My investment rating for Q2 Holdings, Inc. (NYSE:QTWO) stock is a Hold now. QTWO’s second quarter earnings came in above expectations, and the company raised its FY 2024 EBITDA guidance. But I have chosen to downgrade my rating for Q2 Holdings to a Hold, as the stock’s current valuations are fair based on peer and growth comparisons.
QTWO’s “outlook for the intermediate term and long run” was the subject of my earlier March 13, 2024 update. I assess Q2 Holdings’ second quarter results and updated full-year guidance with this latest write-up.
A Beat-And-Raise Quarter For QTWO
Q2 Holdings revealed the company’s Q2 2024 financial performance with a results announcement issued on July 31 after trading hours.
QTWO’s normalized EPS jumped by +92.2% YoY to $0.38 in the second quarter of this year, and the company’s Q2 bottom line was +20.2% higher than the Wall Street analysts’ consensus projection of $0.32 per share.
The company’s top line rose by +11.9% YoY to $172.9 million for Q2 2024, which was ahead of the market’s consensus estimate of $170.9 million (source: S&P Capital IQ).
At its Q2 2024 analyst call, QTWO indicated that its robust top line performance was “primarily driven by expansion sales with existing customers.” In the second quarter, the company was successful in having two “existing customers” adopt additional offerings and getting “an Enterprise bank to increase their utilization of Q2’s relationship pricing platform” as indicated in its recent results announcement.
In other words, QTWO has done a very good job in realizing additional revenue contribution from its current client base, and this has allowed the company to report robust top line growth in the latest quarter.
Separately, my earlier March 13, 2024 update mentioned that the “growth in higher-margin (my emphasis) subscription ARR (Annualized Recurring Revenue) as a proportion of total ARR” will be a key profitability improvement lever for Q2 Holdings.
In specific terms, QTWO’s subscription ARR as a percentage of total ARR increased from 78.3% in Q2 2023 to 81.0% for Q2 2024 as disclosed in its earnings presentation slides. As a result, Q2 Holdings’ normalized EBITDA margin improved by +200 basis points QoQ and +590 basis points YoY to 17.3% in Q2 2024 with this favorable change in top line mix. The company’s actual second quarter non-GAAP adjusted EBITDA margin was also +1.5 percentage points above the consensus forecast of 15.8% (source: S&P Capital IQ).
In a nutshell, Q2 Holdings’ Q2 2024 earnings beat was attributable to an increase in sales generated by the company’s existing clients and a higher percentage of subscription revenue.
More significantly, QTWO’s positive growth momentum is likely to be sustained for the full year, considering the company’s updated fiscal 2024 financial guidance.
The mid-point of Q2 Holdings’ FY 2024 EBITDA guidance was raised from $112 million earlier to $118 million now. QTWO’s full-year EBITDA margin guidance was also revised upwards from 16.3% previously to 17.1% currently. This implies that QTWO’s EBITDA and EBITDA margin are projected to expand by +53.4% and +4.8 percentage points, respectively, in this fiscal year.
Q2 Holdings stressed at the company’s second quarter analyst briefing that “we’ve seen stronger expansion based (i.e. existing clients) bookings (my emphasis) this year than initially planned” and witnessed accelerated subscription revenue growth (my emphasis) for the full year of 2024.” This implies that the positive factors driving QTWO’s good performance for Q2 2024 will most probably remain intact for the rest of the year.
But Q2 Holdings’ Shares Are At A Fair Valuation
QTWO’s excellent Q2 2024 financial performance and positive full-year outlook are already adequately reflected in the stock’s current valuations.
Q2 Holdings’ key listed peer is nCino (NCNO) as highlighted in an earlier June 2023 Seeking Alpha News article.
Peer Valuation Comparison For QTWO
| Stock | Consensus Next Twelve Months’ Enterprise Value-to-Revenue Valuation Multiple | Consensus Next Twelve Months’ EV/EBITDA Valuation Multiple | Consensus Next Twelve Months’ Normalized P/E Valuation Multiple |
| Q2 Holdings | 6.1 | 33.2 | 41.4 |
| nCino | 6.6 | 35.9 | 47.2 |
Source: S&P Capital IQ
According to the peer comparison valuation table presented above, QTWO’s and NCNO’s valuations are pretty close. None of NCNO’s key valuation metrics are more than +15% higher than that for QTWO.
On the other hand, a rule of thumb is that a stock is at a fair valuation, if its earnings multiple is close to its earnings growth rate, and QTWO fits the bill. Q2 Holdings’ consensus FY 2023-2026 EBITDA and EPS CAGR estimates are +36.5% (versus EV/EBITDA multiple of 33.2 times) and +41.3% (versus P/E multiple of 41.4 times), respectively based on S&P Capital IQ data.
In summary, my opinion is that the capital appreciation potential for Q2 Holdings’ stock is limited, notwithstanding its impressive second quarter financial performance. A comparison of QTWO’s key valuation metrics with that of its peers and its expected earnings growth rates suggests that the stock is reasonably valued.
Closing Thoughts
A stock is only deserving of a Buy rating, if the company’s financial outlook is favorable and its shares are undervalued. QTWO only fulfills the first condition now, so a Hold rating for the stock is justified.
I will consider turning bullish on Q2 Holdings again, if its valuations become more favorable such as a forward EV/EBITDA multiple in the mid-twenties range and a forward P/E multiple at the mid-thirties level.
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