Qualys Inc. (QLYS) Stock Analysis

Qualys Inc. (QLYS) is a provider of cloud security that identifies risks to a company’s information tech infrastructure. In an age where more and more companies are storing data and information in the cloud the demand for cybersecurity is soaring. I believe the sector is still in the early stages of its growth as the power of information is only becoming greater and greater. Just last week instead of deploying explosives in Iran, the U.S. retaliated to the shooting down of an un-manned drone by launching a cyberattack on Iranian computers used to control rocket and missile launches. Cybersecurity is growing to the point where it is not only necessary for a company’s data protection but also for the safety of entire nations.

Financial Analysis

Qualys represents a great opportunity to take advantage of a booming industry. The company is in very strong financial standing as it features no debt and is able to generate a sizeable amount in operating cash flow. It has then shown that it will consistently invest this cash in growth by purchasing property & equipment, investing in research & development, or buying back stock as it did in 2018. The company’s strong balance sheet gives it the freedom to continue growing through more services as well as marketing efforts in order to recruit new customers. Qualys has grown revenue by at least 16% in each of the last 10 years and has seen bottom line growth in each of the last four. I expect this growth to continue moving forward as they benefit from a quality business model that scales seamlessly.

Effective Business Model

Qualys’ business model features a process of recurring customers that leads to the company’s sustainable growth. QLYS currently has 12,200 customers and they typically purchase one or two services initially and then upon satisfaction with the product purchase more from the library of over 20 services offered. The ability to continue generating revenue from current customers through the adoption of new services is a factor unique to Qualys that will generate revenue growth moving forward. The company also has bottom side protection as no one customer has accounted for more than 10% of revenue in each of the last three years. Qualys is in a very competitive sector so it is important that the potential loss of one customer will not have too large an impact on the company’s revenue.

Screen Shot 2019-07-07 at 5.51.41 PMSource: FactSet

Qualys has also grown its EBIT Margin in each of the last five years. This improvement in margin can be attributed to the decreasing SG&A Expense. In 2013, SG&A Expense was 79% of all sales but in March of 2019 SG&A only accounted for 57% of sales. This improvement in efficiency is a very positive sign as it proves that the company is reaping the benefits of being an economy of scale. Greater efficiency paired with top line growth signifies compounding earnings growth in the future.

Multiple Analysis

One drawback of Qualys is its high valuation as it currently trades at a P/E of 59. However, the software industry as a whole is currently trading at a P/E of 52. One could argue that the industry as a whole is currently overvalued as it is trading at its highest levels in over a decade but I believe that this just represents the natural growth of the industry. Cybersecurity is becoming a necessity for every company and government. Every business has information that is proprietary and this need is only increasing as more and more data is being stored in the cloud. Qualys warrants a higher than industry valuation because of their strong balance sheet and ability to generate recurring revenues. The lack of debt on the balance sheet allows Qualys to turn their operating cash flow into innovative new services that can be offered to both current as well as new customers.

Surprise History

Another good sign for Qualys moving forward is their history of surprises on quarterly earnings reports. As can be seen in the image from the image below, Qualys has outperformed analysis expectations in each of the last 20 quarters. This impressive surprise history leads me to believe that their management team sets conservative expectations and has a culture of exceeding expectations. Given the impressive scaling of the business and rapidly growing industry, if analysts do not start releasing higher EPS estimates this trend of surprises will continue.

Screen Shot 2019-07-07 at 5.59.53 PM.pngSource: FactSet

Conclusion

Qualys has seen significant top and bottom-line growth by taking advantage of their business model that allows for seamless scaling. The combination of strong research & development, management, and marketing teams allows the company to parlay its ability to generate cash into innovative new services. The valuation of 59 P/E is high relative to the market but I don’t see much multiple contraction moving forward as I believe that the industry is in the early stages of its life cycle and there is significant growth to be had as more and more companies are relying on data storage in the Cloud.

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