NET with Nobias technology: Down 50%+ From Its 52-Week Highs, Is It Time To Buy Cloudflare?
Cloudflare is a very interesting company to follow. The stock exists in an industry (edge computing)) that is expected to benefit from strong secular tailwinds for years (if not decades) to come. However, because of these growth expectations the company came into 2022 trading with a very speculative valuation and therefore, NET shares have been caught up in the selling pressure that we’re seeing surrounding speculative growth stocks throughout 2022 (largely driven by an increasingly hawkish Federal Reserve). After posting roughly 200% capital gains in 2021, NET shares are down 20.21% year-to-date thus far in 2022. But, their sell-off actually began in late 2021. NET shares are down a whopping 52.6% from their current 52-week highs of $221.64.
50%+ sell-offs aren’t uncommon to see in the tech sector right now. And while we’ve seen a stark rotation out of growth and into value throughout 2022 thus far, the fact is, this trade won’t last forward (the market always ebbs and flows). Therefore, investors who’re interested in secular growth are currently picking through the recent wreckage to find growth stocks that have experienced irrational sell-offs due to overly bearish sentiment. Is NET one of them? Let’s see what the credible authors/analysts that the Nobias algorithm tracks have had to say about the stock recently.
In mid-November, Nobias 4-star rated author, Nicholas Rossolillo, published a report on shares which offered a cautious take in the short-term, but an overall bullish long-term outlook. With the benefit of hindsight, we see that this article was essentially published at NET’s recent highs. NET’s share price has been cut in half since Rossolillo published this piece. However, in the short-term, the market isn’t always rational and therefore, we still consider Rossolillo’s opinion on the stock valuable to consider when performing due diligence on Cloudflare shares in the present.
NET Feb 2022
Rossolillio began his piece by highlighting NET’s strong 2021 performance - and noting that the stock was speculatively valued (and therefore, carried a high degree of risk). He said, “Shares of edge computing internet and security company Cloudflare (NYSE:NET) are on an absolute roll this year. As of this writing, the stock is up 220% over the last 12-month period alone -- valuing the young company at a whopping 100 times expected full-year 2021 revenue to enterprise value.” He continued, saying, “Given such a valuation, suffice to say any investor that makes a purchase right now should be expecting incredibly great things from Cloudflare for many years to come. The third-quarter 2021 update underpins the massive potential the firm still has -- although I'd advise against trying to chase returns at this point.”
In his piece, Rossolillio highlighted the strong growth that NET posted during its Q3 ER. He said, “Cloudflare posted revenue of $172 million in the third quarter, up 51% year over year and the fifth straight quarter of at least 50% sales growth. In fact, since Cloudflare started reporting as a public company in the autumn of 2019, it's only dipped below the 50% year-over-year sales growth mark a handful of times -- but never reported a quarterly sales rate lower than 48%.”
“But what about profit margins -- or lack thereof,” Rossolillio asked, rhetorically. He continued to break down the company’s results and the risky nature of the stock, saying, “Free cash flow sank to negative $39.7 million in Q3, down from negative $9.8 million posted in Q2 just a few months prior. Clearly, between a lofty stock premium and persistent losses, investing in Cloudflare isn't for everyone. Shares have been going up in a nearly straight line for months now, but that won't last forever.”
Regarding its speculative valuation, Rossolillio did say that, “If Cloudflare can keep it up, it will earn that sky-high valuation (currently an enterprise value of $66 billion) sooner or later. “As for the fourth quarter of 2021,” he continued “CEO Matthew Prince and the company anticipate revenue to be $184 million to $185 million, up "only" 47% from last year.”
Well, since this piece was published, NET has posted its Q4 results (on February 10th). And, during this report, the company continued along its 50%+ top-line growth trend, posting quarterly sales of $193.6 million, which were up 53.8% on a year-over-year basis (outperforming Prince's prior estimates).
Speculative valuation aside, Rossolillo noted that he maintains a long-term bullish stance on the company. He concluded his piece saying, “Granted, it's far too soon to declare Cloudflare "the next Amazon," or even the next tech giant. But given its stellar performance even during the pandemic where some of its peers have faltered, I certainly wouldn't bet against Cloudflare.”
On January 18th, Manali Bhade, a Nobias 5-star rated author, published an article titled, “2 Unstoppable Metaverse Stocks to Buy in 2022” in which he highlighted Cloudflare as a strong growth pick. Bhade wrote, “Edge computing -- in which data and applications are stored and processed at locations nearer to the end-users rather than at centralized server farms -- improves data reliability, efficiency, security, and speed. Those network characteristics will be vital for metaverse platforms and applications. Consequently, we can expect that edge-based content delivery network operator Cloudflare will play a major role in supporting the metaverse.”
