Profitability Concerns Keep Holding Back FireEye Inc Stock

FireEye stock - Profitability Concerns Keep Holding Back FireEye Inc Stock

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Shares of FireEye Inc (NASDAQ:FEYE) are falling sharply after the cybersecurity company reported roughly middle-of-the-road first quarter numbers. As of this writing, FireEye stock is down roughly 9%.

Revenue came in ahead of expectations. But earnings were simply in-line. Meanwhile, the earnings guide was also just in line with expectations.

For most companies, such a middle-of-the-road report wouldn’t have a huge impact on the stock. But for FEYE stock, which is trading at more than 50-times earnings that are still three years out, in-line earnings just don’t cut it.

Unfortunately, I don’t think that this sell-off is exaggerated. In fact, I see further downside ahead for FireEye stock. Profitability concerns continue to hang over the stock, while revenue growth simply isn’t robust enough to offset those profitability risks. As such, FireEye stock looks overvalued at current levels.

Here’s a deeper look:

Right Market, But Lots of Competition

There is no question that FEYE is in the right market.

The need for cybersecurity solutions will only grow by several magnitudes over the next 5-10 years. Data continues to migrate to digital channels, and as that migration continues, the risks threatening the integrity and safety of that data will only grow.

Consequently, companies like FireEye will continue to benefit from robust demand for cybersecurity solutions over the next several years. But cybersecurity is also a highly competitive space. There a ton of players, and a ton of good players.

While FEYE is one of those good players and does have some headline partnerships with companies like Oracle Corporation (NYSE:ORCL), huge competitive threats will continue to moderate what would otherwise be robust revenue growth over the next several years.

Revenue growth this past quarter was just 8%. That is roughly in-line with what it has been over the past several quarters. Next quarter, that 8% revenue growth rate is expected to continue, and over the next 2 years, analysts see this high single-digit revenue growth trend persisting.

At best, then, this is a 10% revenue growth story. While that is good, it certainly isn’t great or anything that warrants FEYE stock’s currently massive valuation.

FireEye Stock Is Priced for Huge Profitability

Why the huge valuation on FireEye stock? Investors are pricing in massive profitability improvements.

After all, this is a high-margin business with gross margins running in the mid-70% range. But the company is spending an arm and a leg to fuel top-line growth in what has become a highly competitive cybersecurity marketplace.

The operating expense also runs in the mid-70% range, so FEYE’s net profitability is hit or miss, depending on the quarter.

Scale should bring that mid-70% opex rate down dramatically. But even in management’s long-term model, operating margins aren’t expected to get much higher than 20%.

If revenues grow at 10% per year over the next five years and operating margins hit 20% by then, FEYE will be looking at revenues of $1.2 billion and operating profits of $240 million in 5 years.

Taking out $40 million for net other expenses, 21% for taxes, and dividing by a presumably higher share count of 225 million, that equates to roughly $0.70 in earnings per share.

A market-average growth stock multiple of 20-times forward earnings on $0.70 implies a four-year forward price target of just $14. Thus, FireEye stock today is trading above what I view as a realistic price target for this stock in four years.

Bottom Line on FEYE Stock

The cybersecurity space is one investors want exposure to in the long run. But I’m not so sure FEYE stock is the stock to buy to gain that exposure.

FireEye stock looks woefully overvalued here, and it hasn’t done much of anything for investors over the past 2 years.

Consequently, while I’m bullish on the cybersecurity space, I’m not a fan of FireEye stock.

As of this writing, Luke Lango did not hold a position in any of the aforementioned securities. 

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