All Signals Go for F5
09/28/2011 3:46 pm EST
Let’s say this rally runs for a while—like maybe right into earnings season. What about a good buy or two?
(I wouldn’t recommend getting giddy here, though. Remember that the August 31 high on the S&P 500 is 1,219, and the July high is 1,344. This market is in a trading range, in my opinion, until it demonstrates otherwise, though there is a question of where the top is, 1,219 or 1,344. The bottom seems pretty clear at 1,120.)
Both stocks are obviously very responsive to news that suggests the Euro debt crisis might not take down the global economy. Freeport McMoRan was up 5.9% yesterday morning and Johnson Controls 6.2% in the big “euro-crisis-is-over” rally.
But both stocks are also still way—and, I mean, way—off their 52-week highs. Freeport McMoRan is trading at $33.31 today, when its 52-week high is $60.75. Johnson Controls is at $27.56, when its 52-week high is $42.92.
But I’d like to suggest a third category of shares that’s worth a look, especially if this rally extends until the start of earnings season on October 11. (Alcoa (AA) reports that day, and the company’s earnings announcement marks the unofficial start of earnings season.)
And that’s crushed technology stocks. Stocks in the sector dropped along with everything else in the recent market plunge. Third- and fourth-quarter earnings are historically the strongest for technology stocks. And at recent valuations, I think earnings season could give them a lot of momentum, making them a good alternative for investors who might be overweight commodities or industries.
F5 Networks has certainly been hammered in this sell-off. The shares are trading at $76.70 today, September 28. And the stock is barely off its 52-week bottom at $69.01…and way below its 52-week high of $145.76.
The fact that the shares are down big, however, wouldn’t mean anything without the company’s current growth story.
F5 Networks is a networking specialist—it doesn’t try to compete with a giant like Cisco Systems (CSCO) by doing everything, and instead concentrates on doing one thing really well. That one thing is the delivery of applications across networks, in what’s called the application delivery controller market.
Application delivery controllers sit in front of a company’s servers and figure out where the traffic is coming from, what kind of traffic it is (voice or data, for example), and then figure out the most efficient way to deliver the traffic to the appropriate server. All in real time.
During the last few years, F5 Networks has doubled its share of the Layer 4 through Layer 7 server switch market to about 50%, according to Standard & Poor’s, but the really exciting action is in the Layer 7 part of that market. This is the switching layer that lets applications access system interconnections to exchange information.
Increasingly, processing at this layer includes functions that used to be performed by the server or the application itself, including encryption, compression, and rate shaping. F5 Networks’ products at Layer 7 put the company at the core of such fast-growing trends as cloud computing and virtualization. More customers are buying products of this kind to increase the efficiency of their networks, and to cut costs.
Wall Street is projecting earnings growth of 24% for the fiscal fourth quarter that the company is scheduled to report on October 25. (F5 does have a history of reporting positive earnings surprises.)
The recent big price drop has brought the projected price-to-earnings ratio for the fiscal year that ends in September to 27.2, for a PEG ratio (PE to earnings growth rate ratio) of just over 1, extremely low for a fast-growth technology stock.
Especially one that’s sitting on a slew of new products, including its VIPRION 2400 mid-range chassis, which began shipping last quarter, the new version of its core TMOS software, the new “Centaur” blades for VIPRION (scheduled for early in calendar 2012), and new virtual appliances scheduled for 2012.
That will lead to sales growth of 20% in 2012, S&P projects, even in the current economy. Gross margins will increase to 82% in fiscal 2012, S&P says, and operating margins to 39%.
I think a price of slightly below or above $80 a share is a good entry, so I’m adding the shares to Jubak’s Picks today with a target price of $120 a share by September 2012.
Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund, may or may not now own positions in any stock mentioned in this post. The fund did not own shares of F5 Networks as of the end of June. For a full list of the stocks in the fund as of the end of June, see the fund’s portfolio here.