end of September. Two of the seven positions in the portfolio are leveraged with long-term call options. CRWD: of the 14.7% allocation, 14.3% are shares and 0.3% are Jan2024 $200 calls. SNOW: of the 20.1% allocation, 19.7% are shares and 0.5% are Jan2024 $300 calls. Note: there are some rounding errors in the preceding shares/call options splits. The portfolio is comprised of 0.8% in long call options, 74.0% in shares, 25.2% cash, and no short put options.
PORTFOLIO CHANGES
Changes since 30Sept 2022
- DDOG: reduced position size.
- TTD: added shares to TTD position.
- SNOW: added shares to SNOW position.
- BILL: added as a new position.
COMPANY UPDATES
Since the last portfolio update, all of the portfolio companies reported their latest quarterly results. Prior to the quarterly releases of the portfolio companies, the main hyperscalers (AMZN, MSFT, and GOOG) reported their results. With the exception of Google’s GCP, public cloud revenue continued to decelerate during calendar Q3. Furthermore, guidance for next quarter suggests that the deceleration will continue. The theme that cloud service providers have been describing is that their customers are looking to optimize their spend but that spend on cloud is still growing, albeit more slowly. With this backdrop, perhaps we could expect a general revenue growth deceleration across cloud companies.
DDOG (Q3 FY2022 on 3Nov)
Going into the Q3 result, I had some concerns about DDOG in the short-term. First, DDOG being usage-based could be cut back on relatively easily by customers as occurred during Q2 2020. In light of the increasing trend to optimize spend by customers, DDOG could be particularly vulnerable. During Q2 DDOG first noticed that some existing customers began to slow their usage growth of Datadog products; the worry here would be that this trend would continue or worsen. I had considered reducing my DDOG position prior to Q3 earnings, but I ultimately decided against that action.
DDOG’s Q3 was better than I expected. The existing customer usage growth deceleration was similar to what DDOG management described in Q2 but better than what the Company saw during the COVID-19 slowdown in Q2 2020. In addition, the ARR growth slowdown was mostly limited to consumer discretionary customers (mostly in e-commerce and food & delivery) with the affected customers representing mid-teens (call it 14%) of DDOG’s ARR. This doesn’t sound nearly as bad as I thought it could be, and let’s hope the impact to existing DDOG customer spend doesn’t spread more broadly. While revenue growth continued to decelerate, it remained above 61% in this increasingly tough marco environment. The other key performance indicators were mostly solid. Customers continued to adopt new modules with nice upticks in the percentage of customers using 4+, 5+, and 6+ modules (80%, 40%, and 16%, respectively). Churn remained unchanged in the mid- to high-90%s demonstrating that customers are not leaving DDOG. The rate of net customers and net new $100K customers slowed but the Company reported a strong sales pipeline for both new customers and expansions heading into Q4. Overall, the business appears very heathy with great long-term prospects. Management certainly thinks so because they are continuing to invest heavily into future growth and opportunities by adding to both S&M and R&D during Q3; by comparison, many other companies are announcing layoffs and belt-tightening. DDOG is also putting their R&D resources to good use as shown by the large number of new product enhancements announced during Dash. While there many be some tough quarters ahead, DDOG is a company that should sail through this storm and come out relatively stronger. This Q3 report certainly quashed any desire to trim my position. At least for a little while. Although I believe DDOG’s management that the long-term prospects for DDOG remain very much intact, I later considered that DDOG is likely going to face tough comparables for the next several quarters. Therefore, I decided to reduce my DDOG exposure about a week after the earnings were announced.
NET (Q3 FY2022 on 3Nov)
NET has been a steady revenue grower in the 48-54% range for almost four years with huge potential in its TAMs. Last quarter, NET’s revenue growth rate decelerated from three quarters of back-to-back-to back quarters of ~54% growth to 47% growth. I’m not overly concerned about this deceleration because we’re in a tough environment. However, NET has not yet shown a consistent path to high net operating income. In the latest quarter, NET delivered a 5.8% operating profit, but, because NET must invest into CapEx, the Company have a negative 2% free cash flow. While NET expects the operating margin in Q4 to again be positive, I think that we can expect CapEx spending to be a necessity for this business. Also, Prince has stated that that Company has plans “to hold them [operating margin] near breakeven as long as we’re able to deliver exceptional revenue growth”. As an investor, I’m assuming that by exceptional Prince means revenue growth at 47%+. And holding operating margin near breakeven means that NET will reinvest essentially all profits into future growth. I’ve stated many times that there are companies (for example, CRWD, DDOG, and SNOW) that can grow in hypergrowth mode while simultaneously expanding operating margins and delivering ever growing levels of FCF. So, after this quarter, investors are in the same position as before: NET’s money making capability is still in the distant future. That’s what the numbers have shown, and the rhetoric from NET management is that there will be little to no FCF in the foreseeable future. Is the promise of the TAM and those distant cash flows worth waiting for? The unknown about NET’s capability for high profitability in the future certainly will keep my position in NET small. So far, I have kept the position, but, at this point, NET would be the first portfolio company that I’d sell. However, in breaking news this week, NET announced its first ever price hike (20% increase); it’s a positive sign particularly for a company that’s so focused on doing good in the world (a worry has been that NET puts shareholders in a distant last priority).
