What a brutal six months it’s been for Health Catalyst. The stock has dropped 44.2% and now trades at $2.18, rattling many shareholders. This was partly driven by its softer quarterly results and may have investors wondering how to approach the situation.
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Why Do We Think Health Catalyst Will Underperform?
Despite the more favorable entry price, we're swiping left on Health Catalyst for now. Here are three reasons you should be careful with HCAT and a stock we'd rather own.
1. Long-Term Revenue Growth Disappoints
A company’s long-term performance is an indicator of its overall quality. Any business can have short-term success, but a top-tier one grows for years. Over the last five years, Health Catalyst grew its sales at a 12% compounded annual growth rate. Although this growth is acceptable on an absolute basis, it fell short of our standards for the software sector, which enjoys a number of secular tailwinds.
2. Long Payback Periods Delay Returns
The customer acquisition cost (CAC) payback period measures the months a company needs to recoup the money spent on acquiring a new customer. This metric helps assess how quickly a business can break even on its sales and marketing investments.
Health Catalyst’s recent customer acquisition efforts haven’t yielded returns as its CAC payback period was negative this quarter, meaning its incremental sales and marketing investments outpaced its revenue. The company’s inefficiency indicates it operates in a highly competitive environment where there is little differentiation between Health Catalyst’s products and its peers.
3. Cash Burn Ignites Concerns
Free cash flow isn't a prominently featured metric in company financials and earnings releases, but we think it's telling because it accounts for all operating and capital expenses, making it tough to manipulate. Cash is king.
Health Catalyst’s demanding reinvestments have drained its resources over the last year, putting it in a pinch and limiting its ability to return capital to investors. Its free cash flow margin averaged negative 10.4%, meaning it lit $10.40 of cash on fire for every $100 in revenue.
Final Judgment
Health Catalyst doesn’t pass our quality test. After the recent drawdown, the stock trades at 0.5× forward price-to-sales (or $2.18 per share). While this valuation is optically cheap, the potential downside is huge given its shaky fundamentals. There are more exciting stocks to buy at the moment. We’d recommend looking at a safe-and-steady industrials business benefiting from an upgrade cycle.
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