Morgan Stanley upgrades this under-the-radar software stock poised to survive IT budget cuts

Published Fri, Jan 20 20237:31 AM EST

Budget cuts loom in the IT industry, but software stock PagerDuty is well situated to come out unscathed, according to Morgan Stanley. Analyst Sanjit Singh upgraded PagerDuty to overweight from equal-weight, saying in a note to clients Friday that shares look attractive and that Wall Street is underestimating the company's ability to sustain growth in a difficult environment. "Strong unit economics, highly ratable sub revenue and market leadership in an important category provide the backdrop for a strong pivot to profitability," Singh wrote. "At ~4x CY24 sales, we think shares undervalue PagerDuty's ability to sustain 20% growth, expand margins and generate" free cash flows. Shares surged more than 4% on the upgrade. Software stocks face a difficult setup as companies look to trim IT budgets in a slowing growth environment. Despite these headwinds, Singh expects PagerDuty's growth to persist given its stable subscription model and move up from a predominant focus on small-to-medium-sized businesses. PagerDuty's subscription model, in particular, should offer "breathing room" for management to improve its cost structure and margins, Singh said. More important is its role in automating processes clients need to respond in real-time to service incidents. "With these teams being required to do more with less resources going forward (due to reductions in head count and/or tighter budgets), we think PagerDuty's status as a solution to unlock productivity from expensive engineering teams will increase during the current tech downturn and shield it from IT budget cuts," Singh wrote. The bank upped its price target to $36 from $32, implying that shares stand to rally more than 36% from Thursday's close. The stock fell nearly 24% in 2022 and trades about 1% lower in the new year. "We view PagerDuty as the clear market leader and a highly strategic asset in digital operations management, a capability that should see broad-based enterprise adoption as companies try to meet the operational challenge of an increasingly complex application environment," Singh said. — CNBC's Michael Bloom contributed reporting