In late October I wrote an article on Cloudflare (NYSE:NET) that showed it is likely to have a profitless future for a good while. This means that Cloudflare stock is likely to have a difficult time rising in the near term as long as profits stay low or non-existent.
Cloudflare is a U.S. internet infrastructure and website-security company. Specifically, it provides content-delivery-network services, DDoS mitigation, internet security and distributed domain-name-server services. Its growth comes from paying customers, even though it has a free option for smaller clients. Most of its paying clients are small businesses or individual developers.
So far this year, Cloudflare stock is up more than 307%. That discounts a lot of good news and good year-over-year growth. Unfortunately, that growth seems to have slowed on a quarterly sequential basis.
Q3 Growth and Free Cash Flow
In the past year, Cloudflare started to see significant growth in larger paying customers (i.e., more than $100K in annual revenue). Those clients grew from 451 last year, as of Q3 2019, to 736 in Q3 2020.
Moreover, revenue rose 54% year-over-year as the company picked up another 100 new large enterprise-level customers during the quarter. But the company was still unprofitable even with $114.2 million in revenue.
The problem is the outlook for the fourth quarter is not that great. The company forecast a slight rise in revenue in Q4 to $117.5 to $118.5 million. That represents a slow 2.6% to 3.5% gain over the third quarter.
So, unless things start taking off soon, the year-over-year increases in revenue are going to start slowing down next year. The lack of profits won’t help out at all.
For example, in Q3 Cloudflare lost $21.3 million in operating profits and $5.7 million in negative net income. It expects operating losses of $9 million to $10 million in Q4 as well.
In other words, sales need to move substantially higher before the company is profitable on an operating basis. I don’t see that happening for at least a year or maybe longer.
On page 44 of the company’s latest 10-Q for the third quarter, free cash flow was negative $17.85 million. Although this was down substantially from a year ago (negative $33.6 million), it does not look good going forward
If Q4 sales rise by $3 million or $4 million in Q4, free cash flow won’t grow much. So, until Cloudflare can push up sales and profits significantly higher it won’t be making positive free cash flow.
So far Cloudflare has not said when it expects to see positive profits or cash flow.
What to Do With Cloudflare Stock
Analysts surveyed by TipRanks.com have an average price of $69.17 per share. This implies a drop of over 10% in Cloudflare stock from its price of $77.35 as of Dec. 4.
Similarly, Marketbeat.com shows that 17 analysts issued ratings and price targets on Cloudflare stock over the past 12 months. Their average price target is $56.38, implying a drop of more than 27%.
These polls seem to show the same thing. Seeking Alpha says that its survey of 16 analysts has an average price target below the present price. The average is $69.06 per share, which is 10.7% below the price as of Dec. 4.
Therefore, don’t expect Cloudflare stock to rise much as long as the company is producing net income losses. Hopefully, there will be some good news when the company produces its Q4 numbers.
But let’s hope that its free cash flow will turn positive sometime soon. Otherwise, there might be a limited upside for Cloudflare stock.
On the date of publication, Mark R. Hake did not have (either directly or indirectly) any positions in any of the securities mentioned in this article.