Three Buy-rated software stocks that don’t deserve to crash anymore: Analyst

Software stocks have been clobbered in recent weeks. But is now a good time to go shopping? Read More...

Investors are back to hating software stocks for the most part.

The iShares Expanded Tech-Software Sector ETF is down 10% in the past month, badly underperforming the S&P 500, while several key components in the ETF — notably Adobe (-15%) and Salesforce (-19%) — are down far more.

Analysts pin the blame for the renewed selling pressure on economic fears that are driving a slowdown in sales growth for the once-hot space.

“Macroeconomic concerns remain the topic du jour as investors look for clues and attempt to distinguish the companies and categories that are more or less cyclically exposed,” Brad Zelnick, analyst at Deutsche Bank, said in a note to clients after meeting with leaders of 45 software companies at a Deutsche Bank conference.

That said, Zelnick noted that while the software sell-off might persist in the near term, there are a few names investors should begin considering as buys ahead of demand improvement in 2023.

Here were the main takeaways from Zelnick’s note:

Near-term setup for the software industry

“For the most part, management teams characterized the demand backdrop as unchanged from that exiting last quarter (i.e. increased deal scrutiny and deal slippage) and we expect this message to persist throughout a heavy September conference season, which could create some optimism around the state of the demand environment,” Zelnick wrote.

However, the analyst added, “we contend these observations bear risk given how backend loaded Software quarters tend to be, especially for large deals that can make or break a quarter. Sequential changes in demand often come as quarter-end surprises to Software companies, which is a dynamic we saw play out in 2Q and expect will likely persist into 3Q.”

A man arrives with a bundle of balloons at the Salesforce Tower and Salesforce.com offices in New York City, U.S., March 7, 2019. REUTERS/Brendan McDermid

A man arrives with a bundle of balloons at the Salesforce Tower and Salesforce.com offices in New York City, U.S., March 7, 2019. REUTERS/Brendan McDermid

A man arrives with a bundle of balloons at the Salesforce Tower and Salesforce.com offices in New York City, U.S., March 7, 2019. REUTERS/Brendan McDermid

Buy #1: Snowflake

  • Price Target: $190

  • Upside Assumed: +11%

“Based on our conversation with CFO Mike Scarpelli, we come away from the conference feeling better that fiscal first quarter issues were more isolated and that the secular tailwinds are only strengthening, with a market opportunity large enough for multiple massive winners (and no meaningful change in competitive dynamics),” Zelnick explained. “The extent to which Snowflake proactively helps customers drive workload optimization/value impressed us and seemingly yields larger, more loyal customers over time. We also appreciate comments that an increasingly larger base of business helps to more accurately forecast its consumption based revenue model.”

Buy #2: Zoominfo

  • Price Target: $75

  • Upside Assumed: +81%

“Based on our conversations with CFO Cameron Hyzer, companies are not looking to cut back on ‘feet on the street’ sales people but are looking to be more efficient and drive impact with their sales and marketing investments,” the analyst wrote. “Zoominfo’s high quality sales data, quick return on investment and targeted marketing/talent solutions are playing well in this backdrop, along with shorter sales cycles that management believes enable them to better shape their messaging to the current environment.”

Zelnick added: “We walked away more confident in Zoominfo’s secular leadership, less concerned about its Software/VC exposure (sub 40% and sub 10%, respectively) and comfortable with continued outperformance potential vs. a conservative guidance setup that embeds further macro deterioration for the remainder of the year.”

Buy #3: Salesforce

  • Price Target: $255

  • Upside Assumed: +67%

“As our top GARP [growth at a reasonable price] software pick, our perspective on Salesforce is less about the company’s attendance at our conference, but more based on our broader sector thinking coming away from the event,” Zelnick said. “The company scores very strongly across all aforementioned criteria and investor sentiment is incrementally negative post fiscal second quarter results with the stock -14% vs. the IGV Software Index -7%.”

“We believe the model has been prudently de-risked for the second half of the fiscal year,” he continued, “with our rough math suggesting guidance implies about a one-third reduction to its NNACV target, likely implying a year over year decline in new business which is what occurred during the Great Financial Crisis in 2008/2009.”

Beyond the company’s latest earnings, Zelnick noted he sees “the unveiling of a first-time $10 billion share repurchase authorization as a watershed moment, underscoring the company’s commitment to shareholders, and naturally an expression of the value it sees in its stock. Additionally, holding the line on 20.4% non-GAAP operating margin for FY23 despite reducing FY revenue by $800 million (now $30.9-31.0 billion) was a strong display of fiscal discipline which we feel we can count on in the Amy Weaver era (CFO since Feb 2021).”

Brian Sozzi is an editor-at-large and anchor at Yahoo Finance. Follow Sozzi on Twitter @BrianSozzi and on LinkedIn.

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