Is it time to exit Sprout Social? KeyBanc downgrades and slashes target to $28

Sprout Social Inc. (NASDAQ: SPT) is in the spotlight today after KeyBanc Capital Markets downgraded the stock from Sector Weight to Underweight with a new price target of $28, reflecting a 17.5% downside from its current trading price.

KeyBanc’s downgrade is primarily driven by concerns over weak bookings, which have not only slowed significantly in the first half of the year but also declined year-over-year on an organic basis.

Analyst Jackson Ader warned that this slowdown in bookings was expected to have a lasting negative impact on Sprout Social’s financial performance, influencing future revenue growth.

In June 2024, Baird analysts offered a more neutral perspective, rating Sprout Social as Neutral with a reduced price target of $38, down from $45.

Baird highlighted that the company had attracted interest from GARP (Growth at a Reasonable Price) investors, who see potential in small-cap stocks like Sprout Social.

However, analysts at Baird also noted that for the stock to break out of its range-bound state, the company would need to address several key issues, including improved sales execution and better performance from its enterprise-focused tools like Tagger.

Sprout Social Q2 performance

The KeyBanc downgrades come on the heels of Sprout Social’s Q2 2024 earnings, where the company reported a revenue increase of 25% year-over-year to $99.4 million, slightly beating analyst expectations.

Additionally, Sprout Social reported non-GAAP EPS of $0.09, beating estimates by $0.01.

Despite the revenue growth, the company’s guidance for the third quarter suggested a deceleration, with projected revenue growth of just over 19%.

Another key highlight in Q2 was the company’s cash flow situation.

Sprout Social reported $93.2 million in cash and equivalents as of June 30, 2024, down from $95.2 million in the previous quarter.

Despite generating positive non-GAAP free cash flow of $2.5 million in Q2, this was a significant drop from $6.0 million in the same quarter last year.

This decline in free cash flow, coupled with the company’s thin cash balance, raises concerns about its financial flexibility, especially as it navigates a challenging business environment.

Large TAM but challenges loom large

Sprout Social has a large addressable market (TAM) and is positioned in the growing field of social media management, which remains crucial for businesses.

However, the company’s transition to an enterprise-heavy sales model has exposed weaknesses in its sales execution, leading to a significant reduction in its revenue guidance earlier this year.

Moreover, the competitive landscape, including DIY social media management tools and broader economic pressures, adds to the challenges.

From a valuation standpoint, Sprout Social has seen its multiples compress significantly. The stock is currently trading at a forward enterprise value (EV) to sales multiple of 4.7x, a stark contrast to its previous high single-digit valuation multiples.

This compression reflects the market’s skepticism about the company’s ability to sustain its growth trajectory, especially given the deceleration in revenue and ongoing operational challenges.

Can a new CEO change things for Sprout Social?

Looking forward, the management team, under the leadership of incoming CEO Ryan Barretto, is focused on addressing these operational challenges.

Barretto, who transitions from his role as President, is expected to bring a renewed focus on improving sales execution and expanding the company’s pipeline of enterprise clients.

While these efforts could potentially stabilize the business, they are unlikely to yield immediate results, making the next few quarters critical for Sprout Social’s long-term prospects.

With the fundamentals laid out, it’s now crucial to examine how the stock’s price action reflects these underlying issues. Let’s delve into the technical analysis to explore the potential price movements and identify key levels that could guide investment decisions.

Resistance above $37

Sprout Social’s stock experienced a remarkable tenfold increase between April 2020 and September 2021. However, it quickly entered a bearish phase, dropping below $40 by May 2022.

Source: TradingView
For the next two years, the stock fluctuated within a $37 to $70 range but broke below this level after the company released its Q1 earnings report in May, which led to multiple downgrades. Since then, the stock has struggled to overcome resistance above $37.

The stock remains in a vulnerable position unless it can achieve a daily close above $40. Investors with a bullish outlook should wait for a confirmed close above this level before considering entry.

On the other hand, bearish traders can consider short positions around $34 with a stop loss set above $40. If the current bearish momentum continues,  the stock could potentially drop to $26.5 in the coming months, presenting an opportunity to book profits.