Everyone is talking up the prospect of a recession. Mike Wilson, chief U.S. equity strategist at Morgan Stanley, is chief among them.
Wilson warns that the Fed’s current restrictive monetary policy portends downside risks that are not priced in the market – and could even spark a recession on the scale of 2008’s crisis. Wilson sees corporate earnings (which are already down in Q1 of this year) as unlikely to bottom out until the third or fourth quarter.
In Wilson’s view, the lag between Fed policy, its effects, and the central bank’s reaction will be prime mover in the markets for the mid-term.
“Markets often reprice late in the cycle when they realize that Fed policy is not accommodative enough to compensate for the slowing growth backdrop. While the containment of the regional banking stress is clearly a positive in and of itself, it may also mean that policy expectations for ’23 may become less accommodative – via both the liquidity channel and the rates channel,” Wilson explained.
That’s not to say compelling plays can’t be found in the current financial environment. Whatever the macro outlook, the Morgan Stanley analysts expect a pair of stocks to post double-digit gains over the coming months. According to TipRanks, the world’s biggest database of analysts and research, both also boast a Strong Buy consensus rating from the rest of the Street.
Confluent, Inc. (CFLT)
Data is crucial for modern digital businesses, and Confluent, our first Morgan Stanley pick, specializes in delivering data in motion. The company offers businesses a cloud-native real-time data streaming platform that can connect data from multiple sources in real-time. With sophisticated back-end software operations, Confluent boasts the ability to deliver a rich front-end customer experience.
In a highly competitive landscape, digital data platforms need unique features that set them apart. It’s worth noting that some 80% of Fortune 100 firms use data streaming technology, and a majority of them rely on Confluent for data management. Confluent is designed to seamlessly integrate with Apache Kafka, a popular open-source data processing platform, while offering its own unique features to complement Kafka’s capabilities. Developed by the original creators of Kafka, Confluent has leveraged its relationship with Kafka to establish a strong presence in the world of business cloud software.
A look at some general numbers will show just how well Confluent has leveraged its capabilities in the software world. The company is targeting a total addressable market on the order of $60 billion, and currently has more than 4,530 enterprise customers, of whom 991 are generating at least $100,000 in annual recurring revenue. The company brought in $586 million at the top line last year, for a 124% year-over-year increase.
Taking a closer look at the most recent financial results can provide insights into the company’s current standing. In Q4, the top line reached $169 million, growing 41% year-over-year and accounting for 28% of the total 2022 revenue. In terms of the bottom line, the non-GAAP EPS loss per share was 9 cents, surpassing expectations by 6 cents and representing a significant improvement from the 19-cent EPS loss reported in the same quarter of the previous year.
In a metric that bodes well for future gains, Confluent also reported ‘remaining performance obligations’ (their term for the work backlog) of $741 million. This was up 48% y/y.
Showing confidence in the data streaming player is Morgan Stanley analyst Sanjit Singh, who sees several reasons to back Confluent.
“We see an attractive risk/reward in Confluent given 1) the long-term opportunity remains intact, 2) 2023/2024 estimates look achievable, 3) a renewed commitment to better operational efficiency and achieving profitability by 4Q23 as valuation looks attractive with shares trading at 6.4x CY24 revenue (+29% CAGR) or 0.22x adjusted for growth,” Singh opined.
“We see a catalyst path emerging which could drive shares to re-rate higher, as channel checks/surveys start showing a second derivative change in cloud optimizations, estimates are revised higher throughout the year, and the upcoming analyst day in June reveals new use cases and progress against an unchanged long-term opportunity,” the analyst added.
Given all of the above, Singh has high hopes. The Morgan Stanley analyst has assigned an Overweight (i.e. Buy) rating to CFLT, along with a $30 price target, indicating an upside potential of 38%. (To watch Singh’s track record, click here)
Overall, the Street’s outlook on Confluent is a Strong Buy, supported by 15 recent analyst reviews that include 12 Buys and 3 Holds. The shares are currently trading for $21.71 and have an average price target of $29.47, indicating room for ~36% growth in the next 12 months. (See CFLT stock forecast)
Model N, Inc. (MODN)
The next Morgan Stanley pick we’re looking at is Model N, a software firm that offers revenue-optimization and compliance-software solutions to the pharmaceutical, life sciences, and high-tech industries. The company’s products and solutions include pricing, payer, and provider management, deal management, global tender management, and the intelligence cloud. Model N also provides professional services and support for maintaining its products.
This company operates on the global stage, where it counts more than 190 enterprise customers across 120 countries. The customer base includes such major names as Johnson & Johnson and AstraZeneca, and Broadcom and Microchip Technology. Model N manages more than $500 billion in revenues annually.
In recent years, most software offerings have transitioned from package purchases to cloud subscriptions, and Model N is jumping on the bandwagon. The company is in the process of switching its customers to a subscription SaaS (Software as a Service) model – a move that is strongly helped along by the fact that Model N’s pharma customers are subject to heavy governmental regulatory burdens and simply cannot afford to drop their revenue management systems. It is expected that most of this sector, which, along with Life Sciences, makes up approximately 85% of Model N’s customers, will convert to SaaS at high rates.
In the most recent quarterly report, for the first quarter of fiscal year 2023 (the quarter that ended on December 31, 2022), the company posted modest beats. The top-line quarterly revenue of $59.15 million was $1.4 million better than expected, and the bottom-line non-GAAP EPS of 23 cents was 1 cent above the forecast. For comparison, the fiscal first quarter of 2022 revenue was $51.5 million, and the EPS was 15 cents.
On the forward guidance, Model N’s numbers were about as expected. The company is predicting $59 million to $60 million in revenue for fiscal Q2, compared to a $59.57 million consensus. The full year fiscal ’23 revenue guide is in the range of $242 million to $245 million, against a forecast of $243.49 million.
Covering this stock for Morgan Stanley, 5-star analyst Craig Hettenbach sees plenty of potential for investors to grab onto.
“We view Model N as a leader in revenue management solutions for the Life Sciences (85% of total sales) and High Tech (15%) industries. Against the backdrop of ongoing macro uncertainty, the company’s Pharma end market has an attractive combination of near-term defensive characteristics and long-term secular growth drivers. We also highlight an attractive visibility profile of the business, with most SaaS contracts 3 years, some up to 4-5 years and even as high as 7 years,” Hettenbach opined.
“Across SMID software, Model N ranks in the first quartile in EBIT and FCF margins, playing well into our framework that profitable growth is going to be an increasingly important driver of stock performance in Health Tech,” the analyst added.
All of the above combined with a compelling valuation prompted Hettenbach to rate Model N shares as Overweight (i.e., Buy). On top of this, the analyst sets a $43 price target, bringing the upside potential to approximately 30%. (To watch Hettenbach’s track record, click here)
Overall, the Strong Buy consensus rating here is unanimous, based on 5 recent positive reviews from the Street’s analyst corps. Shares in MODN are priced at $33.29, and the $46.20 average price target suggests an upside of ~39% going toward the end of the year. (See MODN stock forecast)
To find good ideas for stocks trading at attractive valuations, visit TipRanks’ Best Stocks to Buy, a tool that unites all of TipRanks’ equity insights.
Disclaimer: The opinions expressed in this article are solely those of the featured analysts. The content is intended to be used for informational purposes only. It is very important to do your own analysis before making any investment.