F5 Inc. (NYSE: FFIV) struggles along with most of its peers in the EDP services sector. The shortage of semiconductor chips and supply chain constraints are slowing the industry’s growth, with many companies reporting a contraction in revenues and cash flows. F5 Inc. is somewhat shielded from the effects of these disruptions because of its pivot toward a primarily subscription-based company offering cloud software and security packages. However, the rest of the company’s operating segments are experiencing a contraction in growth, and investors have been paying attention to this. The company’s stock is currently down 7% YTD and there is room for bigger losses.
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The company is expected to lag the market for the remainder of the year, despite strong growth in business cloud and security software subscriptions. While sales of software for the company are expected to grow near the top of its 35% to 40% guidance range in FY2022, its systems, products and global services segments will only experience an anemic growth rate in the 1% to 1 range. .5% . Because of these issues, F5 Inc. increase its non-GAAP EPS by just 5.2% in Q3 FY2022 to $2.30. By comparison, companies in the S&P 500 are expected to increase their profits by 11.7% in the same quarter. The bottom line is that investors are aware that the company is struggling as it is currently trading 27% below MarketBeat consensus and the semiconductor shortages are expected to continue through FY2022.
F5 Inc. struggles in Q2 FY2022
F5 Inc. experienced a contraction in all its market segments in the second quarter of this year, with the exception of software. The company experienced a 27% contraction in its systems growth and 4% in products, reflecting how reliant its business remains on precious semiconductors. Sales also shrank overall by 2% compared to the previous quarter.
It should be noted that underlying demand for F5 Inc’s products remains strong, but only a handful of suppliers can supply the required semiconductors used in hardware assembly. Suppliers of these chips are expected to add capacity in the fourth quarter of this year, which will translate into improvements in the company’s profits in the second quarter of FY2023.
The company’s earnings call stated that executives believed the semiconductor shortages were a temporary disruption, so no adjustments were made to the company’s cost structure. This negatively impacted F5 Inc’s margins, resulting in a lower net income. Operating margin contracted to 26.5%, down 30.3%, and non-GAAP net income was reduced to $130.8 million, down $155.1 million.
F5’s advantage in software sales growth
Things looked more positive on the software and subscription side of the business. A saving grace to the company’s revenues is the fact that an increasing percentage of software revenues are recurring month-to-month. 69% of the company’s revenue was recurring in the second quarter, up from 64% in the previous quarter. Total software revenues also increased 25% to $152 million.
F5 Inc. also achieved some wins through its infrastructure-independent approach to cloud applications and security. The flexibility in its offerings allowed it to win several major customers during the second quarter, including a US multinational beverage company and the Department of Health for a country in the APAC region. The company’s solutions enable its customers to unify both traditional and modern cloud architectures without locking them into a single cloud, which is one of the company’s key competitive advantages.
Looking ahead, the company is positioning itself to help businesses manage multi-cloud environments with its offering of distributed cloud services. The new platform will bring together a suite of services used to manage cloud platforms into a single Software-as-a-Service offering. It also represents the first integration between F5 Inc. and the recently acquired Volterra company, which was completed in early 2021.
Share buybacks provide investors with value
To compensate for the damage the global chip shortage and supply chain constraints are inflicting on the company, F5 Inc will continue to repurchase shares to increase their value. The company has repurchased $250 million in shares in YTD FY22 and has pledged to repurchase another $500 million in shares by the end of this year. The ultimate intention of the company is to return 50% of the FCF to shareholders through share buybacks by FY23.
The technical outlook: oversold and unlikely to recover soon
F5 Inc. has been in a declining channel since December 21 last year. It can be clearly seen that the general trend is down and is currently oversold on the stochastics. A crossover is imminent on the MACD, suggesting that momentum is gradually shifting upwards. However, given that the channel has been in existence since late last year and the state of the market as a whole, it seems more likely that this will be a short-lived recovery before continuing its course towards the bottom.
