Cybersecurity is an Essential Industry
Check Point Software Technologies Ltd. (NASDAQ:CHKP) is our top pick for building an inflation bulwark in any investment portfolio. We previously recommended CHKP as a safe harbor in June 2020 for reasons that hold water today.
Check Point develops, markets, and supports network, endpoint, and data cybersecurity software. Its services include management and organization assessments, solutions, and training.
We are bullish about cybersecurity, particularly CHKP because cyber threats are never going away. CHKP stock is up 8.15% for one year and 23.15% over the past five years. The consensus is the average price target for the next 12 months is $144 per share possibly topping $160. Some SA authors put the valuation at $137. Short interest sits at a moderately low 3.52%. The PE is 17.85 compared to the US Software industry average of 30.9x. The stock price has far lower volatility than the market.
In this case, “What’s past is prologue.”
Source Seeking Alpha
The chart above was produced when the pandemic was raging, the economy slowing, the stock market plummeting and share prices destabilizing; consumer confidence was wavering, delays in vaccine production, and the slow pace of vaccinations caused hospital overcrowding and millions of deaths. Close-contact businesses including religious services, restaurants, grocery stores, and concerts were economically decimated. The place of work changed forever, especially for computer users.
The inflation rate eventually hit ~7% then moved higher. Some economists blame higher federal interest rates and product shortages. Concomitantly, consumers who stayed home have lots of cash to spend and are driving up prices.
Inflation scenarios are compounded by fears of a recession hanging over the markets like the Sword of Damocles. We advised our readers and investors to focus investment funds on several safer categories: food stocks, tech, energy, defense and cybersecurity, home improvement, and healthcare.
Facts of Life
Protecting data is a cost no longer a choice. Governments, companies, and individuals must pay for protection or pay blackmail to secure their information. The only moderating factor to inflation in the cyber security space is the plethora of cybersecurity competitors offering competitive pricing.
The market is 35xs larger in the last 13 years. Cybercrime costs are +15% annually. By 2025, the cost will reach $10.5T. That is more money than costs from damages caused by natural disasters. Here is what every entity using computers faces: damage and destruction of data, stolen money, lost productivity, theft of intellectual property, theft of personal and financial data, embezzlement, fraud, post-attack disruption to the normal course of business, forensic investigation, restoration and deletion of hacked data and systems, and reputational harm.
It’s not a matter of when, but how deep will the torrents of inflation and recession will cut into economic growth. Stagnation is the immediate fear. Depression looms in the shadows. However, one of the best hedges against these ominous portents is a bullish position on cybersecurity stocks and CHKP in particular.
COVID-19 lingers contributing to the nation’s spiking rate of inflation. Food and product shortages persist. So do supply chain disruptions while China continues to enforce its zero-tolerance policy and lockdowns. Other causes of inflation are Russia’s invasion of Ukraine and the interruption of exports of agricultural products and industrial minerals.
Shortages in fertilizer and energy supplies are sparking inflation for food, consumer goods, transportation, and industrial production. Some blame the Federal Reserve’s record for easy-money policies and money-printing. Now, the Fed needs to “front-load” rate hikes.
CHKP Best in Class
Check Point products are: Quantum, providing real-time cybersecurity protection. Cloudguard is a native security platform preventing advanced threats while users have visibility and control over workloads. Harmony protects remote users’ devices and access. Infinity-Vision offers a unified solution ensuring 100% breach prevention, managing the entire security estate from a single point across networks.
We believe the stock will outperform in this environment. The news sentiment agrees and is universally bullish on CHKP. Hedge funds decreased holdings throughout 2020 and 2021 but started buying shares again this year.
Hedge fund holdings increased by nearly 31K shares last quarter. GuruFocus gives the stock a 98/100 score positive in all categories of measurement and forecasts the revenue trendline will continue on the upside.
Adding to the positive picture is that individual insiders own 19.5% of the shares. Institutions own 77.2%, and the public and public companies own +3%. The next reporting date is July 26, 2022, when the consensus earnings per share are forecast to be $1.62 versus last year’s $1.61. CHKP earnings per share beat forecasts every quarter since July 24, 2018.
