Security-Software Stocks Rally After Goldman Sachs Forecasts ‘Healthy Growth’

Security software stocks were getting a boost on Tuesday from Goldman Sachs analyst Brian Essex, who picked up coverage of the sector with a bullish slant.

“We believe IT security offers attractive levels of exposure to growth technology, and that profitable companies with this exposure could outperform the market through the mature stages of an economic expansion cycle due to the durability of underlying spending,” he wrote in a lengthy report. “Durability in spending is supported by digital transformation initiatives across all verticals.”

Essex said his conversations with executives found that information-technology security spending “is well positioned for healthy growth and is among the least likely budget items to be trimmed as attack surface exposure continues to grow.” He also noted that security vendors are shifting their businesses to be more predictable, as they adopt subscription models. And he said a wave of consolidation in the sector lies ahead, offering valuation support for some of the narrower vendors that might make acquisition bait for larger players.

Essex initiated coverage of seven stocks. He set three Buy ratings: Palo Alto Networks (ticker: PANW), Fortinet (FTNT) and Verint Systems (VRNT). He rates Check Point Software (CHKP), FireEye (FEYE) and Zscaler (ZS) as Neutral. He started SecureWorks (SCWX) with a Sell rating.

Here are brief comments on each company from his report:

• Palo Alto Networks: “Palo Alto Networks has been ahead of the curve in transitioning from a legacy vendor to a next-gen security company, with a host of cloud security solutions and analytics already in place.”
• Fortinet: “Fortinet has managed to deliver profitable growth consistently over its history.”

• Verint: “The stock continues to trade at a meaningful discount to peers with similar fundamental profiles.”
• Check Point: “Even though CHKP has the best margins and cash flow within our coverage group, we believe investors need to see signs of an inflection toward better revenue growth (which has been range-bound), traction with next-generation security solutions, and a material improvement in sales force execution.”
• FireEye: “We need to see sustained acceleration in top-line growth and more meaningful progress toward better profitability to turn incrementally positive on the stock.”
• Zscaler: “Valuation for ZS remains elevated compared to high growth security software peers, even after a recent pullback.”
• SecureWorks: “We are Sell-rated on SCWX, given inconsistent top-line growth, lack of profitability, decline in customer retention rates, and elevated competition in the SIEM space. We also believe a lack of liquidity for the stock limits the number of investors that could buy the stock.”

All three of the Buy rated stocks were trading higher, with Fortinet the standout, up 3.3% to $99.09 near midday. The Neutral-rated names were also higher, with Zacaler up 1.2%, to $44.58. SecureWorks shares were down 2.8%, to $11.39. The S&P 500 was up 0.3%.

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