Saturday, July 25, 2020

Why I added Crowdstrike Holdings CRWD (NASDAQ)

With Nasdaq trading at its all time high, there's not much low hanging fruits left and I have to look elsewhere for more unfamiliar tech companies and came to know Crowdstrike Holdings. It is not exactly trading at a cheap valuation, with 33.5 times price to sales. On 6 Jul 2020, I bought 10 shares at $109.12 because of I am convinced there are still plenty of growth ahead and it demonstrated a strong ability to secure clients and high retention rate. As a result, the company had a good run, and recently showing some weakness at $100 range, declining from its overbought level. Moving forward, I will be keeing much cash to potentially buy more on dips.

Crowdstrike Business

Crowdstrike is recognized by Gartner as one of a few leaders in endpoint security . Unlike antivirus (AV) protection where it protects an indivdual personal computer or a device, endpoint security detects malicious activities and protects the whole network including servers and devices from a malware attack. It is more frequently used in enterprises and organizations rather than individual or home use. New corporate cultures such as working from home and bring your own device policies in light of the current situation has made endpoint security more relevant than ever. In fact, Crowdstrike has gotten a boost from Covid 19.

Another difference between a traditional AV and Crowdstrike's endpoint security is that the former blocks the intrusion of virus or malware by relying on its signature. Hence if the malware was not captured in it's antivirus database or a software experiences a zero day attack, it could end up firing blanks or left undetected. The latter is cloud based and uses machine learning, realtime monitoring of events to diagnose if a particular file or application is malicious. If it detects a suspicious application, it uploads the particular file to cloud, sandbox it and monitor it realtime for any malicious activities. Hence Crowdstrike is benefitting from sort of a 'network effect': the more clients they acquire, the more signals it gets which results in a better threat graph.




Financials



At first glance, it appears that Crowdstrike has relatively high debt. Yet a huge poportion of debt is made up of deferred revenue, which is a plus point to me. Deferred revenue is an unearned revenue  Crowdstrike received in advance which its service has yet to be delivered. It is very common in SaaS companies, when a year of subsciption fees are billed upfront. Once delivered, it will be poportionally recognized and show up in income statement under Revenue.

Strong Growth in Deferred Revenue

A strong growth Deferred Revenue shows that they have managed to secure new contracts which will be delivered during contractual period. Hence, we should keep an eye on its deferred revenue as any signs of slowing deferred revenue will point to a weak sales growth in the next few quarters.

Valuation

Since Crowdstrike is not profitable yet, there are not much valuation metrics which I can apply to this stock. I will be analysing its free cashflow from Q4 2019 to Q1 2021.

As the revenue grows, so does the Net Cash Provided by Operating Activities, with exception of Q1 2020 and Q2 2020. I digged deeper into the financial report to analyze what could have caused a  negative operational cashflow in Q2 2020. That quarter showed an exceptionally high General & Administrative Expenses yet there is no explanation on the sudden spike in G&A; but management expects G&A to decrease as a percentage of revenue over time. It could be that G&A expenses incurred in Q1 2020 were only registered in Q2 2020 as Q1 shown relatively low G&A.

Percentage of G&A by Total Revenue

I plotted the percentage of G&A by GAAP total Revenue and the results seemed to align with management's anticipation. Hence, it would be fair to assume that the spike in G&A is just a one time off.






The past few years has seen strong revenue growth but management's revenue guidance for FY 2021 of USD 723-733mil  i.e. 53% increase, meant growth will be slower than the prior years.

To value the stock, I will be using a discounted cashflow by extrapolating its growth and then poject its relation to free cashflow through the Free Cashflow Margin. 
Using CAPM to calculate Discount Rate:

E(R)= Rf + β (Rm - Rf )
= 0.69+ 0.91 (5.5)
=5.695

According to MarketWatch.com, CrowdStrike has a beta of 0.91, and that gives a discount factor of only 5.695%. I am a little hesitant to adopt a low discount factor for this growth stock and revise it to 8%.


Revenue Growth and Terminal Growth Rate
As Revenue are still growing at high figures, I think that average growth of 30% for the next ten years is conservative for Crowdstrike's growth.

