Analysts Very Cautious on Security Software Stocks: Just 2 to Buy Now

November 15, 2017 by 247lee

Just a few short years ago security software was the hottest segment on the planet, and with good reason. The initial public offerings were met with massive investor demand, and the corporate and government need for the software was huge and growing due to ever-increasing and sophisticated hacks. However, after years of gigantic spending to improve firewalls and guard data, the demand has slowed, and like any sector that has momentum, once the demand slows, so do the stocks.

In a new research report, Deutsche Bank has done some investigative work on the network security space, and after talking with reseller contacts in the industry, the firm is becoming increasingly more cautious on certain companies. The report noted this:

While the firewall remains a critical part of the enterprise security posture, the consensus view of our reseller checks was that traditional firewall demand is stable at best, and more likely weakening. While no one spoke about de-installing existing firewalls or a widespread uptick in price discounting, we heard commentary around a spending shift to new security technologies, a push out in customer refresh cycles, smaller deal sizes (as customers swap existing firewalls for cheaper but equally powerful appliances), the adoption of cloud / software form factors with lower average selling prices and even micro-segmentation of the data center.

Deutsche Bank currently has just has two stocks with a Buy rating in its coverage of the industry, and it does not see any significant signs of recovery in product revenue growth at the main network security vendors in the first half of 2018.

Fortinet

Deutsche Bank team has remained positive on Fortinet Inc. (NASDAQ: FTNT) and kept its Buy rating. The company is a pioneer in the unified threat management segment of network security solutions. Its security appliances offer the ability to run multiple security functions simultaneously, without a significant drop in throughput, enabled by Fortinet’s unique custom-ASIC architecture.

The company reported solid third-quarter results, but guidance for fourth-quarter revenue and billings came in lower than expected. In fact, the company’s management sees risk related to macro weakness in North Asia/Caribbean, soft Service Provider spending and complex sales cycles. The Deutsche Bank report said this:

Looking forward, we think investors continue to underestimate Fortinet’s subscription growth and the potential benefit it brings to operating margin and free cash flow. With the stock at 10.5x 2019 estimated enterprise value/free cash flow, we believe investor sentiment is sufficiently low. In fact, investors should note that the stock is now slightly above where it traded prior to the third quarter earnings report despite the company offering fourth quarter outlook that was below expectations. As a result, we think the shares exhibit a favorable risk reward profile.

The Deutsche Bank price target for the stock is $45, and the Wall Street consensus target is $43.59. The shares traded early Wednesday at $39.60.

Proofpoint

This company has long been mentioned as a potential takeover candidate, and its stock also is rated Buy at Deutsche Bank. Proofpoint Inc. (NASDAQ: PFPT) provides threat protection, incident response, regulatory compliance, archiving, governance, eDiscovery and secure communication solutions worldwide. Its security-as-a-service solutions comprise an integrated suite of on-demand data protection solutions that enable large and midsized organizations to defend, protect, archive and govern their sensitive data.

The company provides Proofpoint Enterprise Protection, a communications and collaboration security suite designed to protect customers’ mission-critical messaging infrastructure from outside threats, including spam, phishing, unpredictable email volumes, malware and other forms of objectionable or dangerous content before they reach the enterprise.

E-mail protection remains a top priority for many companies, and this is a distinct positive for Proofpoint. The company recently entered into definitive agreement to acquire Cloudmark for $110 million in cash, which strengthens its industry-leading investment in messaging security and threat intelligence. Cloudmark’s global threat network will be incorporated into Proofpoint’s nexus platform. The analyst said this in a report on the company:

On the product side, resellers appeared positive on Proofpoint’s email fraud defense solution (EFD). Recent regulations from the Department of Homeland Security on email security / authentication are seen as directly benefiting the company. In addition, contacts noted that Proofpoint was an “easy sell”. In fact contacts highlighted success even in environments where the company was not the primary email security vendor because the product can work on top of solutions such as Cisco IronPort and Symantec email.

Deutsche Bank has a $114 price target, and the consensus target is $105.30. Shares were last seen trading at $89.60.

Palo Alto Networks

This was a momentum trader’s dream a few years ago, before coming back to earth. Palo Alto Networks Inc. (NASDAQ: PANW) develops and sells network security gear, dubbed Next-Generation Firewalls, that protect customers’ networks with the ability to read the content of the traffic (not only its address) and make decisions based on the type of application and a set of access policies.

Palo Alto Networks offers parallel processing of security functions, while some of its competitors offer serial processing mechanisms, which result in a degradation of throughput or speed of the network.

Some on Wall Street see upside to estimates from better salesforce execution and the install base refresh cycle. Deutsche Bank notes that checks on the company were the most constructive of all the firewall vendors, and the firm does not see material downside risk into the earnings, which are scheduled for November 20. The analysts noted this in the research as a potential issue:

Palo Alto customers seen trading down on appliance refresh resulting in smaller deal sizes. In particular, one reseller cited a trade-down from the company’s big 7050 appliance (a pair of which can cost $1.7 million according to this check) to the new 5260 appliance. Apparently, the 5260 appliance can meet customer throughput requirements in many cases but at a significantly lower post-discount average selling price.

Deutsche Bank’s $160 price objective accompanies a Hold rating and is in line with the consensus target of $160.74. Shares were trading at $136.80.

Check Point Software Technologies

This stock was hit hard when the company posted results in late October. Check Point Software Technologies Ltd. (NASDAQ: CHKP) provides network security solutions, selling software, hardware and subscription services for IT security, with a focus of reducing complexity of security management. Its hardware is based on a software blade architecture that allows for multiple security functions to be run concurrently.

Check Point sells its solutions to service providers, small and medium-sized businesses, consumers and enterprises, including all the Fortune 100 companies. This long-time industry leader used to be a must-own stock for tech portfolios, but it has encountered some issues, which Deutsche Bank noted:

Check Point used to be on autopilot, making its quarters like clockwork. This is no longer the case, and one check claimed that sales rep turnover is starting to pick up a bit now that they’ve entered a slower growth and tougher environment. Given the company’s admission of sales execution issues as it ramped sales rep growth, this comment made us wonder whether some of the “sales execution” challenges could be turnover-related.

The Deutsche Bank price target is $114. The consensus target is $110.10, and shares traded at $102.50.

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Clearly the tables in the industry have turned some, so Deutsche Bank is playing it pretty safe. All these companies remain leaders in the sector and are solid stocks to consider for the long term, especially on a pullback.