Shares of Cloudflare (NET 1.44%) were in the doghouse after the company released its first-quarter 2023 results on April 27, as management spooked investors with a guidance cut and pointed out that macroeconomic headwinds are affecting its business.
Cloudflare stock plunged 21% on April 28 as the company missed Wall Street's revenue expectations by a slim margin, bringing an end to an impressive 2023 rally. Investors were also disappointed with the company's second-quarter guidance, as it is expected to deliver much slower growth than analysts' expectations.
Shares of the internet infrastructure services provider have now lost 52% of their value in the past year. However, the near-term weakness in Cloudflare's business could open an opportunity for savvy investors to buy shares of a potential long-term winner at a relatively attractive valuation. Let's see why this is an opportunity you may not want to miss.
The market overreacted to Cloudflare's latest report
Cloudflare, which is sitting on a massive addressable market opportunity, battled multiple headwinds this year. CFO Thomas Seifert remarked on the latest earnings conference call:
With intensifying business uncertainty, companies became increasingly cautious in more deeply scrutinized deals, which impacted numerous areas of our business, including a material lengthening of sales cycles, delays in collections, and the significant back-end weighting in the linearity for the quarter.
Despite the headwinds, Cloudflare reported impressive year-over-year revenue growth of 37% during the quarter to $290 million. Its adjusted earnings increased to $0.08 per share last quarter from $0.01 per share in the prior-year period. Analysts were looking for $290.8 million in revenue and $0.03 per share in adjusted earnings.
The guidance, however, set the alarm bells ringing among investors. Cloudflare expects $305 million to $306 million in revenue and $0.07 per share to $0.08 per share in earnings in the current quarter. Wall Street was looking for almost $320 million in revenue. Even worse, the company now expects 2023 revenue to land at $1.28 billion, down from its earlier forecast of $1.33 billion.
A guidance cut doesn't bode well for a stock sporting a rich valuation, which explains why Cloudflare stock fell big time following the earnings release. But a closer look suggests that things aren't as bad as they seem. Cloudflare is still on track to deliver a solid 30% year-over-year increase in revenue in the current quarter, compared to Q2 2022's revenue of $234 million. The non-GAAP earnings forecast also points toward a nice improvement over the break-even it achieved in the prior-year period.
Even though Cloudflare downsized its full-year revenue guidance, its updated forecast would still translate into a 31% jump over 2022 levels. The company also anticipates adjusted earnings between $0.34 and $0.35 per share in 2023, which would be a big jump over last year's non-GAAP net income of $0.13 per share.
All this indicates that Cloudflare stock was punished a tad too harshly, especially considering that it continues to enjoy robust customer growth.
Investors shouldn't miss these positives
Though Cloudflare faced headwinds in Q1, it still managed to report healthy growth in its customer base. The company ended the quarter with 168,000 paying customers, a 13% increase over the prior-year period. Additionally, the number of large customers who have generated over $100,000 in annualized revenue for Cloudflare increased at a much faster pace of 40% to 2,156 in the first quarter.
The increased spending by Cloudflare's large customers helped the company report a dollar-based net retention rate of 117% last quarter. Though that was lower than the year-ago period's figure of 127%, it is still good to see the company deliver a reading of more than 100% in this metric, as it indicates that its existing customers spent more money on its offerings.
It is also worth noting that Cloudflare expects to sustain its impressive levels of growth in the long run as well, which is not surprising as its addressable market is expected to be worth a whopping $125 billion this year.
NET Revenue Estimates for Current Fiscal Year data by YCharts
The company's impressive top-line growth is expected to drive solid earnings growth as well, with analysts expecting Cloudflare's earnings to increase at an annual pace of 47% over the next five years. If that's indeed the case, the company's adjusted earnings could increase to $2.34 per share at the end of 2028 (using 2023's forecasted earnings of $0.34 per share as the base). Such terrific earnings growth could send Cloudflare stock soaring in the long run.
That's why investors looking to buy a fast-growing cloud stock should consider accumulating Cloudflare while it remains beaten down. It is currently trading at 15 times sales. While that's rich, there may be an opportunity to buy it on the cheap if it continues to pull back in the near term following its latest earnings report.
