Overview
Q4 2022 earnings were strong for Gartner, Inc. (NYSE:IT), and management issued an FY23 outlook that, in my opinion, is both conservative and offers promising room for growth. Increases in sales staffing levels and spending on enterprise IT technology have helped the Research segment post robust double-digit contract value (CV) growth. In addition, the essential nature of IT solutions is assisting customers in optimizing costs and operations despite the general economic slowdown – which is a strong value proposition. This year’s expansion in the consulting sector is being bolstered by a robust order book, while expansion in the Conferences sector is being fueled by the revival of face-to-face gatherings. Most importantly, I believe that IT has a chance to outperform its 2023 EBITDA margin target thanks to strong revenue and structural cost efficiencies from T&E and real estate.
Overall, I believe IT will do well business wise. But stock-wise, my suggestion is to have a small position (trim if the position is large), as there are still plenty of uncertainties surrounding Gartner, Inc. that could disrupt expected growth. Especially since we are talking about a business that is trading at 36x forward earnings and the stock has rallied 50% since 7 months ago. A lot of expectations are baked into this one.
Earnings update
Revenue increased by 15.2% year over year to $1.5 billion, which was significantly higher than the consensus estimate of 11.1% growth. Research segment grew 9% y/y while CV for all Global Technology Sales (GTS) and Global Business Sales (GBS) increased over the same period last year; 10.0% for GTS; and 18.8% for GBS. Conferences revenue increased by 76.0% year-over-year due to the continued return of in-person events, while Consulting revenue grew by 17.0% year-over-year on the strength of contract optimization growth. As a result of operating leverage from high revenue performance and low expenses, EBITDA margins increased by 450 basis points, to 28.0%.
Growth update
One encouraging indicator was the double-digit growth of Research CV (80% of total revenue) in 4Q22. More importantly, IT expects global enterprise IT technology vendor spend will increase by 7-8% in 2023 despite macro headwinds in the technology sector. Additionally, the IT industry’s massive exposure to enterprise (75% of CV) supports GTS growth as well.
With a labor-based revenue backlog that was 24% higher than in 2021 by the end of December 2022, Consulting is poised to lead the way in 2023. As for Conferences, management expects to host 47 conferences this year, and has already sold out more than half of its exhibit space for 2023.
Increased headcount
It’s important to remember that since the pandemic, IT has been operating with a drastically reduced sales force. EBITDA margins have increased to the high 20s% over the past 2 years as a result of a reduction in sales staff and associated travel and entertainment expenses. While it’s common knowledge that current margins are unsustainable, the 21.5% predicted for 2023 represents a major drop. The significant drop is primarily the result of operating for a full calendar year with a significantly larger sales force and some return to T&E.
Good news is that IT is having no trouble filling Research sales positions despite the tight labor market, and they plan to resume their normal hiring pace in 2023, with the goal of having headcount growth come in at 4-5 percentage points below Research CV growth. If the research business does better than anticipated, it is possible to see an increase in the EBITDA margin to 24% by 2023.
Balance sheet
Higher CAPEX, the lack of one-time insurance proceeds, and invoice delays due to Hurricane Ian all contributed to a decline in 4Q22 free cash flow (“FCF”) generation of $166 million. According to management, billing issues that had been ongoing since 2022 have finally been resolved as of January. As long as gross leverage remains within the 2.0 to 2.5x target range, I do not foresee any problems appearing on the balance sheet.
Capital allocation
Share repurchases are likely to be funded by the $164 million in proceeds from IT sale of TalentNeuron, as well as free cash flow generated in 2023. Given that IT’s EPS guidance conservatively assumes no buybacks, this could drive further EPS upside.
Guidance
Gartner, Inc. guided at least $5.8 billion in revenue, $1.26 billion in EBITDA, and $8.80 per share in EPS for FY23. IT is effectively guiding to EBITDA margins of at least 21.5% with room for upside if the business performs in line with historical trends.
That said, I do think the management guide is reasonably conservative. Especially so, it reflects management’s conservative view of the high degree of economic uncertainty in light of the current elevated rate environment. I expect Gartner, Inc. to see great results if demand turns out to be stronger than anticipated, due to the high operating leverage in the business and the efficient conversion of EBITDA to free cash flow.
Conclusion
In my opinion, Gartner, Inc. will do well to form a business perspective. However, if you’re going to invest in Gartner, Inc. stock, I’d recommend keeping your holdings modest (or cutting them down) because so many unknowns could derail growth. Given that Gartner, Inc. stock has increased by 50% in the past seven months, and that the company is trading at 36x forward earnings, a lot of expectations are baked into the stock. If Gartner, Inc. were to miss by 1 quarter, the stock could tank badly.
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