Why Cybersecurity Is Our Top Investment Theme, Crowdstrike vs. Sentinel One Earnings, Cyclical Investing and Macro Datapoints

This week’s Weekly Insights focuses on opportunities in cybersecurity, Crowdstrike vs. Sentinel One earnings, “hurricane” of macro data and cyclical investing.

CONTENTS

Stocks and Focus Areas 

• Why cybersecurity is a top theme for our strategies
• Not all cyber stocks are positioned equally: Crowdstrike (CRWD) vs. Sentinel One (S)

Macro Datapoints

• Investing in cyclicals: early vs. late cycle 
• Housing data continue to disappoint 
• US auto-sales down in May  

STOCKS AND FOCUS AREAS

Is it time to invest in cybersecurity? 

Cybersecurity stocks have declined (some significantly) this year. Fundamentals have, if anything, improved. While the macro environment remains challenging, IT spend could hold up relatively better. Within IT spend, we expect that cybersecurity will be the most defensible area, as increase in threats and geopolitical concerns add to an already strong secular backdrop driven by changing data architectures. Consequently, several areas of the cybersecurity market are expected to grow at ~15%+ CAGR with innovative companies capturing market share and growing significantly above that level. For more info refer to our Cybersecurity Primer.

Specifically, the two major trends within cybersecurity that we have identified as focus areas are:

Trend #1 Cloud adoption driving the need for “zero trust” solutions: as organizations embrace digital transformation, legacy firewall providers are losing relevance creating opportunities for “zero trust” architectures

Trend #2 Endpoint Security needs “next-gen solutions”: legacy solutions are inadequate and can only detect ~50% of threats. “Next-gen” predictive solutions based on artificial intelligence (AI) and machine learning (ML) are gaining market share and are expected to grow at a 20%+ CAGR for the next 5 years

Last week we had several notable cybersecurity earnings reports: Crowdstrike, Okta and Sentinel One. Overall, companies reported strong growth, >20%+ topline, with "next gen" solutions growing >40%+ rates and exceeding expectations by >5%. 

Crowdstrike vs. Sentinel One 

Crowdstrike and Sentinel One both offer "next gen" solutions for end-point security. While both earnings reports were strong at first sight, it is important for investors to dive deeper into the financials:  

• Crowdstrike is growing at scale (61% revenue growth despite relatively large revenue base - F22 $1.5bn and F23E $2.2bn) aided by comprehensive offering. The company has a solid >30%+ FCF margin and we expect it to generate $1bn+ in FCF in FY23 which provides a valuation support for the stock. Generally high growth companies trade on revenue multiples as opposed to FCF, as they do not generate cash flow, but Crowdstrike stands out on both metrics.  
• Sentinel One is a relatively newer entrant in the endpoint security space growing rapidly (>100% revenue growth rate) albeit on a lower revenue basis - F22 $200mm and F23E $400mm.  The company reported a -73% operating margin and -$55mm FCF.

Two years ago we would have viewed both reports equally favorably. However, the era of "free money" has now ended, and consequently there is a strong premium assigned to companies that can demonstrate profitable growth at scale. Crowdstrike's valuation will likely continue to look favorable on a FCF basis 1-3 years out. Conversely, for Sentinel One, investors will be looking at the run rate of cash burn (~$100-$200mm) vs. the current cash balance ($1.2bn minus $375mm for Attivio). While there is still cushion for multiple years of negative FCF, investors today are warry of <5 year runways and potential to have to raise equity. 

MACRO DATAPOINTS 

Last week we had several executives highlight week macro with headlines ranging from "hurricanes" foreseen by J.P. Morgan's CEO, Jamie Dimon, to "super worry", felt by Tesla's CEO, Elon Musk. While we expect significant downside from the economy, we would note that company management teams are generally not the most forward looking indicators. 

Weak economic data has been emerging ever since the spot trucking rates weakened in March this year. This was followed by weakness in consumer discretionary spending (especially big ticket items such as PCs, appliances etc.) in April, weak retail earnings, excess inventory, weakening contract truck pricing, followed by new home sales and declining used truck pricing in May (refer to our prior Weekly Insights series for more detail). 

The vast majority of these datapoints have been well publicized, and are following a typical economic tightening cycle. Consumer discretionary spending is the first to get impacted, followed by interest rate sensitive end-markets - housing and autos. Lastly, longer cycle commercial construction, aerospace, metals & mining sectors would be considered late cycle, and would start noting headwinds depending on the severity of the downturn, as it takes time to work through projects and equipment backlog.

Current environment vs. a typical downturn? 

• Generally downturns are caused by a shock - in this case it is commodity inflation and raising interest rates 
• Increasing interest rates create headwinds for spending that is typically financed (e.g. housing, autos) - consequently these areas are first to experience weakness and are considered "early cycle"
• Compared to 2008/09, the consumer does not have excess leverage, which limits the downside. However, the common perception that the consumer is coming from a position of strength (high personal savings), only lasted a very short time and we are now down to 2008/09 personal savings levels 

From investment standpoint, we are staying away from early cycle exposure (housing, autos and discretionary consumer spending). The industrial economy already went through a recession in 2015/16 and never fully recovered. As a result we expect general industrials, aerospace, and metals and mining to fare relatively better. We expect that the pressure will be mostly focused on the consumer. 

Datapoints from housing and autos

As expected, housing and autos are already experiencing a slow down. In addition to weak new home sales, mortgage applications and existing home sales (see our last weeks Weekly Insights) housing inventory has started to increase. Inventory bottomed seasonally at the beginning of March 2022 and is now up 56% since then (up 14% YoY).

In U.S. autos, industry sales fell 6 percent in May, with General Motors and Ford reporting lower U.S. vehicle sales for the month (~6%) due to sluggish demand for sedans and two fewer selling days. While many are still blaming supply chain issues, we believe that there is a potential of rolling over autos cycle in the US, and we are closely watching the trends.  

For more research visit out website spear-invest.com. 

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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