QLYS - Qualys: Downgrading To A Hold - Expectation Of Recovery Priced In

2023-12-23 09:00:00 ET

Summary

• We’re downgrading Qualys to a hold.
• 3Q23 results and outlook lead us to believe QLYS will see slower top-line growth due to continued muted IT spending, and we don’t believe the higher multiple is justified.
• We think the expectation of recovery has been priced into the stock at current levels; up 57% QLYS over the past 6M.
• We think QLYS will benefit from the estimated 14% Y/Y increase in security and risk management spend next year but don’t see any near-term catalyst driving material outperformance.

We're downgrading Qualys ( QLYS ) to a hold; we're picking up our coverage of the stock after QLYS outperformed the S&P 500 by 44% since our buy-rating at the end of 2021. Our positive thesis of QLYS showing signs of reaccelerating revenue growth as Vulnerability Management remains a top three IT-spending priority played out well. Now, 3Q23 results and outlook lead us to believe that QLYS stock has priced in the expectation of recovery and will now see slower top-line growth due to macro headwinds spilling into 2024 and causing longer deal cycles. Gartner expects global end-user spending on security and risk management to increase 14% Y/Y in 2024 ; this makes us more confident in the cloud security space, but we don't see any near-term catalyst unique to QLYS driving outperformance.

We're concerned over a slowdown in the QLYS growth rate after the stock's run-up this year, up 57% over the past 6M versus the S&P 500, up 8% during the same period. We expect cloud-based solutions for networked assets, particularly servers and network devices (e.g., routers, switches, firewalls, etc.), to see a healthier spending environment in 2024, and we think this has been priced into the stock. Now, we see more difficulty for QLYS to grow its top line materially due to longer sale cycles and see investor confidence in the stock decreasing into early 2024. The company reported revenue up ~13% Y/Y this quarter to $142M and non-GAAP EPS of $1.51, both ahead of consensus, with management noting, "We started to see some indication of stabilization in the selling environment with customers confirming their prioritization of security with an IT budget, but believe ongoing budget scrutiny will linger for the foreseeable future" on the earnings call .

The following outlines QLYS stock against the S&P 500 over the past 6M.

We don't think QLYS is immune to the macro weakness spilling into 1H24; revenue growth Y/Y has slowed in 3Q23 YTD, but we believe the company will be relatively resilient. The company's margins have been sustained despite the lingering budget scrutiny, at 45% in 3Q22 YTD and 47% in 3Q23 YTD. Still, we don't see any catalyst at play, providing QLYS with a competitive advantage in 1H24.

Valuation

QLYS is expensive, trading above the peer group average. The is trading at 11.3x EV/C2024 Sales versus the peer group average of 8.9x. We think the higher multiple isn't justified at current levels. We see QLYS' growth rate slowing early in the New Year and think the current valuation is pricing in future earnings that we don't see necessarily playing out. We recommend investors to stay on the sidelines and wait for more attractive entry points down the line.

The following chart outlines QLYS valuation against the peer group average.

Word on Wall Street

Wall Street is less optimistic about the stock. Of the 20 analysts covering the stock, four are buy-rated, 12 are hold-rated, and the remaining are sell-rated. We think Wall Street is more cautious about IT spending in 2024 amid macro uncertainty. The stock is currently priced at $202. The median sell-side price-target is 153, while the mean is $151, with a potential downside of 24-25%.

The following chart outlines Wall Street's sentiment on QLYS.

What to do with the stock

We continue to like QLYS' position in the Vulnerability Management market in the mid-to-long run, but we see more near-term pressure due to the macro backdrop. We don't see room for more near-term upside and believe valuation is too high at current levels. We think QLYS will remain resilient but don't see material outperformance and hence recommend investors stay on the sidelines and wait for better entry points down the line.

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