DCF has two major components: forecast period and Terminal Value. As forecasting gets more challenging when time horizon grows longer, a perpetuity growth rate of 2% is assigned with the assumption that revenue will continue to grow, albeit at a slower pace. 

Net Cash Provided by Operating Activities as a % of Revenue
Cash Generated by Operating Activities making up 50% of revenue may seem to be on a high side when Form 10K showed Crowdstrike generating positive cash flow from Operations in Year 2020 with only 21% of Revenue. If we analyze its quarterly reports, cash generated from Operating Activities only started turning positive in 3Q 2020, making up of 31% of Revenue in 3Q 2020 and 43% at 4Q 2020.  Hence its net cash generated as a percentage of Revenue in 2020 was actually marred by first two quarters of negative cashflow. It continued to grow with 1Q 2021, making up 55% of Revenue. Currently, Crowdstrike is in its growth stage and its emphasis is on acquiring clients instead rather than profitability and ability to generate cash. Over time, costs as a percentage of revenue could decrease once they have captured a larger share of the market and lesser costs is required to retain existing clients. (see below)

Operating Expenses as a Percentage of Revenue (quarterly) decreases with time

Operating Expenses as a Percentage of Revenue (Yearly) decreases with time


Purchase of PPE
Past three quarters' average was 13% and I would assume a 15% for 2021 onwards.

Capitalized Internal-Use Software 
The yearly trend showed a modest increase in Capitalized Internal-Use Software and only comprised of 1% of the Total Revenue for the last two quarters. 



Summing up present values= USD 143.28

Potential upside of 43%. (current share price of $100.03).

Whats your take on Crowdstrike Holdings. Would you purchase at current levels? 

p/s Indeed its hard to swallow at today's price to sales of 33.5 times, but such levels simply indicates that market expects strong growth in upcoming earnings. If the upcoming financial results can exceed these demanding valuations, it can still be undervalued.

Anyways, I hope you find this analysis useful or as a starting point to do research on this stock. If there is any particular stock that you would like me to analyse, feel free to drop a comment down below! :)

Thanks again for reading. Happy investing and if you are keen to follow my posts or get updates, do like/follow my FB page here where I will update once there's a new post.

My Transactions



Wednesday, July 8, 2020

Arista Networks- riding the cloud computing wave with potential upside

I got to know Arista Networks (NYSE:ANET) through Motley Fool's article back in 2019 as I was browing through its website. Back then, the stock was trading at its peak level of $324 and it rode on the growing demand of cloud computing. I added 5 shares without giving a second thought and 6 shares at $195.77 to average down. Currently it is trading at $210.78 (8 July).

It had a good run since it was listed in NYSE and the stock trended downwards after it reported its first quarter earnings on 2nd May. Although results showed a solid set of numbers with revenue growth of 26%, the drop was attributed to forward guidance on slowdown in orders from tech titan, which was believed to be Microsoft. Despite assuring investors it was a short term issue, it gapped down and opened at $261 the following day.

Earnings forecast continued to disappoint on 3rd quarter with another cloud titan cutting down orders. Despite several quarters of earnings disappointment,  I felt that its current pe ratio of 21.66  is whole lot more reasonable in valuation compared to the past years. Here's why:


Very strong Balance Sheet


Today, many tech companies listed in Nasdaq reported earnings loss, huge pile of debt and analyst continues to be bullish on its outlook. They could be in their growth phase with much growth catalyst. However, Arista Networks is unlike any of these. It has a strong balance sheet with minimal debt and large pile of cash. In fact during uncertain times that we are going through, companies with strong balance sheet stands the test of time and could emerge stronger post covid. Its cash & cash equivalents and marketable securities accounts for more than 50% of its balance sheet because it is able to consistently generate free cash flow. Its cash has been growing every year too.  I remembered reading investment books in the past which describes two kind of stocks investors should own: growth stocks or value stocks. In the case of Arista, you have can have the best of both worlds, tapping onto the growth in cloud computing and trading at relatively attractive valuations.

Its future growth in Data Centre Network & Artificial Intelligence

Under such challenging time, when many companies earnings forecast are in doubt, I think this company could be one of the Covid 19 beneficiary. The virus has actually speed up the adoption in digital transformation. CEO of Microsoft , Satya Nadella said: We have seen two years worth of digital transformation in two months.

