No New Highs for Cloudflare in 2024

Key Points

• Cloudflare had a solid quarter, but the results were tepid relative to analysts' consensus, giving no reason to rally. 
• Analysts are lowering their targets and providing a headwind for the market. 
• The stock could rebound within its range, but only a relief rally is expected, and range-bound conditions will likely persist. 

Cloudflare NYSE: NET is a great company growing its business and building leverage. However, despite the massive decline in the share price, the stock remains overvalued and faces headwinds that investors may want to avoid. The valuation alone is enough to keep the stock from moving higher. Trading at 95X next year’s earnings growth needs to accelerate for this tech stock, and it isn’t. 

Add in the analysts, and the change in their sentiment, and the odds are high that Cloudflare stock will remain range-bound this year. As uninteresting as it sounds, range-bound trading is an opportunity for investors seeking the leverage of options, providing an environment for advanced options strategies. 

Analysts' activity following the Q1 release was mixed and included one upgrade and two boosted targets. However, the analysts also issued enough negative revisions following the release to put the stock in the 25th position on Marketbeat’s Most Downgraded Stock list. Their consensus rating is still a Hold, and the price target (trending higher) implies a 20% upside for investors, but sentiment has topped and is unlikely to lead the market to a new high. The salient point is that the 20% upside predicted by the consensus estimate will put the market smack in the middle of a trading range not likely broken until next year, if at all. 

Cloudflare has a Solid Quarter, Issues Weak Guidance

Cloudflare had a solid quarter, with top and bottom-line results outpacing the consensus estimate. Still, problems with the report will keep the market depressed for the foreseeable future. Among them is that 30.5% growth is a slowdown from last year’s pace, and the guidance forecasts an additional slowdown this year. That said, the 30.5% growth is underpinned by record net new clients contributing greater than $100,000, $500,000, and $1,000,000 in ARR, a detail that promises to sustain operations at current levels, if not growth. 

The margin news is the best of the report. The company is still generating GAAP losses, but the burn is shrinking and is primarily non-cash related. The adjusted results include a 70 bps improvement in the gross margin and a 450 basis point improvement in the operating margin that left it at 19% and FCF margin at 9%, with both results roughly doubling from the prior year. The adjusted $0.16 in earnings beat consensus by $0.03 and is double last year, including a higher share count. 

Guidance is also solid but falls into the bad news category because the projected revenue growth of 27% aligns with the expectation for strength and is the slowest pace of growth in years. Additionally, the margin is expected to contract sequentially, and the full-year guide is weak—no catalyst to rally for this highly-valued name. 

Institutional Support May Wane, Insiders are Selling Cloudflare

Insiders have been selling Cloudflare for years due to its leaning into share-based compensation. However, sales ramped higher in 2023 and spiked to a multi-year high in Q1 2024, holding strong in Q2. Insiders own about 13% of the stock, so are a formidable headwind that is, for now, offset by the institutions.

 Institutions own about 80% of the stock and have been buying in 2024. The risk is that their activity is down significantly from 2023 and may wane or revert to selling now that results and guidance are in. The news isn’t a reason to sell per se, but with no dividend or share repurchases, there is little reason to hold while the market works through this phase. 

The Technical Outlook: Cloudflare is Range Bound

Shares of Cloudflare sank more than 10% following its earnings release and could fall further. The market shows a volume-supported downdraft that could take it back to the lows near $40 if support at $70.25 is broken. The long-term 36-month EMA highlights support at $70.25 and may be strong enough to keep the market from falling further. Shares of Cloudflare are oversold at this level and could rebound in this scenario. The risk for investors is that any rally within the trading range should be viewed as a relief rally and only investible once there is a change in sentiment.