Post-Covid, Cloud Software Proves The Naysayers Wrong (Again)
Despite historic levels of growth last year, many leading cloud stocks reported strong growth in the recent Q1 earnings reports. We’ve heard the narrative before that value stocks are a safer choice, yet the cloud category’s revenue growth and high margins refuse to pause in order to let non-tech investors have their moment.
Below, we discuss the State of Cloud post-covid and what we saw in the most recent earnings reports that led us to believe cloud is stronger than ever. We also review statistics on where we are in cloud’s adoption cycle.
Cloud Stocks in an Open Economy
Last year, decision makers were under pressure to stay afloat in a sudden, recessionary environment. The uncertainty of the pandemic along with the effects of locking down the economy led to budget cuts with little preparation.
As a result, we saw CFOs reducing overhead at an aggressive pace. A 2020 Gartner survey found that 62% of CFOs surveyed were planning expense reductions to their budgets. We see below that despite budget cuts in IT, cloud software remained resilient last year — a prediction I had made in 2019 when I said:
“My prediction is this may be one of the last cycles when tech is considered less safe than value stocks. As the market will find out (the hard way), cloud software is actually very safe. It is insulated from trade wars and overseas manufacturing issues. It reduces costs for enterprises, which is ideal for a recession. Lastly, cloud software is at the beginning of a rapid growth cycle compared to its counterparts in tech.”
In 2020, IT spending was reduced yet cloud software grew at historic levels. This is because cloud software and also infrastructure migrations help to lower costs, and meanwhile increases productivity. However, during times of expansion, the increase in productivity and ability to scale is also welcomed.
This acceleration from last year was vastly misunderstood to be a one-time event rather than a permanent shift in how companies leverage cloud products. The narrative around cloud stocks going into 2021 was that valuations were unrealistically stretched because of the unusual growth in 2020. We even saw many beneficiaries of the cloud migration being coined as “coronavirus stocks” and were said to make poor investments after the lockdowns were over.
Meanwhile, Zoom went on to report its 5th quarter of triple digit YoY growth, with an 8.7% upwards surprise to their reported revenue. Zoom also confirmed an expectation for 42% revenue growth in the fiscal year ahead, which led analysts to raise their consensus by 4.7% and 4.8% for both this year and next, respectively.
Shopify was another coronavirus stock that was expected to continue its decline from the February high as more people would be shopping offline. Not only did they benefit from the cloud migration, but they also benefited from e-commerce acceleration, which catered well to a shelter-in-place environment.
With the US economy almost fully opened, Shopify reported triple digit YoY revenue growth, the highest in their history. Shopify’s reported revenue was just over a 14% surprise to the upside based on analyst expectations. This is nearly 3 times the average revenue surprise for the tech sector at 5.6%, according to FactSet for Q1.
In fact, if we look at the top growth companies from last year, we see many of the same names in the Top 10 for this year’s expected growth now that Q1 has come in. This is the exact opposite of what we were told would happen when cloud software faced “tougher covid comps.”
Cloud Spending Marches Onward
Gartner’s most recent survey indicates that there is still quite a bit of growth ahead despite the harder comps the cloud software leaders face in 2021.
According to Gartner, worldwide public cloud spending will grow 18% in 2021 to total $304.9 billion. Relative to overall IT spend, cloud still has a long runway and is projected to make up 14.2% of total global enterprise IT spend in 2024 compared to 9.1% in 2020.
Furthermore, the data shows that 70% of organizations using cloud services plan to increase their spending, stating “the proportion of IT spending that is being allocated to cloud will accelerate even further in the aftermath of the COVID-19 crisis.
The analyst firm points towards mobility, remote working and hybrid workforces as trends that will lead to further market growth. This is being confirmed with the earnings recent reports from leading cloud companies post-COVID.
The analyst firm also states the hyperscale cloud market will “return to hypergrowth” of 35% to $120 billion in 2021. This is up from the original prediction that cloud IaaS would grow 28%. The analyst firm also predicts Alibaba will take the number three spot instead of Google Cloud.
Forrester’s recent survey showed similar results with 47% of North American managers anticipating a permanently higher rate of full-time remote employees and 53% of employees wanting to work from home postpandemic.
Conclusion:
Going into 2021, at the height of the SPAC bubble, we had specifically stated that Zoom and Shopify would be strong performers going into 2021 (ref. minute 53:00 on YouTube video). We were not fazed by cloud being labeled “coronavirus stocks” as there is no evidence of this; the category has always been a strong performer and will be into the foreseeable future.
It’s easy to get creative with new names coming on the market, especially with IPOs, the small cap rally we saw earlier this year and the SPAC bubble. Yet, it can often pay off to stick with the tried and true. Winners tend to keep winning and Q1 of 2021 was no exception to this rule.
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