While many enterprise software firms still look fairly expensive, some quality names look pretty reasonably priced, following three months of software stocks broadly underperforming various cyclical names seen as reopening and/or economic recovery plays.
Though it can get easily forgotten at a time when things like inflation fears, chip and labor shortages, soaring commodities prices and rebounding travel/dining spend often dominate financial headlines, the enterprise software sector still has a lot of things going for it in the current environment. Chief among them:
- Software spend continues steadily taking IT spending share from hardware. Research firm Gartner forecast in April that global enterprise software spend would rise 10.8% and 10.6%, respectively, in 2021 and 2022, comfortably outpacing total IT spending growth of 8.4% and 5.5%.
- The pandemic led many companies to make IT modernization efforts a bigger priority. And inevitably, software purchases in fields such as collaboration, security, CRM, data warehousing and analytics have factored heavily into such modernization efforts.
- Though often labeled as pandemic beneficiaries, many software firms are actually poised to see demand improve amid reopenings, thanks to improved SMB spending, rebounding demand from COVID-impacted industries such as travel and retail and/or a broader rebound in on-premise IT spending.
Meanwhile, with sector rotations often deciding in recent months which stocks happen to be rising or falling on a given day, many growing software firms sporting low or moderate multiples have sold off in tandem with more richly valued peers. I think that creates some opportunities for discerning buyers.
Broadly speaking, I’d place the enterprise software names that I think have intriguing valuations in two categories:
- Fast-growing cloud software/SaaS market leaders that for one reason or another have been given lower valuations than many other such names.
- Moderate-growth software names that don’t fit the profile (growth and/or business-wise) of recent high-flyers, but which have low multiples and differentiated offerings.
Here are three names that arguably fit into category #1:
- Salesforce.com (CRM) — The CRM software leader, which is set to buy Slack (WORK) , has an enterprise value (EV – market cap minus net cash) equal to just around 7 times the billings consensus for its Jan. 2022 fiscal year. Its earnings arrive on Thursday. (A prior article making a bull case for Salesforce can be found here.)
- PagerDuty (PD) — A top provider of alerting and incident-response software for IT departments, PagerDuty has an EV equal to about 10 times the billings consensus for its Jan. 2022 fiscal year. Its earnings arrive on June 3.
- Elastic (ESTC) — A fast-growing provider of search, observability and security software based on the open-source ELK stack, Elastic has an EV equal to 13 times the billings consensus for its April 2022 fiscal year — a consensus that might prove conservative based on how Elastic has been topping its guidance. Given a recent ~10% rally from its mid-May lows, this is a name that might be better to pick up during a correction. Its earnings arrive on June 3.
And here are three names that arguably fit into category #2:
- Dropbox (DBX) — The cloud storage platform/collaboration software provider has an EV equal to just 17 times a 2021 free cash flow (FCF) consensus of $665 million and continues to guide for 2024 FCF of $1 billion. It has also begun aggressively buying back stock and (in a move that gives it another offering to cross-sell to subscribers) recently bought document-sharing software firm DocSend).
- Mitek Systems (MITK) — Mitek is a long-time provider of mobile check-deposit software to banks, and now also has a fast-growing ID-verification software business that services banks and other financial institutions. The company is expected to post 15% or greater sales growth this fiscal year and next, and is trading for 19 times the EPS consensus for its Sep. 2022 fiscal year.
- Splunk (SPLK) — Down 48% from its December high, Splunk now carries an EV equal to just 7 times its Jan. 2022 billings consensus. Shares have been pressured by worries about executive departures, a pricing strategy overhaul and competitive headwinds in the observability software space. But it’s still considered the leader in the machine data analytics software market and should benefit from an improving on-prem software spending environment. Its earnings arrive on June 2.
As always, investors are advised to do their own research before buying any stock mentioned in an article such as this one. And for the companies set to report earnings in the coming days, please stay mindful that big post-earnings swings have been quite common for enterprise software names.
