BUG - CrowdStrike: Downgrading To Hold On Valuation; FCF And Momentum Remain Compelling

2023-11-15 11:14:59 ET

Summary

• Cybersecurity stocks, including CrowdStrike, have gained popularity among investors following recent data security breaches.
• CrowdStrike is a leader in the Endpoint Protection Platform market and has a strong position in the cloud-based cybersecurity sector.
• The stock has seen strong earnings growth and positive technical indicators, but its valuation is currently stretched.
• I outline key price levels to watch ahead of CRWD's Q3 2024 earnings report due out later this month.

Cybersecurity stocks are back in vogue. I make this statement based on the performance trends in the Global X Cybersecurity ETF ( BUG ). Following a slew of significant data security breach events since September, investors have recently taken a shine to this slice of the tech sector. BUG is up 24% on the year, outpacing the S&P 500 ETF ( SPY ) by about 5 percentage points. But jumping out on the chart is the performance of one of the fund's top positions.

CrowdStrike ( CRWD ) is the third-largest holding in BUG and has performed incredibly well this year, but I have a hold rating on CRWD. I see very strong momentum and positive fundamentals with the Texas-based Systems Software company, but the valuation is stretched today compared to when I first reviewed the company in the summer.

Bugging Out on Cybersecurity Plays in 2023

According to Bank of America Global Research, CRWD is a leader in the Endpoint Protection Platform ((EPP)) market. EPP solutions help protect enterprises' internet-connected devices from cyberattacks, and there is a market shift from signature-based on-prem solutions to cloud-based platforms using AI and machine learning. CrowdStrike's platform is one of the few 100% cloud-based architectures and is uniquely positioned to displace incumbents with its platform breadth, including advanced detection and remediation capabilities.

The Austin-based $50 billion market cap Systems Software industry company within the Information Technology sector has negative trailing 12-month GAAP earnings and does not pay a dividend. Ahead of earnings later this month, the stock has a high 49% implied volatility percentage along with a modest 2.4% short interest as of November 14, 2023.

Back in August, CRWD reported yet another strong quarter. Non-GAAP Q3 EPS totaled $0.74, beating the $0.56 consensus estimate, while revenue rose 37% from year-ago levels, also above expectations. Annual Recurring Revenue ((ARR)) jumped 37% as well to $2.93 billion.

While shares slipped in the after-hours on August 31, CRWD surged in the following session as investors recognized how strong the guidance was. Q3 EPS was seen at $0.74 (which is the consensus today) versus a consensus at the time of just $0.60. FY 2024 EPS was seen in the $2.80 to $2.84 range.

Just recently, CRWD was upgraded by analysts at Stifel. The firm took the stock from a hold to a buy, lifting its price target to $225 from $153. But that just leaves a modest amount of upside based on the sharp price appreciation lately.

A tough competitive landscape could pressure ARR, however, and this will be a key metric to monitor in the earnings report due out later this month. Also, keep your eye on gross margins, which verified at 77.7% in the previous reporting period. In its guidance, the management team raised FY 2024 operating margin guidance to 20% from the previous 17% on improved operating leverage.

On valuation , analysts at BofA see earnings rising 83% in the current FY after consecutive years of more than doubling its EPS. FY 2025 and 2026 profit growth should remain stout, but not as strong as what we have seen in recent periods.

Still, a high 25% EPS growth rate is somewhat rare in today's market. Don't expect dividends to be paid on the stock any time soon, and given its current operating P/E ratio above 73 at latest check (using 2024 numbers from Seeking Alpha), there is clearly a valuation premium here. Still, free cash flow is strong and expected to rise over the coming quarters, underscoring the solid fundamental case.

CrowdStrike: Earnings, Valuation, Free Cash Flow Forecasts

If we assume normalized EPS growth of 25% and assume an above-sector forward PEG ratio of 2.0, then a fair non-GAAP earnings multiple would be about 50. Using next-12-month EPS estimates, perhaps slightly above $3.30, then we are talking about a stock price that should be between $160 and $180, a bit under where the stock sells for today. Thus, while I like the fundamentals and growth, shares are just too expensive in my view.

CRWD: Expensive Across Valuation Metrics

Compared to its peers , CRWD features a comparably weak valuation rating, so there is an argument that we can look past some of the dicey earnings multiples. With an industry-leading growth rate and strong profitability trends, the future appears solid when assessing EPS and FCF trends.

What's more, the technical momentum situation, which I will detail later, is quite strong with shares about doubling so far in 2023 - that's bullish relative strength in the eyes of a technician. Finally, earnings revisions Wall Street analysts have been to the good side since CrowdStrike last reported earnings.

Competitor Analysis

Looking ahead, corporate event data provided by Wall Street Horizon show an unconfirmed Q3 2024 earnings date of Tuesday, November 28, after the close with a conference call immediately after the numbers cross the wires. No other volatility catalysts are seen on the corporate event calendar.

Corporate Event Risk Calendar

The Options Angle

Option Research & Technology Services (ORATS) notes that the company has topped analysts' earnings expectations in each of the previous 12 reports, and $0.74 of per-share operating profits are expected this go around - that would be a remarkable 85% growth rate on a year-over-year basis. Traders have priced in a 7.8% earnings-related stock price swing when analyzing the at-the-money straddle expiring soonest after the November 28 earnings report.

A High Implied Earnings Move

The Technical Take

So there's a lot going on with CRWD's chart. Let's take things one at a time. First, shares are right near key resistance around the $205 mark but following a nice gap higher earlier this week and Tuesday's strong advance, that level could be busted by the bulls. Next, you will see that there was resistance near $167 for a time earlier this year - pair that with the low notched near $92 this past January, and an upside measured move price objective to around $245 is absolutely in play today. $245 would have confluence with the April 2022 peak, too.

Bigger picture, shares broke a downtrend in the second quarter and have been trending higher all year, though the current price appears stretched compared to where the uptrend line is (about $160). With a rising long-term 200-day moving average, though, the bulls are clearly in control. Moreover, the 50dma is accelerating and above the longer-term moving average. Finally, notice the top of the chart where I have overlayed the RSI momentum indicator - it has been in a bullish zone since Q1, cementing the positive momentum and bullish turnaround following the November 2021 to January 2023 bear market.

Overall, long with a stop under $170 should work, targeting the $245 area detailed earlier.

CRWD: Bullish Uptrend In Place, Probing Through $205 Resistance, $245 Target

The Bottom Line

I have a hold rating on CrowdStrike. I very much like the chart and momentum situation, but shares are more richly valued today compared to this past summer. Buying on dips could work, but the company might have to grow into its valuation.

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