ANET stock could rise 25% based on its huge free cash flow

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Arista Networks (NYSE:A NET), a growing cloud software services company, produces stellar results for its third quarter ending September 30. However, despite what some analysts think given its already high valuation, ANET stock could rise further.

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Arista Networks produces cloud networking solutions for US businesses. In this regard, it’s a bit like Cloudflare (NYSE:REPORT), but with a much more profitable operation.

For example, third quarter revenue increased 23.7% to $ 748.7 million year-over-year (YOY). It was also 5.8% more than the previous quarter. But more importantly, its gross margins are very high at 64.9% on a non-GAAP basis. This shows that the company’s software and server solutions for the cloud have pricing power.

Arista Networks Huge Profitability and Cash Flow

Everything else falls into place after that, in terms of profitability. For example, his operating result was $ 233.3 million. This represents a whopping 31.1% of its revenue for the quarter. This shows that the company is very profitable on an operational basis.

In fact, if you look at his cash flow statement, you see the same things. For the nine months ended September 30, cash flow from operations was $ 790.6 million. This can be seen on page seven of his latest 10-Q filing. After deducting $ 55.5 million in capital spending, its free cash flow (FCF) stood at $ 735.1 million, or 34.6% of its $ 2.124 billion in nine-month sales.

This is a very high FCF margin. In fact, we can use it to estimate the valuation of the business in the future.

For example, 22 analysts estimate that sales will increase by more than 29% to $ 3.76 billion by the end of 2022, according to In search of the alpha. We can use this estimate to derive an FCF estimate for next year.

To be on the safe side, let’s use a 34% margin (down from 34.6% in the last nine months) from this sales forecast of $ 3.76 billion. This translates into an FCF estimate of $ 1.278 billion for 2022.

Valuing Arista Networks stock

This can lead us to the value of Arista Networks stock. For example, using a return metric of 3% FCF, we can derive a target market cap of $ 42.6 billion. That’s about 10% more than the current market cap of $ 38.8 billion.

However, given that the company is incredibly profitable with its 34% FCF margins, we should use a higher metric. For example, if we used a multiple of 38 times FCF (the same as a return measure of 2.63% FCF), the resulting target market cap is $ 48.564 billion.

This can be seen by multiplying $ 1.278 billion in FCF for 2022 by 38, the FCF multiple, or by dividing $ 1.278 billion by the 2.63% return on FCF.

This translates to a top target market of $ 10 billion compared to a market cap of $ 38.8 billion today. That’s a 25% higher price for Arista Networks, which means its target price is $ 160.95 per share based on its Dec. 9 price of $ 128.66.

Where that leaves investors in ANET shares

Some analysts believe that at 37 times the forward earnings (using In search of the Alpha ‘s price / earnings ratio measures), ANET share is too expensive. For example, an analyst of In search of the alpha noted that the company had “beautiful execution, but valuation is a constraint.

However, we have shown that the company enjoys high profitability and huge margins. Also, using conservative free cash flow margins and a reasonable multiple, it appears to be undervalued by at least 25%.

However, most analysts disagree with me. For example, TipRanks reports that 15 Wall Street analysts provided 12 month course objectives on the ANET share during the last three months. Their average price target is just $ 134.37, just 4.44% from yesterday’s price.

So you can believe these analysts or you can look at my analysis, which shows that the profitability of the company deserves a very high mark. I suspect that over the next 12 months these analysts will have to increase their price targets.

As of the publication date, Mark Hake does not hold (directly or indirectly) any positions in any of the stocks mentioned in this article. The opinions expressed in this article are those of the author, subject to the publication guidelines of InvestorPlace.com.

Mark Hake writes about personal finance on mrhake.medium.com and run the Total Value of Return Guide that you can consult here.


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