Check Point Software: Should You Buy The Dip?

Summary

• Check Point has recently reported fairly good earnings results for 2017.
• The buyback program along with the growth of retained earnings will make sure that Check Point’s business stays afloat.
• I believe that Check Point shares are trading around their fair value and do not recommend acquiring them at the current price.

Let's start with analyzing Check Point's (NASDAQ:CHKP) annual reports provided by the company over the recent years. Over the past year, revenue grew to 7% YOY amounting to $1,855 million. The active demand for the company's products designed for small and medium-sized businesses as well as increased revenues from subscription served as the growth drivers. According to GAAP, the net profit in 2017 grew by 6.5% YOY amounting to $803 million. Earnings per diluted share increased by 15% amounting to $4.82. Check Point's management also provided projections for the entire year 2018. The company expects the annual adjusted profit of $5.50-5.90 per share at the revenue of $1.9-2.0 billion.

If you look at the long-term indicators, you'll notice that the company is developing: its revenue increases steadily, its net income grows each year, while its operating margin remains stable and the highest in the industry.

(source: company reports)

In addition, there is a positive trend related to the retained earnings indicator. In recent years, both cash and cash equivalents of the company have remained stable and retained earnings have been steadily growing. The growth of retained earnings increases the financial stability of the company, revealing the source for its further development.

(source: company reports)

Sustainable financial performance allows the company to reward its investors through the buyback program. As you can see in the graph, the amount the company spends on these programs almost equals the operational cash flow. As you know, shares buyback program reduces the number of existing shares, increasing earnings per share (EPS) of a company.

Last year, Check Point approved the new buyback program, under which the company will spend $250 million per quarter over the next four quarters to repurchase its own shares. It means that the company wants to demonstrate its investors that its shares are undervalued, and it has enough money for emergencies.

(source: company reports)

Let's take a look at the potential of the cybersecurity market in order to predict Check Point's future revenues. Let me remind you that about a half of Check Point's revenue comes from North America, where the largest player is, undoubtedly, the United States. It is expected that the U.S. cybersecurity expenses will continue to grow in the current year.

The global cybersecurity expenses will also continue to rise and are expected to reach $96 billion in the current year. After a series of high-profile cyber attacks such as WannaCry, NotPetya, and Equifax, most companies recognized the need to increase budgets to prevent hacker attacks. It will allow the cybersecurity market to demonstrate the annual average growth of 6-7%, reaching $200 billion by 2021.

If the cybersecurity market meets the growth forecasts, Check Point has all chances to become one of the main beneficiaries of this trend, therefore, its financial indicators will continue to grow. I believe that the new company's product line will also contribute to it.

(source www.gartner.com)

Taking all the available data into account, I think it is best to build a simplified DCF model to determine the fair price of Check Point's stock. In order to do this, I suggest using the cost of equity as the discount rate.

As for the current company's beta, I used the data from multiple aggregators such as this and this. The current Check Point's beta is not high, which is a good sign. High beta means that the stock is highly volatile and reacts to any market movement with an even sharper movement. I used the returns on the U.S. 5- and 10-year government bonds as the risk-free rate of return. As for the Market Risk Premium, I used the data provided by this website.

(the calculations and the table of the author)

I built my projections of the free cash flow on the growth projections of the cybersecurity market (6-7%) and the growth of the free cash flow demonstrated by the company over 5 years (10%).

(the calculations and the table of the author)

Next, we need to calculate the terminal stock price, taking into account all future cash flows the company will demonstrate over the next five years. I used the conservative approach, using the 10-year bond rate (2.85%). I also used the previously calculated cost of equity (8.7%) to discount to the current price. Having calculated the terminal value and the present value of terminal value, we can calculate the total value. And finally, we divide the total value by the total number of shares. At the moment, the fair share price is $108.8 which does not look attractive at the current price of $98.

(calculations of the author)

Let's stop at the company's multiples. The company looks undervalued under most multiples in comparison with its closest competitors, most of which do not make any profit. At the same time, when we compare the company's multiples with those of the application industry (which is the median of the global software multiples), the majority of them looks a little overvalued.

Source: gurufocus

Conclusion

Check Point is a growing company that has been demonstrating profit and revenue growth for several years now. The company operates in the rapidly developing cybersecurity market that allows talking about the growth of its financial indicators in the future. The company has a substantial cash cushion in the form of retained earnings, which ensures its financial stability. Moreover, Check Point runs buyback programs from one year to another which is good news for its investors.

However, both the DFC analysis and the analysis of the multiples show that it is too early to talk about purchases at the current levels. In my opinion, Check Point's stock will be clear candidate for purchase from $80-85.

(source www.tradingview.com)

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Comments

[Charlie's Munger]

I have a starter position in CHKP, will buy more lower. Forever stock?