Up 50% Year to Date, Is Cloudflare (NET) Still a Buy?

Shares of internet security company Cloudflare, Inc. (NET) have had an impressive 2021.  NET is currently up 50% year to date (YTD), outperforming its benchmark, iShares Expanded Tech-Software Sector ETF (IGV), which has returned 13%.

Headquartered in San Jose, CA, NET is a web infrastructure and website security company that provides a wide range of services aimed at securing the external and internal resources of their clients such as websites, APIs, and behind-the-firewall applications. The company also provides services to increase the performance of customers’ business-specific applications.

In this article, I will analyze NET from a qualitative and quantitative standpoint to see if the stock is still a Buy after its bullish run over the past 9 months.

Recent Developments 

On September 27th, CloudFlare announced that it had entered the email security niche. CloudFlare noted that clients would be able to “create custom email addresses, manage incoming email routing, and prevent email spoofing and phishing on outgoing emails” for free. The company also said that users could get early access to its Advanced Email Security Suite. This development, having failed to impress investors, did not help NET shares avoid the 5% decline that followed.

Recent Financial Results 

Cloudflare’s revenue for its fiscal second quarter of 2021, ended June 30th, 2021, increased 52.8%% year-over-year to $152.4 million, topping Wall Street estimates by $6.3 million. This increase was primarily driven by a higher number of new paying customers and the expansion within the company’s existing paying clients. 

Notably, the company’s paying customers came in at 126,735, up about 32% from the prior-year period. Also, the company’s gross profit margin and free cash flow margin have been reported at 77% and (6%), respectively. These figures represent a respective improvement compared to 2Q2020 by 1% and 14%. As a result, its Non-GAAP EPS stood at ($0.02), surpassing analysts’ expectations by $0.02. 

The company’s EPS for the third quarter of the fiscal year 2021 is expected to come in at ($0.04) versus its year-ago figure of ($0.02). However, Cloudflare sales for the next quarter are estimated to advance 60.60% year-over-year to $165.66 million.

Finally, Cloudflare trades with rich valuations compared to the sector’s median levels, which is a common sign for high-growth stocks. For instance, its Forward P/S and EV/Sales multiplies stand at 55.53x and 54.97x versus the sector’s median of 3.90x and 3.92x, respectively. 

How much volatility are options traders expecting for the stock? 

Taking a look at the January 21st, 2022 option chain, we can determine the expected price movement by using the long straddle options strategy. Using this method, my calculations indicate that Cloudflare’s stock could rise or fall by about  22% by the January expirations from the $110.00 strike price. This estimate would place the stock in a trading range of $87.63–$137.05 by mid-January. In addition, let’s shift our attention to the number of open calls and put contracts as well. In Cloudflare’s case, the number of open calls at the $110.00 strike price outweighs the open puts by around 2.2x. At the time of writing, there are 2,089 calls to 941 open puts. This divergence comes up with that options traders are rather bullish than bearish on NET stock’s medium-term growth prospects.

Conclusion 

Cloudflare is a high-quality business that continues to expand in the cloud infrastructure market at a solid pace, as evidenced by its improving margins profile and strong revenue growth rates. 

Wall Street rates NET as a “Buy” with an average price target of $128.78, representing a 15% upside.  Options market sentiment is favorable for NET stock as well, taking into account the call/put ratio. 

I believe that Cloudflare is a great long-term buy candidate and the recent pullback allows investors to scoop up shares at a discounted price.