Regarding the company’s operations, he said, “Cloudflare's broad network already extends to 250 cities in more than 100 countries. Approximately 95% of the world's population can connect to that network within 50 milliseconds.” “Additionally,” Bhade said, “Cloudflare also offers Zero Trust security solutions: Every user inside or outside the network is validated multiple times before being given access to resources. Such protocols will be essential for protecting the metaverse and those who use it from unscrupulous agents and hackers.”
Cyber security is another industry that is likely to benefit from strong long-term tailwinds, which means that Cloudflare is well situated to benefit from multiple bullish trends. While Cloudflare is a relatively volatile stock, the company’s growth trajectory has been very reliable. Bhade echoed similar sentiment to Rossolillo regarding the company’s long-term growth saying, “From 2016 to 2020, Cloudflare's top line grew at a compound average rate of 50% annually.” He also touched upon the expected reliability of these sales moving forward throughout a wide variety of economic conditions, saying, “Currently, 1,260 of Cloudflare's customers are large organizations that spend $100,000 or more on its services annually. Since these large customers account for more than half of its top line, its business model is relatively resilient in the face of changing macroeconomic conditions.”
This is the benefit of strong secular growth - companies like NET that benefit from it are well positioned to continue to take market share and post strong sales growth even during periods (like the 2020 COVID-19 recession) where broader economic growth contracts. Bhade concluded his article saying, “Cloudflare is technically not a metaverse stock. However, it will have a significant role to play in providing the underlying networking and data services required to make the metaverse a reality. This, coupled with its formidable position in the enterprise market, makes it an attractive pick for retail investors.”
During the full-year in 2021, Cloudflare generated revenue of $656.4 million. Even after its 50%+ correction, this still means that the company is trading with a very lofty price-to-sales multiple (NET’s current market cap is $37.5 billion). However, looking ahead to 2022, it appears that NET is primed to continue along its strong growth trajectory, which, as Rossolillo said, could eventually justify the stock’s valuation. During its recent Q4 report, NET provided investors with 2022 sales, GAAP income from operations, and income per share guidance.
The company is currently calling for total revenue in 2022 of $927-$931 million. Compared to 2021’s full-year result, this would represent year-over-year growth of 41.5%. This does represent a slowdown from the 50%+ growth that Rossolillio and Bhade highlighted, but 40%+ growth in today’s economic environment is certainly not shabby.
Nicholas Ward is a Senior Investment Analyst at Wide Moat Research. He has spent the last 8 years writing about the stock market at various publications, including Seeking Alpha, The Street, Forbes Real Estate Investor, Sure Dividend, The Dividend Kings, iREIT, Safe High Yield, and The Intelligent Dividend Investor.
The company says that it expects to generate income from operations in the $10 million to $14 million range. Net income per share is expected to arrive in the $0.03-$0.04 range. Therefore, management doesn’t expect to see strong profits anytime soon - meaning that this is a hyper growth company which will have to be evaluated based upon sales growth prospects.
With that in mind, NET is certainly not a company that all investors will feel comfortable owning. Even after its massive pullback, it remains a speculative, long-term bet. But, when looking at the recent opinions expressed by the credible authors and analysts that we track with the Nobias algorithm, it appears that the vast majority of individuals who cover this stock remain bullish on the risk/reward prospects that shares present.
Right now, 93% of the opinions that we’ve seen expressed by credible authors carry a “Bullish” sentiment rating. And, looking at the credible Wall Street analysts that we track (those with Nobias 4 and 5-star ratings), we see that the average price target applied to NET shares is currently $118.57.
Today, NET shares trade for $104.92. Therefore, the average price target represents upside potential of 13%. This 13% upside pales in comparison to NET’s 2021 rally; however, in today’s market (remember, the S&P 500 is down 7.26% on a year-to-date basis) many investors are likely to continue to be attracted towards secular growth plays that offer double digit upside potential.
Disclosure: Nicholas Ward has no position in any stock mentioned in this article. Nicholas Ward wrote this article for Nobias at their request with a view of giving investors a balanced perspective based on the writings of Nobias highly rated analysts and bloggers. Nobias has no business relationship with any company whose stock is mentioned in this article and does not have a position in this stock.
Additional disclosure: All content is published and provided as an information source for investors capable of making their own investment decisions. None of the information offered should be construed to be advice or a recommendation that any particular security, portfolio of securities, transaction, or investment strategy is suitable for any specific person. The information offered is impersonal and not tailored to the investment needs of any specific person.
Disclaimer: The Nobias star rating is based on past performance results and is not an indicator of future results. These past performance returns do not represent returns that any investor actually earned. Assumptions made include the ability to purchase the stocks recommended by the author under liquid markets where the transaction would be at the market price for the day. In reality, loss in liquidity may have a material impact on the returns that actually may have been earned. Further, returns are calculated without any including transaction costs, management fees, performance fees or expenses, or reinvestment of dividends and other income. This information is provided for illustrative purposes only.