The CHKP market cap tops $16B. The PE is 17.85. The share price rose to $128.54, midway between the 52-week high of $149.62 and the low of $107.86. Two other SA analysts are split on the stock this year between strong buy and hold. The SA Quant Rating is a current hold but tilting to the buy-side. I consider a hold recommendation to mean the stock has resistance to down winds in a period of inflation.
US stocks are weak anticipating lower corporate earnings and spending as the Fed seeks to tame inflation. That situation hurt CHKP somewhat, but over the longer term, companies and governments have to rev up cybersecurity investing again. Hacks are increasing exponentially. The number of attacks grew in 2021 by 98%, so it is only a matter of time regardless of rising costs for protection. CHKP gets high marks from SA in every other category, especially profitability:
Source Seeking Alpha
The healthy Q1 financial report (April ’22) undergirds the good grades analysts give the stock, the positive rating consensus, and the handsome outlook for the future. Non-GAAP EPS of $1.57 beat by $0.02. Revenue of $543M (+6.9% Y/Y) beat by $7.43M. Security Subscription Revenues of $202M, is +14% year over year. Deferred Revenues (as of March 31, 2022) of $1,666M, is another 14% increase year over year. Non-GAAP Operating Income of $239M represents 44% of total revenues.
Inflation is Like Fire
Inflation spreads to every sector like fire. Check Point is not inflation-proof. Check Point is an American-Israel company headquartered in Israel. Israel has its inflation rate under acceptable control at 3.1%. This undoubtedly holds some costs down for CHKP. But their biggest expense is personnel, and everyone agrees with the Haaretz statement that
The Israeli high-tech industry is on fire: Billions of dollars of investment are pouring into startups, exports of everything from semiconductors to research and development services are growing, and companies are begging for workers.
The coronavirus and the demand for digital products and services it has spurred have made Israeli tech bigger and richer than ever before. But this process is also widening the digital money divide between the high-tech elite and the rest of society.
On the downside, success hurt CHKP somewhat: Q1 ‘22 EPS of $1.32 is down from $1.35 in Q1 ’21. Net income of $169.4m is down 7.4% from Q1 ’21. The profit margin of 31% is down from the 36% it was in Q1 ‘21. The decrease in margin was driven by higher expenses.
One more caveat. Inflation has a potential impact on cybersecurity firms’ profits. Companies like CHKP have to pay more for experienced seasoned employees and Checkpoint has over 6,000 worldwide. The startup nation has been setback by too few well-trained cyber employees and is seeking to recruit more from overseas by investing $70M in a plan to grow the Arab tech workforce.
Though CHKP gets a relatively low grade for growth, the company closed this year on Spectral, a cybersecurity start-up. It cost them $60M. Spectral technology will help Checkpoint detect security issues earlier in the software development cycle. Spectral’s scanner in development identifies errors in code development and security leading to breaches. The purchase is part of management’s stated focus to drive growth.
A conservative valuation of the stock sets the price at about $160 per share. It will hit $170 in our opinion if revenue and earnings uptick in this next half-year; that is an implied upside of over 20%. We base this on an analyst’s estimate and calculations at Simply Wall Street, with which we agree, of cash flows going forward 10 years and assume the company grows at a stable rate. Moreover, Check Point is reinvesting its profits for a higher rate of return than the industry average.
Inflation might stunt CHKP’s revenue growth and profits by requiring increases in employee compensation and recruitment costs. One observer claims, “Inflation can create unseen resignation rates (and) competition for cloud security talent is razor-sharp in the private sector already.”
Nonetheless, demand for cybersecurity services will far outdistance the down winds of inflation, in my opinion. CHKP presents a valuable opportunity for investors, especially on a dip in the price. Hackers are going to make life harder by installing ransomware, creating data leaks, challenging password protections, and cloud security. PKWARE.com offers a monthly breach report they are so common. Iranian hacker group The Open Hands breached and leaked personal information about the current Mossad Director. Check Point has a healthy future ahead for which companies will pay regardless of inflationary costs.
In an age of inflation with threats of a recession in the offing, retail value investors ought to be stuffing their portfolios with highly profitable companies that are undervalued, at low risk for tumbling and have growth potential. Add in that Check Point’s equity tops $3.1B and it has no debt. Check Point Software Technologies checks off all the boxes as a hedge against inflation for retail value investors.