It is a matter of time when the world recovers from Covid19 with more face to face interactions, but the new normal will change the way we do business, socialize and leisure.Given a choice, employees would still opt for online meetings to save traveling time and more cost effective. Consumer may prefer to catch the latest Netflix show at the comfort of their home over a cinema trip.

All these meant a rising demand for strong network infrastructure and Arista stands to benefit from the growth. When consumer are obsessed with online games, Facebook streaming and riding on the Netflix bandwagon, it will cause an sizable strain in the Ethernet connectivity, speaking from the server side of things. While the current 400G switches were only developed around two years back, 800G is getting underway - currently in its stage of standards perfection and testing before rolling out. This meant that Arista will stand to benefit from sales of network switches as companies constantly upgrade their switches to accomodate higher networking speed.




Leader in Data Centre Networking





Arista has been stealing Cisco's market share in switch market share in the past years, however, there's still much competition among big names, such as Juniper Networks, Huawei etc. One of the reasons which makes Arista stands out is its amazing operator experience i.e. great customer experience. In the video, Arista's COO mentioned that it only takes 18 seconds for a person to reach a real life Arista staff to assist in his query, and not a machine and they are the not operator assistance to transfer your call to a technician, but are trained support staff who can solve your problems. Checkout the video here: https://www.youtube.com/watch?v=6FTrdjF3Hoc&t=314s

Secondly, in terms of  Data Centre Networking, Arista has beeen ranked as a leader in 2019 Magic Quadrant for 5th Consecutive Year. To be ranked as a leader means excelling in both vision and execution. This means that they have a clear understanding of market needs, and ability to stay competitive and come out with innovative solutions to be well postioned for tomorrow.




Valuation

Since Arista doesn't pay dividend, valuing the stock using Dividend Discount Model is not possible. I will use DCF since it generate substantial Free Cash Flow.

I will use CAPM to determine the Discount Rate.

Beta=1.16 (as of 5th July)

Market Risk Premium =5.6%



Risk Free Rate= 0.69


Discount Rate= Risk Free + Beta x Market Risk Premium
                      =  0.69 + 1.16 x 5.6
                      = 7.186

I would use a growth rate of 5 % till 2024 and a terminal growth rate of 2% from year 2025 onwards.

Capex = Purchase of Property Plant & Equipment + Business Acquistions. 
Arista Networks aquired Mojo Networks in 2019 and purchased Big Switches in 2019. As it is more of a one time purchase, I won't be including any projection of business acquisition for 2020 onwards.

Average 5 year of Purchases of PE = $19,254,000. Its 5 year trend did not show an increase in purchases of PE with a rise of Revenue over the year, hence I would set the future Capex to be $20mil.


Summing the all the years of Free Cash Flow per share= $263.48

Since Arista is in a net cash position, and sitting on a pile of cash, I am inclined to include its cash & Equivalents and Marketable Securities to calculate intrinsic value. It was mentioned in its annual report that marketable securities are highly rated securities with the objective to minize potential risks of principle loss. Returns may be low but it's also for the purpose to meet working capital needs when they may require access to liquditiy. Moreover Cash, Cash Equivalents and Marketable Securities were lumped as one category in Consolidate Balance Sheet Data in its AR

Value of Cash+ marketable Securities= $2,724,368,000
Outstanding shares as of 2020 =76,264,000
Cash+ Marketable Securities/share= $35.72

Present Value of Arista Networks= USD 299.20

My Transactions



What's your view on Arista. Would you invest at current prices?


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Monday, June 15, 2020

Why I think Link Reit (HKG: 0823) is severely undervalued


The protests hit Hong Kong to usher in a low key traditional new year celebration, with many locals looking forward to a better 2020. While many are hoping that city will turn a corner, it’s been unfortunately hit by the Coronavirus. As the virus began to abate, the protests started gaining momentum again. Since mid-2019, many mainland tourists and foreigners have largely avoided travelling to HK, and even travel insurance companies started imposing exclusion for injuries sustained during the protests (even if you are a victim).

