AppFolio Growth Should Slow As Market Questions Linger (NASDAQ:APPF)

A Quick Take On AppFolio

AppFolio, Inc. (NASDAQ:APPF) provides property and investment management software to the real estate industry.

I previously wrote about AppFolio with a Hold outlook.

The company’s stock has risen sharply in recent months, but the U.S. residential real estate market is in flux, and it is difficult to predict how real estate investors will react to changing conditions.

Also, management is guiding to a markedly lower revenue growth rate in 2023 versus 2022’s growth rate, so I’m Neutral [Hold] on APPF’s stock for now.

AppFolio Overview

Santa Barbara, California-based AppFolio was founded in 2006 to provide a range of software capabilities to real estate owners, managers, and investors.

Its products offer tools for tracking rental income, tenant screening, online rent payment processing, maintenance requests, communication with tenants, and more. AppFolio also provides a suite of marketing and advertising services to assist property managers in marketing their properties.

The firm is headed by president and Chief Executive Officer Shane Trigg, who has been with the firm since April 2020 and was previously Senior Vice President, Commerce Cloud at Salesforce and VP of Global Sales & Marketing at MRI Software.

The company’s primary offerings include:

• Real Estate Property Management.

• Real Estate Investment Management.

The firm acquires customers via its direct sales and marketing efforts as well as through partner referrals.

AppFolio has nearly 19,000 customers of all sizes, managing over 7.5 million units worldwide.

AppFolio’s Market & Competition

According to a 2022 market research report by Grand View Research, the market for real estate property management software was around $3 billion in 2021 and is forecast to reach $4.9 billion by 2030.

This represents a forecast CAGR of 5.6% from 2022 to 2030.

The main drivers for this expected growth are a changing real estate landscape and increasing demand from buyers for more advanced and integrated offerings that increase business efficiencies across the organization.

Also, below is a chart showing the historical and projected future growth trajectory of the North American property management software market:

Major competitive or other industry participants include:

• CoreLogic.

• Console Australia Pty. Ltd.

• Entrata.

• InnQuest Software.

• IQware.

• MRI Software.

• RealPage.

• REI Master.

• Yardi Systems.

AppFolio’s Recent Financial Trends

• Total revenue by quarter has continued to rise; Operating losses were reduced in the most recent quarter.

• Gross profit margin by quarter has remained flat; Selling, G&A expenses as a percentage of total revenue by quarter have fluctuated substantially in recent quarters.

• Earnings per share (Diluted) have worsened markedly further into negative territory.

(All data in the above charts is GAAP.)

In the past 12 months, APPF’s stock price has risen 81.82% vs. that of the iShares Expanded Technology-Software ETF’s (IGV) rise of 22.37%, as the chart indicates below.

For the balance sheet, the firm ended the quarter with $168.9 million in cash and equivalents and no debt.

Over the trailing twelve months, free cash flow was $23.7 million, during which capital expenditures were $5.5 million. The company paid a hefty $49.9 million in stock-based compensation in the last four quarters, the highest trailing twelve-month figure in the past eleven quarters.

Valuation And Other Metrics For AppFolio

Below is a table of relevant capitalization and valuation figures for the company.

Click to enlarge

(Source – Seeking Alpha)

The Rule of 40 is a software industry rule of thumb that says that as long as the combined revenue growth rate and EBITDA percentage rate equal or exceed 40%, the firm is on an acceptable growth/EBITDA trajectory.

APPF’s most recent Rule of 40 calculation was 14.9% as of Q1 2023’s results, so the firm’s results have worsened in the most recent period, per the table below.

Click to enlarge

(Source – Seeking Alpha)

Commentary On AppFolio

In its last earnings call (Source – Seeking Alpha), covering Q1 2023’s results, management highlighted the growth of its real estate property owner customer base to almost 19,000.

The company is seeing growth in ARPU (Average Revenue Per User/Unit) through customer adoption of its Property Manager Plus platform.

Leadership made the obligatory references to the integration of AI into its system, noting its applications with “smart maintenance, bank feed and [its] AI leasing assistant, Lisa, […] to optimize the leasing process by matching tenants with available units.”

The firm is also seeing the continued growth of its Stack integration marketplace, now with 26 partners, and aimed primarily at AppFolio’s larger-sized customer base.

Management did not disclose any company, customer, or revenue retention rate metrics.

Total revenue for Q1 2023 rose 29.2% year-over-year and gross profit margin fell slightly by -0.1%.

Selling, G&A expenses as a percentage of revenue increased by 3.2%, a negative signal while operating losses increased by 80.2% year-over-year.

The company’s financial position is solid, with ample liquidity, no debt and decent free cash flow generation.

APPF’s Rule of 40 performance has been mediocre and dropping.

Looking ahead, management guided top line revenue growth for full-year 2023 to be approximately 22% at the midpoint of the range.

If achieved, the growth rate would represent a material growth deceleration from 2022’s growth rate of 31% over 2021.

From management’s most recent earnings call, I prepared a chart showing the frequency of key terms mentioned (or not) in the call, as shown below.

I’m most interested in the frequency of potentially negative terms, so management or analyst questions cited “Challeng[es][ing]” four times.

Regarding valuation, the market is valuing APPF at an EV/Sales multiple of around 12.8x on TTM revenue growth rate of 22% against a median Meritech SaaS Index implied ARR growth rate of 21% (Source).

The Meritech Capital Index of publicly held SaaS application software companies showed an average forward EV/Revenue multiple of around 8.8x on July 2, 2023, as the chart shows here:

So, by comparison, APPF is currently valued by the market at a significant premium to the broader Meritech Capital SaaS Index, at least as of July 2, 2023.

Risks to the company’s outlook include an economic slowdown that may be underway, reduced credit availability which may affect customer/prospect spending plans and lengthening sales cycles which may reduce its revenue growth potential in the near term.

In the past twelve months, the firm’s EV/Sales valuation multiple has risen 56%, as the chart from Seeking Alpha shows below.

Thus, most of the stock’s recent upside has come from a re-rating of its EV/Sales multiple in 2023.

Although the residential real estate market has remained strong as rising interest rates have pinched affordability for prospective home buyers, consumers may be reaching a breaking point and spending the last of their elevated pandemic cash balances.

If so, residential rental real estate may see a more difficult environment, reducing demand from its SMB customer cohort.

It’s difficult to estimate the impact of a slowing residential rental real estate market on the firm’s results in the near term and management is guiding to a markedly lower revenue growth rate, so I’m Neutral [Hold] on AppFolio, Inc. stock for now.