NTCT - NetScout: Consider Undemanding Valuations And Potential Earnings Miss

2023-07-19 06:09:48 ET

Summary

• NetScout Systems' valuations have become appealing, as the company's shares underperformed the broader market since the beginning of the year.
• But NTCT's first quarter results announcement next week is unlikely to be the positive catalyst needed to re-rate its shares.
• My rating for NetScout Systems stock is a Hold, taking into account both the risk of below-expectations Q1 results and NTCT's attractive valuations.

Elevator Pitch

I award a Hold rating to NetScout Systems, Inc. ( NTCT ) shares. NTCT stock is cheap for good reasons, as the company's near-term financial outlook is unfavorable. The market expects a revenue decline and slower earning growth for NetScout Systems in Q1 FY 2024 (YE March 31). Taking into account the sell-side's channel checks, NTCT's below-expectations Q4 FY 2023 results, and the company's management commentary, NetScout Systems' first quarter financial performance might turn out to be worse than analysts' forecasts. NetScout Systems' undemanding valuations and poor financial prospects justify a Hold rating for the stock.

Company Description

Established in 1984 and publicly-listed in 1999 , NTCT calls itself a provider of "service assurance and cybersecurity solutions" that help "companies to protect their digital business services against disruption" in its FY 2023 (YE March 31) 10-K filing .

An Overview Of NetScout Systems' Solutions

NetScout Systems' Market Leadership As Evidenced By Its Client Base

As indicated in its FY 2023 earnings presentation slides , NetScout Systems derived 74% and 26% of its most recent fiscal year revenue from service assurance and cybersecurity products and services, respectively. NetScout Systems' client mix is reasonably balanced, with telecommunications services providers and enterprises & government agencies accounting for 52% and 48% of its top line, respectively for FY 2023. Separately, NTCT boasts a certain degree of geographical diversification with international markets representing 36% of its FY 2023 revenue. The company's home market, the US, still makes up the majority or 64% of its sales for the recent fiscal year.

Share Price Performance And Valuations

NetScout Systems' year-to-date stock price performance has been lackluster, and NTCT's current valuations are undemanding.

In 2023 thus far, NTCT's share price has declined by -7.5% . In the same time period, the Nasdaq Composite and S&P 500 indices rose by +38.2% and +19.1%, respectively. NetScout Systems' last traded stock price of $29.97 as of July 18, 2023 is just +15.7% above its 52-week low share price of $25.90 registered during intra-day trading on May 3, 2023.

With regards to valuations, the market values NetScout Systems at consensus forward next twelve months' EV/EBITDA and normalized P/E multiples of 8.0 times and 13.4 times, respectively based on S&P Capital IQ data. NTCT's historical 10-year mean forward EV/EBITDA and normalized P/E metrics were superior at 9.6 times and 17.2 times, respectively. In absolute terms, NTCT's high single-digit EV/EBITDA and low-teens P/E ratios imply that the stock is inexpensive.

In the subsequent section, I evaluate whether NetScout Systems' upcoming quarterly earnings announcement could be a catalyst for the company's shares.

Q1 FY 2024 Results Preview

NTCT will be revealing its financial performance for the first quarter of fiscal 2024 (April 1, 2023 to June 30, 2023) next week on Thursday, July 27 before trading hours. The market doesn't think that NetScout Systems' results in the most recent quarter were good.

The Wall Street analysts' consensus financial estimates for NTCT indicate that the company's top line is projected to contract by -0.4% QoQ and -0.7% YoY to $207.3 million in Q1 FY 2024. If the sell-side is spot-on with its revenue forecasts, Q1 FY 2024 will be the first quarter of negative YoY revenue growth for NTCT for the period between March 31, 2022 and June 2023. The analysts also see NetScout Systems' normalized earnings growth decelerating from +31.0% YoY in Q4 FY 2023 to +27.1% for Q1 FY 2024 based on consensus numbers.

I am of the opinion that NetScout Systems' actual Q1 FY 2024 earnings might be even worse than what the market is currently anticipating.

NTCT's Q4 FY 2023 top line and bottom line missed the analysts' consensus forecasts by -8.7% and -24.0% , respectively. At the company's FY 2023 earnings call in early May, NetScout Systems acknowledged that it "probably will have the normal backlog that we've had over the last few years with the exception of last year and this year (which were supernormal years during the pandemic outbreak period)" based on "the low end of the (full-year FY 2024) guidance."

Investment bank Piper Sandler recently surveyed channel partners in the infrastructure software space and published its findings in a report titled "2Q23 Infrastructure SW (Software) Checks." According to this particular research report (not publicly available) issued on July 10, 2023, NetScout Systems' "bookings trends remain challenging (in Q1 FY 2024) as backlog is 'normal'". In other words, there has been a faster than expected normalization of NTCT's backlog as evidenced by Piper Sandler's channel checks. This indicates that NetScout Systems' Q1 FY 2024 and full-year FY 2024 results might come in the lower end (rather than the mid-point) of the company's management guidance.

In summary, I think that there is a reasonably high probability of NetScout Systems reporting an earnings miss for Q1 FY 2024.

Closing Thoughts

I have a mixed view of NetScout Systems, which translates into a Hold rating for the stock. On the positive side of things, NTCT's current valuations are enticing on both absolute and historical terms. On the negative side of things, there is a lack of potential re-rating catalysts, as positive surprises are unlikely to emerge from NetScout Systems' Q1 FY 2024 results release next week.

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