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Splunk Stock Stuck in a Funk: Time to Buy?
Stock Analysis & Ideas

Splunk Stock Stuck in a Funk: Time to Buy?

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Splunk stock has been stuck in a funk for a few years now. With a recession that could weigh heavily while the cloud transition slows, many investors have quickly given up on the stock as it flopped below $100 per share. Though challenged, Splunk seems too cheap for its own good, given many overlooked positives from its latest quarter.

Shares of big-data solutions software developer Splunk (SPLK) have been struggling lately, thanks in part to an earnings beat that failed to impress over a turbulent cloud transition. Undoubtedly, transitions to the cloud are always a source of volatility, but they tend to work out in the grander scheme of things. I am bullish on SPLK stock.

Splunk’s transition has gone far bumpier (and messier for analysts) than many shareholders would have thought. With annual recurring revenue (ARR) guidance downgraded from $3.9 billion to $3.65 billion, questions linger as to how Splunk will cope with the harsher environment that lies ahead.

Though a slowdown in the cloud transition has investors ready to throw in the towel here, I do think the valuation to be had in the name is the best it’s been in years.

Splunk may be up against it, following its 12% post-earnings flop. However, newly-appointed CEO Gary Steele seems to be the right man to turn the ship around as economic storm clouds look to produce more turbulence.

Understandably, the sudden departure of former CEO Doug Merritt still has many investors on edge amid the broader market’s tech-driven valuation reset. Regardless, the mere 5x sales multiple makes Splunk stock far cheaper than traditional “value” stocks that have held up steady for the year thus far.

Splunk’s Strong Net Retention Rates are a Bright Spot

For the second quarter, Splunk posted just shy of $800 million in revenue. That’s up 32% year-over-year. Operating margins improved to a positive 4%, up from the negative double-digits over the same period last year. With 26-28% in revenue growth expected for its next quarter, questions linger as to how severely growth will stand to be weighed down as enterprise spending looks to grind to a slowdown. Still, its high net retention rate of 129% and digital transformation trends work in Splunk’s favor.

Many enterprise firms have already cut away at their budgets, with selective layoffs and more cautious hiring practices. While new customer growth could slide going into a downturn, I view the stickiness of the Splunk platform as a source of strength that could help it climb out of its funk.

The cloud transition slowdown may be discouraging, but I suspect the firm will make it through the period as many other Software-as-a-Service (SaaS) firms have in the past. It’s a painful process, but it has to be done for the sustained betterment of margins.

For now, investors would much rather sell now and ask questions later as growth steadily grinds lower.

Splunk Can Expand Its Total Addressable Market

Splunk is hitting the spot with the consumers it does have. As a dominant player in its niche, the company could have a relatively easy time cross-selling new solutions and raising the bar on its total addressable market as it looks to parallel frontiers such as cybersecurity. Data analytics and cybersecurity solutions often go hand in hand.

Cybersecurity is a more competitive space, but effective integration could prove a differentiating factor for the many clients who stand by the Splunk platform. Further, Splunk could make the most of the recent sell-off in the tech sector with prudent M&A moves.

Unlike many up-and-coming tech firms, Splunk had not grown euphoric when it came to chasing potential takeover targets. With so much emphasis on the price paid, Splunk has been able to bolster its portfolio without running the risk of excessive acquisition-fueled M&A destruction.

Undoubtedly, Block (SQ), formerly Square, is one firm that may have gotten a tad too excited when it went after “exciting” Australian BNPL (Buy Now, Pay Later) firm Afterpay. There were synergies to be had as the service was embedded into the firm’s existing apps. However, the price paid was probably a tad too rich, given the dire fate of the BNPL stocks.

With a robust balance sheet and $1.74 billion worth of cash and cash equivalents as of the end of the July 2022 quarter, there are many angles that Splunk could take should it look to add to its arsenal.

What is the Target Price for SPLK Stock?

Turning to Wall Street, SPLK stock comes in as a Moderate Buy. Out of 27 analyst ratings, there are 18 Buys and nine Holds. The average Splunk price target is $131.79, implying an upside of 42.3%. Analyst price targets range from a low of $95.00 per share to a high of $200.00 per share.

Conclusion: Tough Times Ahead, but Valuation Overly Depressed

At writing, Splunk is at risk of returning to 52-week lows in the mid-$80 range. Down more than 57% from its all-time high, it seems like all hope is lost for the misunderstood software company that could endure far bigger bumps in the road as macro headwinds continue to weigh.

Despite the headwinds and lack of catalysts, I find it hard to turn against the company at this juncture. The digital transformation trend is still very much in play, and although the cloud transition will likely be a source of further volatility moving forward, it’s challenging to overlook the stickiness of the platform.

Wall Street is standing by Splunk amid its epic decline, with a Street-high $200 price target that implies a whopping 115% upside from current levels. Such a price target may seem far-fetched, but I do think the bar is a tad too low, even if rates are to move much higher from here.

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