Semrush stock will recover from the crazy post-earnings selloff

Companies are tightening their marketing budgets because burning cash to grow is no longer an affordable option in the current high-interest rate environment. Instead, more and more companies are focusing on organic growth, which is more efficient and can lead to sustainable long-term results. In the digital age, organic growth means achieving organic rankings on search engines, and Semrush ($SEMR) is the leading software name in the space.

SEMR is seeing continued strong demand for its marketing platform, and its earnings results confirm that. Its Q1 revenue grew 24% y/y and topped expectations, while the full-year outlook was ahead of estimates as well. Yet, despite the positive results, the stock tumbled after the earnings announcement.

The company actually missed earnings estimates by a penny, but if this is the reason behind the selloff, an overreaction would be an understatement. The company is making great progress on all fronts, with operations becoming more efficient, the platform becoming more powerful, and demand remaining resilient. SEMR stock is going to recover from the recent selloff, as the current prices are unjustifiably low. Let's take a deeper look.

A Succesful Platfom Strategy

Software as a Service (SaaS) is a brutally competitive space. It's a winner-takes-all market, meaning that the leader in every SaaS niche has a very large market share. Just look at Salesforce ($CRM), which is the leading CRM name for large businesses. Twilio ($TWLO) is another software name that dominates the cloud communication space. Its closest competitor, Bandwidth ($BAND), has a 97% smaller market cap.

All software companies aim to build all-in-one platforms in their respective niches because this is how they can build a moat and keep competitors at bay. Without a platform strategy, most software companies have no competitive advantage, meaning that they will need to compete on price and, which is a terrible business model.

Organic marketing or Search Engine Optimization (SEO) could be considered a commoditized software space as there are many different platforms that offer similar solutions. While Semrush is a first mover in the space, there are now a lot of strong competitors. Ahrefs, SE Ranking, and Moz are high-quality platforms that offer SEO solutions.

Semrush is successfully differentiating itself by building a marketing platform instead of an SEO platform. In 2021, it introduced the App Center with many different marketing apps that customers can use as add-ons to existing plans. The App Center has been quite successful as there are now over 50 apps that make Semrush different from competing SEO platforms.

Not including the apps, Semrush has over 55 tools, making it the most comprehensive SEO platform on the market. And this platform approach resonates with customers. Now more than 20% of customers use multiple products. By building a comprehensive marketing platform, Semrush differentiates itself in a highly competitive market.

Another strategy the company follows to maintain its leading market position is by creating educational content. It has recently created the Semrush Academy to provide training to new marketers. It recently acquired Traffic Think Tank Academy, one of the most well-respected resources for digital marketing education in the world, to enhance Semrush Academy. By adding educational content, Semrush makes its product stickier, educates new marketers, and increases the chances of converting them into loyal customers. It's a smart strategy that will pay off in the mid and long-run.

In general, Semrush is a highly innovative company that continuously adds new offerings to keep its platform competitive. Now it's leveraging AI to create AI-powered apps and help its customers succeed in the new digital reality. For example, this year it released ContentShake, an app that combines Semrush data with GPT to create content that is optimized for virtually any audience or topic. They also launched Instant Video Creator, which makes videos from blog posts in seconds, allowing customers to repurpose existing text content on social media. All these platform-building initiatives are paying off, helping Semrush add a record number of new customers despite the challenging environment.

Difficult Y/Y Comps Cause Short-Term Deleverage

Semrush is one of the software firms impacted the most by the war in Ukraine. Prior to the invasion, nearly 80% of its employees were based in Russia, and the company enjoyed the benefits of a relatively cheap cost of labor. But following the invasion, it decided to close its offices in the country and relocate all of its employees to offices across Europe.

This relocation has negatively affected Semrush's cost structure as employees have relocated to countries with a higher cost of living, meaning that the company now pays higher wages. In the short term, this decision causes expenses to increase faster than revenue, causing operating deleverage. As you can see below, when the company started to relocate employees in the second quarter of 2022, the profit margins started to deteriorate. The first quarter of 2023 is the last quarter with unfavorable y/y comps.

Comparing the Q1 financials y/y is like comparing apples to oranges because this time last year, most of the company's employees were still based in Russia, so its cost structure was different. This is the main reason operating expenses jumped 44% y/y in the most recent quarter, compared to a revenue growth of 24% over the same period. This caused the adjusted net loss to increase to -10% from -2.8% a year ago. But starting in Q2, Semrush expects to improve its operating leverage again.

In fact, profitability is expected to improve significantly throughout the year. In Q2, the adjusted operating margin is forecast to improve to -3%, which is a significant improvement from the -10% margin in Q1, while for the full year, the company expects a positive adjusted profit margin. In other words, Semrush's financials are expected to recover soon. The high customer stickiness and the increasing functionalities make it more attractive and allow the company to grow efficiently.

Short-term cost pressures aside, Semrush continues to rapidly add new customers. In Q1, it topped 100K customers for the first time as it added a record number of new customers. Most importantly, its largest customers who spend over $10K per year, grew 45% y/y in Q1, which shows that companies prioritize organic growth amid economic weakness and trust Semrush for their growth initiatives. Overall, the Net Retention Rate (NRR) of 116% in Q1 is healthy and shows that all customers continue to increase their spending on the platform by adding more seats or buying add-ons.

A very important sign of strong future growth is the increase in free users. In Q1, the company had 885K registered free active users, up 36% YoY. This is very strong top funnel growth that will lead to healthy growth in paid subs in the coming quarters.

What About Valuation  

Semrush stock currently trades at an all-time valuation multiple for several reasons. The short-term profit margin pressures have certainly contributed to the multiple compression. The unfriendly environment for tech names has also impacted the company's valuation. But given that profitability is expected to improve, and that the shares of high-quality tech names have likely bottomed out, $SEMR has significant upside potential. Assuming full-year revenues of $308 million and a PS ratio of 6, Semrush stock can rise 55% from current prices to $13.3.

What Else

Semrush is doing pretty well amid a tough environment for tech companies. Its platform remains in high demand as companies are looking for ways to grow more efficiently. However, the short-term cost pressures haven’t helped the stock.

As the leading name in its space and with a platform-building strategy, Semrush is building a moat that will help it keep its private-held competitors at bay. Eventually, investors will reward this name for its solid execution.

SEMRUSH RATING

Short Term: BuyLong Term: Buy

🎯 12-Month Price Target: $17.7 ➡️ $13.3

I'm long SEMR.

The boring Disclosures: Newsletters express the opinion of the authors. Nothing in this email is a buy or sell recommendation. I'm not a financial advisor; make your own decisions.