J.P. Morgan Says Now Could Be a Good Time to Buy Cybersecurity Stocks; Here Are 2 Names With Promising Growth Potential
In today’s digital world, there will always be a need for cyber security. Too many of our essential systems, from the upper levels of government and finance to the automation systems that run traffic lights, depend on online connections to ignore the basics of securing our computer networks. Recent events, including ongoing questions about election integrity, deep macroeconomic volatility, and the Russian war in Ukraine, have simply underscored the importance of cybersecurity.
Against this backdrop of accelerating tailwinds, cybersecurity has become a top priority for tech managers. The situation has caught the attention of JP Morgan analyst Brian Essex, who says, “With less than $200 billion in corporate spending to address the estimated annual cost and value destruction of over $1 trillion associated with… Cybercrime, we expect security budget growth to outpace IT budget growth for the full year, and with multiples now below pre-pandemic levels, we see several compelling security opportunities.”
Essex does not leave us with a macro view of the sector. Going further to the micro level, the analyst picks two cybersecurity stocks that he sees as potential winners in the coming months. These are buy-rated stocks that the analyst believes have promising growth potential. Let’s take a closer look.
Fortinet, Inc. (FTNT)
We’ll start with Fortinet, known for its line of high-quality digital security products, including firewalls, endpoint security, intrusion prevention, antivirus systems, and zero-trust access. Fortinet’s products and services are used to secure and protect data, networks, and system users. Over the past few years, Fortinet’s quarterly revenue has grown steadily as demand for cybersecurity has increased.
A look at the numbers confirms it. In 2019, before the COVID-19 pandemic forced a major shift in online and network connectivity, Fortinet had total revenues of $2.2 billion; in 2021, the most recent full year with available data, the company had sales of over $3.3 billion. In its most recent reporting quarter, 3Q22, revenue was $1.15 billion, up 33% year over year. The Company will release fourth quarter and full year 2022 data on February 7; we will then see how the trend line continues.
In the meantime, looking at the drilldowns on the Q3 data is instructive. Product revenue increased 39% year over year to $468.7 million, while service revenue increased 28% to $680.8 million. Billings rose 33% to $1.41 billion, and deferred revenue, a measure of future work and income, was $4.19 billion, up 35% from the year-ago quarter. The company’s diluted non-GAAP EPS of 33 cents was up 65% from Q3 21.
Fortinet also has deep pockets to handle eventualities. The company brought in $22,483 million in cash from operations in the third quarter, which included $395.2 million in total free cash flow. This came after spending $500 million in cash to buy back shares. The company had $964 million in cash and cash equivalents at the end of the quarter.
JP Morgan’s Essex began coverage of Fortinet with an Overweight (ie Buy) and price target of $69, suggesting a 1-year upside potential of 31%. (To see Essex’s track record click here)
In support of this stance, Essex writes, “We think current valuation levels are compelling as the company is on its mid-term target of $10 billion in sales, $8 billion in sales and adjusted FCF margins in the mid-to-high range of 30% working towards 2025. In our view, demand for core firewall, segmentation, SD-WAN and OT security is strong enough to support double-digit growth in product sales, with subscription acceleration and gross margin expansion being continued fundamental strength push forward.”
Tech stocks tend to draw a lot of attention, and Fortinet is no exception — the stock has 20 analyst ratings on record, including 13 buys versus 7 holds, to give the company its Moderate Buy consensus recommendation. The stock has an average price target of $63.56, indicating room for ~21% growth from the current price of $52.86. (See FTNT Stock Forecast)
The second stock we look at is Okta, a cloud computing company that offers security software for user authentication and identity control. The company’s cloud-based software enables enterprise customers to deploy secure user authentication and identity controls built directly into apps, devices and website services. Okta has been in business since 2009, a public entity since 2017, and currently has over 17,000 customers.
The cybersecurity industry was valued at more than $200 billion last year and is projected to reach $266 billion by 2027. Okta carves a piece of that pie, having combined sales of $1.3 billion in fiscal 2022. The company exceeds this sum in the current financial year; In the first three quarters of fiscal ’23, Okta already generated $1.35 billion in revenue. Okta will release its full-year data for fiscal 2023 next March.
Results for the most recently reported quarter, fiscal 2023 third quarter, showed revenue of $481 million, up 37% year over year. That included subscription revenue of $466 million, up 38% year over year. The company’s remaining benefit obligations — how the backlog is reported — rose 21% year over year to $2.85 billion, a metric that bodes well for future revenue and earnings. Currently, Okta has non-GAAP EPS that is balanced, an improvement over the 7-cent EPS loss reported in the year-ago period.
Okta’s cash flow in the third quarter was modest at $10 million in net cash flow from operations and $6 million in free cash flow, but the company’s cash and cash equivalents at the end of the third quarter were $2.47 billion US dollars in cash and cash equivalents much more impressive.
Among the bulls is JP Morgan’s Brian Essex, who calls Okta a “market leader at a discount.” Going into more detail, Essex says of the company, “We believe that digital transformation and cloud adoption will continue to drive demand for cloud-native identity management technology in the near future. Over the longer term, we believe distributed identity could also be a significant underappreciated trend, and we see Okta as one of the best positioned vendors to capitalize on each of these trends…”
“We believe the multiple compression is overdone given the Company’s market-leading position, de-risked growth expectations and valuation at a significant discount with material opportunity. The stock has significantly underperformed the S&P 500 as well as the rest of the coverage universe, but with 4.9x EV/NTM sales compared to 6.1x for the company’s security software peers, the setup is for upside potential versus OKTA compared to the current cheap share price level in our view,” added Essex.
Essex puts some clear numbers on this stance, placing OKTA overweight (ie Buy) along with a price target of $90, implying a 25% gain over a one-year horizon.
Essex leads the Bulls on OKTA. The stock is a moderate Buy by analyst consensus based on 29 ratings, including 18 Buy and 11 Hold. (See OKTA Stock Forecast)
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Disclaimer: The opinions expressed in this article are solely those of the featured analysts. The content is for informational purposes only. It is very important that you do your own analysis before making any investment.