Hong Kong shares naturally took a beating, including Reits with exposure to Hong Kong. Despite the doom and gloom, I think there are still some bright spots in the Hong Kong stock market. One of the Reits which I believe is resilient and has much growth potential is Link Reit.

Link Reit is one of the largest Reit by market Capitalization in Asia. Despite a drop from its peak at HKD 99.8 to current level of HKD 67.1 (price as of 12th June)  it’s market cap is HKD 138 bil (SGD 24.8 bil).  In Singapore, the largest market cap Reit is Capitaland Mall Trust, with a market cap of (only) SGD7.3bil.



Some history of Link Reit

Link Reit’s properties was formerly own by Hong Kong housing authority, which consisted of shopping malls, carparks, wet markets and welfare centres. Most of the units are located near housing estate, serving the poorest, and elderly people with disabilities. Government then made the move in 2005 to privatize and list in the stock market. Since it was privatized, it was managed in a ‘business school fashion’, with the cash generated from housing properties to venture into commercial properties, and undergoing asset enhancement works and sending rental price soaring. This drove out cheap family run shops, and less business opportunity for lower income people who cannot afford the rent.

Hence housing estates termed Link Reit as a ‘Blood Sucker’, ‘Corporate Monster’ and the ‘ugly face of Capitalism’. The rental increase has been an increasing concern that the matter was brought to Carrie Lam to propose capping rental increase in Link Reit.

Despite the unhappiness among residents, Link Reit has done well for shareholders and outperforming Hang Seng Index. Unfortunately, it has given most of that back since the onset of protests.

However, I felt that the decline in Link Reit price is overdone and below are some of the points on why I think it is undervalued.

Here’s why.



Suburban Malls located in heartland Areas

Earlier this month, Link Reit announced its full year results ending Mar 2020. Despite the protests and Coronavirus lockdown, Link Reit achieved a revenue growth of 7% year on year and managed to increase its distributable Income by 4.23%  It’s occupancy rate for Hong Kong properties stands at 96.5% and 97.8% for mainland China property.

Link Reit Malls are mainly situated in suburban areas close to residential properties, hence it’s properties are less affected by disruptions or roadblocks caused by the protesters, as compared to shopping malls in central HK. Even as protests continues, life will still go for Hong Kongers. Residents will continue with their daily life shopping for groceries, necessities and ordering food.

Here’s the breakdown of it’s Trade Mix.



From the chart, its Food Related Trades: Food & Beverage, Supermarket & Foodstuff and Market/Cooked Food stalls account for 64.1% of the total portfolio as of 31st March 2020. With the bulk of it’s rent deriving from food and retail, it’s earnings should remain resilient despite the ongoing economic challenge.  Although Food & Beverage suffered a dip in rental tenant, its drop of 3.4% in sales growth was caused by social distancing measures in Hong Kong and China during the lockdown period rather than the HK protests.


In FY2019 ending September, Food & Beverage manage to register a growth of 2.1% Year on Year in growth in gross sales psf despite the ongoing protests. This shows that the protests have minimal impact on F&B sector. Management has also said in the results briefing on 1st June that things are slowly returning to normal. F&B, especially fast food outlets are experiencing a positive surge in the takeaway orders. As for retail stores selling discretionary goods, online orders help to make up for the decrease in footfall. The same is happening in China as well. 

Hence, should the economic situations and protests worsens, the overall retail portfolio stays resilient with trade related tenants accounting for 64.1% of retail portfolio’s Revenue.

Leverage within ‘A’ Rating

Since the start of the year, many Reits got a credit rating downgrade due Coronavirus, especially Hospitality and retail sector. This is especially true in Hong Kong.

Whereas for Link Reit, they managed to maintained their credit rating. In general, the better the credit rating, the lower the costs of debt.



To qualify as a reit, a company must have a bulk of assets & income related to real estates distributes 90% of the taxable income to shareholders. Hence Reit tend to hold lesser cash reserves and dependant on raising of cash in order to fund property acquisition. Cost of Capital is important is important to Reit, especially it comes to debt financing. It is the 2nd cheapest option after funding via retained cashflow. The formula for REIT’s cost of capital is Total Interest Expense/ Total Debt.