TTD (Q3 FY2022 on 9Nov)
TTD was first added as a portfolio company in August. I was seeking some investments outside of IT software, the sector that has dominated my portfolio for the past several years. TTD has had a great track record for the past several years. With the increasing adoption of connected TV (CTV), TTD continues to grow at three times the industry. With a possible recession looming, it’s possible that advertising budgets may be cut. However, at this time, I’m planning on holding onto TTD through a recession because there continue to be favorable trends that will benefit TTD. I realize that TTD is slower growing than the SaaS companies in my portfolio so I may achieve a lower long-run CAGR with this investment.
MELI (Q3 FY2022 on 3Nov)
MELI was first added to the portfolio in August. It delivered another solid quarter growing revenue 61% on a foreign exchange neutral basis. It’s astonishing that a company that’s approaching $3B in consolidated revenue is still growing this fast. Part of the reason is that the fintech portion of the business grew revenue at 115% (e-commerce segment grew 33%). Latin America is underbanked so fintech offers an opportunity for MELI; however, it’s important to monitor for bad debt provisions which stood at 10.3% of the total portfolio at the end of the quarter. MELI has a solid balance sheet and is profitable with an 11% operating margin.
LNG (Q3 FY2022 on 3Nov)
LNG was first added to the portfolio in July. Analyzing a company like LNG is bit outside of my wheelhouse. What I do know is that the company is a leading producer of liquid natural gas which is and will be in high demand for years to come as evidenced by LNG’s long-term contracts to provide gas to countries around the globe. These contracts have very long durations (20-25 years). LNG offers another position outside of IT software.
CRWD (Q3 FY2023 on 29Nov)
CRWD reported results this week on 29Nov. PANW had reported a great quarter with their next generation solutions particularly strong and resilient (PANW’s quarter also ended on 31Oct, the same as CRWD’s) so my expectations for the CRWD results were high. CRWD’s results were disappointing especially considering that cybersecurity was supposed to have industry tailwinds and be one of the least likely of SaaS contracts to be skimped on during this tough macroeconomic environment. Well, it seems that even a strong company like CRWD is not assured to post strong results in this environment. We’ve been hearing about vendor consolidation within SaaS; this is when customers try to reduce the number of SaaS vendors with customer preferences going to the strongest industry vendors with a wide breadth of offerings. For example, customers might ditch vendors that offer a narrow, specialized solution for a company like MicroSoft that also has a product in addition to the many other products. Some have posed the question whether PANW may be benefiting from vendor consolidation at the expense of CRWD. I don’t think so for several reasons. First, CRWD reported that record gross retention is being maintained indicating low churn among CRWD’s customer base (i.e. customers aren’t leaving). Second, CRWD’s management stated on the earnings call that the win rate among SMBs has improved suggesting that CRWD is winning a higher percentage of the deals for which it’s competing. Therefore, there must be relatively fewer deals to go after in SMB. The disappointingly low increase in ARR (annual recurring revenue) is being caused by several factors including: a) increase in phased start dates for subscriptions which pushes some of the ARR to a further date and b) elongation of the sales cycle (i.e. it takes longer to close deals) which also pushes business into the future. Furthermore, CRWD sees the tough marcoeconomic environment extending into Q4 and possibly beyond. Q/Q ARR growth is expected to contract 10% in Q4 to ~$180M. Also, FY2023 revenue guidance was not increased. Revenue growth decelerated from 58.5% in Q2 to 52.8% in Q3. Clearly, the market was expecting better results, and the after hours stock price declined about 18%. Subscription customer growth continued to decelerate to 7.4% as expected because of it’s largely driven by new SMB logo addition which was affected as mentioned above. Subscription customers with 5+, 6+, and 7+ modules continued positive progression and free cash flow continued to be very strong.
