Ultimate Software: Zacks’ Bear of the Day Play

Earnings estimates have been falling for Ultimate Software (ULTISnapshot Report) after the company reported its first quarter results on April 28. The drop in consensus has been significant enough to send the stock to a Zacks Rank #5 (Strong Sell), putting it in the bottom 5% of all companies we rank based on earnings momentum.

Meanwhile, shares of Ultimate Software trade at a lofty 115x forward earnings as investors apparently still have very high expectations for the company.

Ultimate Software provides human resources, payroll, and talent management software through a cloud-based, software-as-a-service model. Its flagship product is UltiPro.

The company is headquartered in Weston, Florida and has a market of $4.7 billion.

First Quarter Results

Ultimate Software reported its first quarter results on April 28. Adjusted earnings per share (which excludes amortization of acquired intangibles but includes stock-based compensation expense) came in at $0.15, well below the consensus of $0.27. It was a 38% decrease from adjusted EPS in the same quarter last year.

Total revenues rose 20% to $144.9 million, which was in-line with consensus. Recurring revenues, which represented 82% of total revenues, increased by 22% due to growth from its cloud offering.

Stock-based compensation expense jumped 48% to $16.1 million. Excluding this, non-GAAP operating income increased 11% as the operating margin declined from 19.4% to 18.0% of total revenues.

Meanwhile, free cash flow increased just 5% to $15.1 million. Over the last twelve months, the company has generated $43.2 million in free cash flow versus a market cap of $4,700 million. That equates to a free cash flow yield of less than 1%.

Estimates Falling

Following the Q1 miss, analysts unanimously revised their estimates lower for both 2015 and 2016. This sent Ultimate Software to a Zacks Rank #5 (Strong Sell).

The 2015 Zacks Consensus Estimate is now $1.25, down from $1.43 before the report. The 2016 consensus has fallen from $1.89 to $1.70 over the same period.

Lofty Valuation

Shares of Ultimate Software have fallen since the Q1 report, but investors apparently still have very high expectations for the company. The stock trades at a lofty 115x 12-month forward estimates, well above the industry median of 21x. And its enterprise value to cash flow ratio is a frothy 76x, well above the industry median of 13x.

The Bottom Line

With falling estimates and premium valuation, investors should consider avoiding Ultimate Software for now.

Todd Bunton, CFA is a Stock Strategist for Zacks Investment Research and Editor of the Income Plus Investor and Surprise Trader services.

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