GEN - Gen Digital Stock: A Value Pick In Cybersecurity

2023-08-23 17:33:38 ET

Summary

• Gen Digital reported fiscal Q1 earnings highlighted by solid operating trends and firm margins.
• We like the stock given its leadership position as a pure play on consumer cybersecurity tools and overall positive fundamentals.
• Shares appear undervalued relative to industry peers while an effort at deleveraging should support a higher valuation going forward.

Gen Digital Inc. ( GEN ) was previously known as Norton LifeLock and is recognized as a leader in consumer cyber safety focusing on security solutions, online privacy, and identity protection through a diverse brand portfolio. Nearly a year following its merger with competitor "Avast" in 2022, all indications are that the deal has been a success.

Indeed, the company's latest quarterly report was highlighted by strong operating and financial metrics with margins benefiting from significant cost synergies. New AI-driven tools are working to keep customers engaged while management is offering positive growth guidance for the year ahead.

We like the stock for its high-quality profile given solid fundamentals, sustained earnings momentum, and a well-supported quarterly dividend. On this point, GEN stands out as a "value pick" in the cybersecurity industry and we see room for shares to climb higher going forward.

GEN Financial Metrics

GEN reported its fiscal 2024 Q1 earnings on August 3 with non-GAAP EPS of $0.47, up 5% year-over-year, or 9% higher on a constant currency basis considering a large international presence.

Headline revenue of $946 million representing an increase of 34% y/y, although the growth was more modest 3% on a pro-forma basis including the impact of the Avast merger.

The bigger story here was the firming operating margin that reached 57.6%, up 390 basis points from the year prior. A large part of that included the climbing level of average revenue per user (ARPU) at $7.26, up sequentially each quarter over the past year. This is based on not only the shifting product mix but also some targeted pricing initiatives.

As mentioned, the company has also captured significant cost synergies through a series of cost reductions and portfolios. Expense line items between sales and marketing, R&D, and administrative spending are all down as a percentage of revenue reflecting an effort at efficiency. Separately, the firm-wide headcount at around 3,500 at the end of the quarter is down from 4,500 last year.

With the fiscal Q1 results, management is offering full-year guidance, forecasting revenue between $3.8 and $3.85 billion, reflecting pro-forma growth in the low-to-mid single digits. There is also an expectation for further cost savings gains to push the operating margin higher to around 60%.

This dynamic reflects the fiscal 2024 EPS target between $1.95 and $2.02, representing an increase of around 9% y/y. Longer-term, management sees a path for EPS to reach $3.00 by the end of fiscal 2025.

Gen Digital ended the quarter with $623 million in cash against $9.7 billion in total debt. While this level is elevated given the merger financing, a net debt to EBITDA leverage ratio of 3.9x is seen as well-supported by underlying cash flows.

The company has generated $850 million in free cash flow over the past year which has provided room for $517 million in debt repayments along with $645 million in share buybacks and $317 million toward the regular dividend. The plan is to continue deleveraging with a long-term net leverage ratio target of 3x in the coming years.

What Challenges Does Gen Digital Face?

We're bullish on GEN but will set the record straight that the stock isn't perfect. Beyond the good financial trends, one area of concern is the total number of direct customers which has stagnated at around the current level of 38 million following a post-pandemic boom slowdown.

Management notes that churn and retention are relatively stable, but we'd like to see a return in customer growth as a better measure of organic product momentum. What we mean by this is that while firming margins and the climbing ARPU are a good start, those steps can only go so far if the "pie of customers" isn't expanding.

The company is addressing this through new marketing initiatives and planned expansion into new geographical markets, but nevertheless highlights fundamental questions to the core business model.

On that point, another weakness we see with GEN is the question of its "economic moat" being the major differentiation relative to alternatives on the market.

We know the company is unique as a pure-play on consumer cybersecurity but can recognize that larger mega-cap tech leaders like Microsoft Corp ( MSFT ), Alphabet Inc. ( GOOGL ), and even Apple Inc. ( AAPL ) are moving forward with an increasingly extensive portfolio of solutions to address similar security threats users face.

Again, Gen Digital's platform maintains a commanding spot in the market, but it becomes difficult to envision what the company will look like over the next decade. That uncertainty is the key risk when looking at the stock.

Is Gen Digital Overvalued?

We're willing to put aside some of the challenges facing GEN and give the company's management team the benefit of the doubt. The main attraction with GEN, as we see it, is its compelling valuation supported by a solid outlook over the next few years.

According to consensus estimates, the company is expected to generate earnings growth averaging 15% per year through fiscal 2026. With shares trading at a forward P/E of just 10x, our take is that GEN is simply underappreciated and undervalued by the market.

As mentioned in the introduction, Gen Digital offers good value among cybersecurity stocks, relative to names like Fortinet, Inc. ( FTNT ), Palo Alto Networks, Inc. ( PANW ), Zscaler, Inc. ( ZS ), CrowdStrike Holdings, Inc. ( CRWD ), and Cloudflare, Inc. ( NET ) among others that generally trade at a higher premium across several multiples. In this case, Gen Digital is free cash flow positive when other companies are still struggling to reach consistent profitability.

While each of these companies focuses on different areas of security, targeting various market segments, what they share is the tailwind of increasing importance seen to online protection.

Gen Digital also stands out as an exception within the industry by paying a regular quarterly dividend. The current payout of $0.125 per share yields approximately 2.4%. While the rate has been held constant going back to the last hike in 2019, we believe there will be room for an increase down the line as the company continues to deleverage which should provide some greater flexibility for shareholder distributions.

GEN Stock Price Forecast

We rate GEN as a buy with a price target for the year ahead at $25.00 representing a 12.5x multiple on the EPS guidance by management of around $2.00 per share for fiscal 2024.

The bullish case here is that results over the upcoming quarters can exceed expectations, supporting higher long-term earnings estimates, and opening the door for even more upside. The way we see it, the company's solid financial momentum warrants a higher valuation premium, at least partially narrowing the spread to cybersecurity peers.

On the downside, disappointing trends either through weaker growth or signs customer retention is waning would force a reassessment of the outlook. Monitoring points for the rest of the year include the evolution of the operating margin as well as the trend in average revenue per user.

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