With its sound financial position, and cash balance of HK$ 7.8b, it’s average costs of debt stands at 2.94%. Recently, it managed to issue green bonds at an interest of 2.875%, rated A2 and A by Moody & S&P respectively yet purchase HK$2.8bil investment grade bonds of BBB+ on average, yielding 3.5%, benefitting from the spread in interest rate. This is done so to manage surplus cash and enhance returns to shareholders.

Hence under challenging times, Link Reit is well positioned to acquire more properties with lower cost of debt. It’s low gearing also gives Link Reit ample room to take on more debt and acquire properties under distress during market downturn.

Pipeline of Cashflow generating properties & Good AEIs to come

Link Reit also seeks to strengthen it’s portfolio through Asset Enhancement Initiatives. Since IPO till date, it has completed 85 enhancement projects. Generally Retail Reits tend to benefit from AEI as it unlocks the potential value of the mall by enhancing the retail environment and strengthen its appeal to shoppers.  

Being one of the largest Reit has it’s advantages. It has the financial clout to acquire more properties with better terms and favourable deals. Reits of such size also has ability to undergo more AEI without impacting its DPU significantly. For instance, a Reit consisting 10 properties undergoing AEI for two shopping malls will have greater impact on its overall on its NPI compared to Reit with having 132 properties.

Currently it also has pipeline of 23 AEI projects, with 19 projects under planning which will improve its DPU once completed. 

Valuation

Unlike the size of Champion Reit or Mapletree NAC Trust , Link Reit has a portfolio of 131 properties hence, I am unable to analyse individual properties in depth. I will be valuing based on 3 stage dividend discount model.

It is interesting to note that the management has been actively conducting share buybacks and cancelled the shares prior to the financial year end, a positive sign to investors which signals that it not only has sufficient funds to acquire properties, but positive outlook on the company’s future prospect. It's different from the buyback seen in SGX, where management conduct buyback shares but only held as treasury shares and to be issued to management for share vesting purposes or when stock options are exercised.






As management highlighted that retaining tenants is the key over increase in rental, I will assume a zero revenue growth from Mar 2020-2022, followed by a growth of 7% growth for the next 5 years 2022-2027 and terminal growth rate of 2%.

The average YoY drop in unit since 2015 is 2.13%. For units in issue, I will assume a 1.9% YoY decrease


NPI Margin
Although the average NPI margin is 74.9%, I am inclined to use NPI margin of 76% throughout because FY2018 results onwards shown a NPI margin above 76% and it’s improving year on year. Hence NPI Margin= 76%

Ratio of Distributable Income/NPI
Ratio of Distributable Income/NPI is fairly stable at low 0.70 range. I shall use the average of 0.73.

Discount Rate
Discount Rate= E(R)= Rf + β (Rm - Rf )
= 0.543+ 0.6 ( 5.43 – 0.543)
=3.4752.

According to CAPM, Link Reit has a low discount rate attributed by its low beta.

I will be more conservative and assume a discount rate of 5%.



Summing up all present values = 2.8+2.7+2.8+2.9+3.1+3.2+3.3+116.4= HK$ 137.3

If one holds a pessimistic view on Hong Kong's future after 2047, and Chinese government officially takes away all HK properties and Link Reit cease to exist.

We can find its intrinisic value by calculating perpetuity cashflow from 2047 onwards and discounting it to present value.


Hence, intrinic value of Link Reit= 137.3-64 = HK$ 73.3. It's still undervalued even with such conservative standards.

Anyway, my belief is that Chinese government will want to maintain Hong Kong's 'One Country, Two Systems' framework beyond 2047. I think there are many reasons to do so, one of which is HK's status as a gateway for global capital, benefitting Chinese companies listing in HKSE to raise funds. 
Also most of the properties owned by Link Reit have a leasehold of 50 years from 2005-2009 onwards, hence, it's very likely that Link Reit continue to exist beyond 2047.

There are many many more positive points on Link Reit which I did not touch on, as well as other commercial properties and carpark which it owns. As spoken in my previous posts, I would like to maintain the momentum in blogging. The key is to blog consistently and not to break the chain, rather than to blog a very long post.


What are your thoughts on Link Reit? Do you think current price is undervalued?

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