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Stocks  | April 15, 2020

The enterprise-software sector is headed for a tough couple of quarters, with companies reining in spending as we suffer through a deep recession triggered by the coronavirus pandemic. But there are places where investors can wait out the storm.

Morgan Stanley software analyst Keith Weiss and his colleagues wrote a major report Tuesday outlining their picks for the new environment, upgrading a few stocks and downgrading a few more.

“Our survey work, channel conversations and macro data all point to a very difficult software spending period over the next several months,” Weiss writes in the report. “However, as the impacts and duration of those impacts become clearer, investor focus likely turns to the longer-term, where software’s broader positioning is actually strengthened. By and large, we are looking at the recent pullbacks as an opportunity to build positions in the stronger franchises in software.”

Weiss sees strong core secular growth in trends in software, with a particular focus on recurring revenue models, and sees benefits for the sector from the aggressive fiscal and monetary steps to fight the crisis.

“While investors are likely to see additional volatility in the near-term, over a longer time horizon this will prove an attractive entry point,” Weiss writes. He argues that current conditions will act as a catalyst for key trends, including a shift to the public cloud, increased workflow automation, and improved worker and team productivity.

Weiss offers seven software stocks to buy in the current environment, two of which he upgraded on Tuesday.

  • Weiss lifts Workday (WDAY) to Overweight from Equal Weight, setting a price target of $170. He thinks the company will be a long-term winner from the adoption of software-as-a-service as it gains share in both HR and financial software. He notes that the stock is down 30% since its February high, offering an opportunity for investors to buy the stock “with an asymmetrical risk/reward at current levels.”
  • He also raises his rating on Coupa Software (COUP), a provider of business spend-management software, to Overweight from Equal Weight, with a target price of $182. “With COUP shares down ~25% from their annual highs, we see an opportunity to get on board” one of the “leading secular beneficiaries” in software as a service, he writes.
  • Weiss also repeated his Overweight ratings on Microsoft (MSFT), Adobe (ADBE), (CRM), Atlassian (TEAM), and Veeva Systems (VEEV).

Morgan Stanley cut ratings on four other software stocks:

  • Appian (APPN) is cut to Underweight from Equal Weight, with a $32 target price. “While Appian’s vision to emerge as a key low-code automation platform represents a compelling long-term opportunity, the economic disruption from COVID presents challenges to executing new business in the near-term,” Weiss writes.
  • Cloudflare (NET) is cut to Underweight from Equal Weight, with a $22 target. “Beyond FY 2020, Cloudflare has a very attractive runway for growth as internet properties look to the company’s expanding solution portfolio to solve an increasingly broad se of security and performance challenges,” he writes. “However, in the near-term, consensus estimates likely need to move lower and with shares up ~38% year to date, investors may be overly bullish on tailwinds from higher internet traffic and new remote access solutions.”
  • New Relic (NEWR) is cut to Equal Weight from Overweight, with a target of $50. “Prospects for better growth have diminished as the spending environment weakens, leaving us without a catalyst for our turnaround thesis,” Weiss writes. “We move to the sidelines until better visibility returns.”
  • Zuora (ZUO) is cut to Underweight from Equal Weight, with a target of $8.50. “Zuora’s leadership in the Subscription Economy provides a long runway of growth,” he writes. “However, with upcoming disruptions from COVID-19, we see greater uncertainty about the pace of overall adoption. We believe Zuora’s FY 2021 guidance numbers have not been adjusted enough to offset upcoming disruption to selling cycles from Covid-19, adding further downside potential to the stock. While valuation is undemanding, we see ZUO as a relative underperformer.”
  • Weiss also repeats an Underweight rating on Zscaler (ZS). “Zscaler’s product portfolio is well positioned for longer-term secular themes in security (cloud security, zero trust architectures),” he writes. “However, we see risk to Zscaler in 2020, given the company’s exposure to long deal cycles tied to transformational initiatives, which will likely come to a halt within enterprises in the near-term.”

On an up day for the stock market, almost all software shares are trading higher; among the group discussed by Morgan Stanley, Coupa Software is the leader, up 10.8%. Appian and Cloudflare are laggards, with modest losses on the session.

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