PANW - The Bottom Fishing Club: Extreme Networks

2023-12-30 04:14:02 ET

Summary

• Extreme Networks just outlined a -50% selloff, which seems excessive given past operating results and forward growth prospects.
• The stock should benefit from its potential as an AI puzzle piece for customers.
• An 11% free cash flow yield and ultra-low PEG valuation ratio are very attractive vs. industry peers.
• After December's wickedly oversold chart condition, a price upturn and a stronger 2024 look probable.

Extreme Networks ( EXTR ) experienced a 50% selloff between August and early December, that appears to be quite overdone, considering past business results and future growth prospects. The company is a leader in computer and wireless networking, including proprietary cloud and security management through SaaS software. Switches, routers, and other hardware are offered. In a minor way, the stock benefited from the idea its tools and products can be used as an Artificial Intelligence [AI] puzzle piece for customers. However, the excitement of potential AI growth earlier in the year was dashed by weaker management guidance for the December quarter.

There are some similarities to the peer business model and late 2023 chart pattern of my last Bottom Fishing Club selection, NetScout Systems ( NTCT ), posted a few weeks ago here . NetScout is primarily a computer network security firm.

Both are experiencing a temporary bump lower in operating results (my forecast) with a slowing global economy. Today, much smarter valuations and on still decent growth prospects are being ignored by Wall Street and main street investors alike.

The truly bullish news for Extreme Networks shareholders is above-average growth is still expected by analysts vs. the industry during calendar years 2024 and 2025, while a peer-leading free cash flow yield and PEG ratio are now available for investment.

The Business

A quick overview of business offerings is available on the Extreme Networks website here . A summary of operations is presented by management,

Trusted by more than half of the Fortune 50 , Extreme is a market leader in cloud networking. Our innovative solutions help more than 50,000 customers across the globe securely connect devices and applications in new ways, helping to enrich customer experiences, reduce risk, improve operating efficiency, and grow top line revenue.

Some screenshots from the main webpage also help to explain the value proposition to customers. The idea is the company and its partners can physically set up your network, while Extreme Networks software applications will help you access actionable data in real-time to make better decisions.

Strong Valuation Setup

Plenty of positive developments on the valuation front have appeared with the oversized share price selloff since August. The 25x P/E ratio on GAAP earnings sounds a little high at first, until you consider it is the lowest ratio for this business since 2013. Price to cash flow is the lowest since the 2020 pandemic wipeout. Plus, price to sales are hovering near 5-year and 10-year averages.

When we consider the organization's minor $195 million in total debts vs. $224 million in cash held at the end of September, enterprise valuation numbers look even better (where we add net debt totals to the equity market capitalization and divide by cash earnings before interest, taxes, depreciation and amortization). On forward projections, EV to EBITDA ratios are hovering near 5-year lows (under 9x), while the sales multiple of 1.65x is close to its average since 2018.

More good news, EV to analyst estimated EBITDA for 2024 is pointing to a clear undervaluation vs. peers and competitors. The Extreme Networks multiple of 8.6x is very appealing vs. alternatives. My sort group list includes Cisco ( CSCO ), Oracle ( ORCL ), Palo Alto Networks ( PANW ), Juniper Networks ( JNPR ), Arista ( ANET ), Motorola Solutions ( MSI ), F5 ( FFIV ), and NetScout.

Desirable Free Cash Flow

The free cash flow yield of 11% on a trailing basis is the highest for shareholders ever (the company went public in the late 1990s), outside of a few weeks during the 2020 pandemic panic in U.S. stocks, and a month during 2015. In addition, it is one of the strongest yields currently available in the computer networking sector. The trailing free cash flow yield is running almost DOUBLE the industry average. Considering FCF is one of Wall Street's favorite valuation yardsticks, EXTR should be high on your research list today.

Free cash flow vs. debt numbers have also improved dramatically from the end of 2020. Sitting at one of the most conservative ratios in the networking field, free cash flow generation over the next 12 months could theoretically be used to pay off all debt.

PEG Ratio Analysis

The best valuation argument to own shares is today's ultra-low multiple on earnings is crossed with peer-leading EPS growth rates (analyst estimated). Between now and the end of calendar 2025, Extreme Networks is projected to expand income at rates even faster than overvalued Wall Street darling Palo Alto Networks.

The sum of this equation is represented in the Price to Earnings to Growth [PEG] calculation. This growth multiple valuation technique highlights Extreme Networks as one of the cheapest in the networking sector, alongside NetScout.

Final Thoughts

The most interesting part of the 2023 chart trading pattern is Extreme Networks has had somewhat equal swings in overbought and oversold conditions. First, excitement about potential AI-related growth shot price higher by almost +100% into summer. Then, a -50% decline brought the stock quote right back to late April and early May levels.

On a 1-year chart of daily price and volume changes below, I have circled in green the overbought readings on the 21-day Relative Strength Index and 21-day Average Directional Index during June-August. In comparison, the early October to December shift to major selling and an oversold condition are highlighted with red circles.

At this stage, the share quote is slightly lower than 12 months ago, while underlying business results have improved nicely. So, long-term buyers are nibbling on starter stakes (like myself) or adding to their positions. For sure, weak-hand holders have been flushed out of Extreme Networks on the oversized price slide in the second half of 2023.

The initial hint that overhead share supply is evaporating and a reversal higher could be in progress will be when price gets back above its 50-day moving average. It's been five months since any type of short-term uptrend has played out.

Another reason to be optimistic is Extreme Networks has the largest short interest position of major names in the industry, that may need to cover soon. If price begins to zigzag higher and earnings beats are coming next year, short sellers may buy, providing additional support for larger quote increases throughout 2024.

The last two instances free cash flow yield rose above 11% (2020 and 2015) proved great times to buy the stock. I have drawn both periods, comparing price changes vs. free cash generation on your investment, below.

For a target price range in 12 months, I am modeling prices of $20 during a recession to as high as $30 again in a soft-landing scenario. I am using a 10% reduction on trailing EBITDA alongside EV multiple of 12x for a low-$20 share forecast during a mild economic contraction. On the upside, EBITDA beats of 10% and a similar EV ratio of 13x produces an upside target of $30. For reference, the industry average was over 12x for the duration of 2023 before October's step lower.

I rate Extreme Networks a Buy around $18 per share, with Strong Buy territory under $15.

Thanks for reading. Please consider this article a first step in your due diligence process. Consulting with a registered and experienced investment advisor is recommended before making any trade.

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