Is Cloudflare Stock a Buy Now?

Cloudflare's (NET 1.44%) stock jumped 8% during after-hours trading after it posted its second-quarter earnings report. The cloud-based content delivery network (CDN) provider's revenue rose 32% year over year to $308.5 million and beat analysts' estimates by $2.7 million. Its adjusted net income surged from $0.3 million to $33.7 million, or $0.10 per share, which also cleared the consensus forecast by three cents.

Those headline numbers were impressive, but Cloudflare's growth is still cooling off as it faces challenging macro headwinds. Let's identify those weaknesses and see if its stock is still worth chasing after its year-to-date gains of more than 50%.

Image source: Getty Images.

Another quarter of slowing growth

Cloudflare's CDN services accelerate the delivery of photos, videos, and other digital content for websites. It accomplishes that by storing cached copies of all that media on edge servers that are located closer to a website's visitors. It also shields websites from bot-based attacks with verification tools that filter out non-human visitors.

Cloudflare serves data from 300 cities in over 100 countries, and it processes an average of 46 million HTTP requests every second. Its annual revenue rose at a compound annual growth rate (CAGR) of 50% between 2019 and 2022.

But over the past year, its revenue growth and large customers (who spend more than $100,000 annually) decelerated. Its dollar-based net retention rate (which gauges its year-over-year revenue growth per existing customer) and its adjusted gross margins also gradually declined.

Data source: Cloudflare. YOY = Year-over-year.

Cloudflare repeatedly blamed that slowdown on the macro headwinds, which drove many companies to rein in their software spending. It expects that deceleration to persist with 30% year-over-year revenue growth in the third quarter. For the full year, it expects its revenue to only rise 32%, compared to its 49% growth in 2022.

Fastly is growing at a healthier rate than Cloudflare

That slowdown isn't disastrous, but Cloudflare's smaller competitor Fastly (FSLY 4.43%) seems to be growing at a healthier rate. Fastly's dollar-based net expansion rate (which can be compared to Cloudflare's dollar-based net retention rate) actually rose two percentage points sequentially to 123% in the second quarter. Its adjusted gross margin also expanded year over year from 50.4% to 56.6%.

For the full year, Fastly expects its revenue to rise 16%-18% for the full year, compared to its 22% growth in 2022. Fastly faces the same macro headwinds as Cloudflare, but it faces a milder slowdown while growing its margins and expansion rates.

Cloudflare is still growing faster than Fastly, but it's also valued accordingly at 17 times this year's sales. Fastly trades at just five times this year's sales. That big gap might make Fastly the more appealing CDN play for value-oriented investors.

Focusing on the factors it can control

Cloudflare's revenue growth won't accelerate anytime soon, but it expects its adjusted operating margin to expand from 3.7% in 2022 to 6.3%-6.6% as it reins in its spending. It expects to stay unprofitable on a generally accepted accounting principles (GAAP) basis for the full year, but it believes its non-GAAP EPS will surge 185%. By comparison, Fastly expects to stay unprofitable by both GAAP and non-GAAP measures this year. 

For 2024, analysts expect Cloudflare's revenue and non-GAAP EPS to rise 30% and 24%, respectively, as the macro environment improves. That outlook is promising, but a lot of that recovery already seems baked into its valuations.

Is it the right time to buy Cloudflare?

Cloudflare's stock isn't cheap. However, I believe it's still worth nibbling on if you think it can keep pace with the global CDN market, which Grand View Research pegs to grow at a CAGR of 23% from 2022 to 2030. If Cloudflare merely matches that growth rate, its stock could easily generate more multibagger gains through the end of the decade.