Overall, I was a bit disappointed by the CRWD result. New customer acquisition slowed, but, fortunately, existing customers continued to strongly expand their business with CRWD and churn remained very low. Guidance for FY24 when it’s released in early April will likely be in the 30%s. That’s quite a slowdown. However, despite supposed cybersecurity tailwinds, we are in a very tough environment. The question is whether growth will reaccelerate once we’re past this challenging macroeconomic time or the growth deceleration will continue due to the law of large numbers. Despite the post-earnings share price drop, CRWD’s stock is still highly valued and could experience further valuation multiple compression if growth slows too much. Perhaps the earnings results from ZS and S will shed more light on CRWD’s relative performance within the broad cybersecurity space. I haven’t sold any CRWD shares but I may consider reducing after I see the ZS and S reports.
SNOW (Q3 FY2023 on 30Nov)
SNOW reported Q3 FY23 results on 30Nov. The results were solid with 67% top line growth, increasing operating leverage, strong FCF, continued strong progress on the data sharing front, good customer growth, and a still extraordinary NRR of 165%. The Company also offered preliminary FY24 guidance of 47% growth which of course they will have a chance to raise four times. Overall, customers continued to consume Snowflake with six of the top ten customers expanding their spend faster than the overall customer base. Three of the top ten are in industries that have been hard hit by macro. SNOW continues to track well on all of its KPIs. SNOW remains a story about growth for a very long time forward with their $10B product revenue target for FY29 still intact; note that would calculate to a 36% product revenue growth CAGR over the next 6.25 years. I believe that there’s a very good chance that SNOW will beat this long-term “guidance”. Investors are paying a valuation premium for this growth story, and the question remains whether the valuation remains too high. I think that as long as SNOW continues to deliver solid results, its valuation will always command a premium.
FINAL THOUGHTS
It has been an absolutely brutal 1+ year, and there’s still one month to go in 2022. Increasingly, the talk has shifted away from individual company performance to macroeconomic “analysis”. I do read opinions of others, but there are always good arguments for more bad times ahead and better times ahead. I continue to believe that I just don’t know what’s going to happen. Will there be a recession and if so will stocks go up or down. I continue to mainly focus on the results of my portfolio companies. For the most part, these results continue to be very good albeit with some signs of weakness compared to past results.
I also believe that these high growth companies’ valuations depend strongly, not only on their business results, but also on interest rates. For more than a decade, we’ve had extremely low interest rates, but now that period is over, at least for now. Therefore, valuations have been hit. Are we going into a new normal of higher interest rates even after the central banks are done restricting credit by raising rates. If rates come back down, how low will they go? Of course, the lower rates eventually go the higher the valuation multiples can be on the hypergrowth portfolio companies. The interest rates that the central bankers set will depend on inflation and unemployment so this begs the question whether inflation will be able to return to a 2% target and what terminal interest rate will be required to maintain inflation at that level. If the answer is a 2% Fed funds rate then this could be good news, but if the answer is a 3%+ Fed funds rate then this would mean low stock valuations. So, on a broad level, I try to think of the inflationary and disinflationary forces. Globalization was deflationary and we had a multi-decade period (that recently ended) where the world was opening up trade. That trend seems over due to geopolitical competition and a higher emphasis on shorter and more secure supply chains; there’s lots of on-shoring occurring. So we need other forces to keep inflation low especially since we’re going into reverse on globalization (this reverse is inflationary). Note that the main benefit to globalization was lower costs. Can increasing use of automation be a viable substitute for lower labor costs in developing countries? If so, how long would this take to have a deflationary effect? Implementation of technology is another deflationary force that could keep inflation at bay. A third disinflationary force is the lowering of the cost of energy through increasing use of low cost renewables will be deflationary; I continue to believe that the cost of energy will continue to approach free; it’s a matter of how quickly we get there. Higher and higher public debt levels continue to lower the so-called neutral interest rate (i.e. the rate that neither stimulates or contracts economic output), but higher and higher debt levels increase the chance of other problems; the continued rise in debt to GDP in developed countries is not sustainable.
So there’s a lot to consider, and it’s just too hard to figure out what’s going to happen. And I’m not even an economist. I now believe that the SaaS valuation multiples that we saw in the Fall of 2021 will not ever return; but can we perhaps get halfway back to those levels if inflation gets tamed and the Fed Funds Rate retreats back to 2.5% or lower? I think it’s probable. I think that doubling the valuation multiples from current levels and combining that with growth in business fundamentals can lead to an optimistic investing outcome. At the moment, we just don’t know whether valuations need to compress further before we start to see that light at the end of the tunnel.
The opinions, thoughts, analyses, stock selections, portfolio allocations, and other content is freely shared by GauchoRico. This information should not be taken as recommendations or advice. GauchoRico does not make recommendations and does not offer financial advice. Each person/investor is responsible for making and owning their own decisions, financial and otherwise.