Palo Alto Networks: I Am Optimistic About The Upcoming Earnings Release
[Palo Alto Networks, Inc.(PANW)](/symbol/PANW?source=content_type%3Areact%7Csection%3Amain_content%7Csection_asset%3Ameta%7Cfirst_level_url%3Aarticle%7Csymbol%3APANW)
Summary
– IT threats for businesses are growing, which increases the demand for the most technologically advanced offerings from cybersecurity companies.
– With Palo Alto Networks’ intense focus on innovation and stellar success track record, the company is well-positioned to absorb secular industry tailwinds.
– My valuation analysis suggests PANW stock is about 27% undervalued.
Investment thesis
I am very bullish about Palo Alto Networks (NASDAQ:
PANW), and today, I would like to explain to readers why I reiterate my “Strong Buy” rating.My previous bullish thesis about the company worked well, as the stock rallied by more than 15% compared to the broader market’s 2% decline over the same period.The company delivered a strong previous quarter, and my upcoming quarter’s earnings preview analysis suggests that there is still room for optimism.Moreover, my valuation analysis suggests that the stock is still very attractively valued despite a massive year-to-date rally.
Recent developments and earnings preview
The latest
quarterly earnings were released on August 18, when the company slightly missed consensus revenue estimates but delivered a positive EPS surprise.Revenue demonstrated a staggering 26% YoY growth, which means it was the twelfth straight quarter of an above 20% YoY revenue increase — a jaw-dropping revenue growth pace.
Profitability metrics followed the topline growth, and the gross margin expanded YoY from 68% to 74%.This strength allowed PANW to improve its operating margin substantially, which expanded YoY from 1% to 13%.
It is crucial to underline that the operating margin was not at the expense of innovation as the R&D to revenue ratio remains above 20%.The management’s firm commitment to innovation, multiplied by its strong track record of success, is a huge positive sign for investors.The company’s healthy balance sheet means PANW is well-positioned to continue investing in innovation to fuel long-term growth.
Now, let me move on to preview the upcoming quarter’s earnings release, which is approaching.
The earnings call is scheduled for November 15.Quarterly revenue is projected by consensus at $1.84 billion, which indicates an 18% YoY growth.
With the strong revenue momentum expected to be sustained, consensus also forecasts a solid YoY adjusted EPS improvement from $0.83 to $1.16.
There are several reasons why I am optimistic about the upcoming quarter’s earnings release.I believe that IT security services are critical as, in the modern world, the adverse consequences of successful cyberattacks can destroy almost any business.That said, enterprises are not keen on cutting cybersecurity spending even amid uncertain times.The financial performance of PANW over the last two years proves my thoughts.
Revenue grew by about 62% between FY 2023 and FY 2021, which is a massive growth given the environment, which started worsening rapidly in early 2022.
At the same time, I do not feel that management pursues growth at all costs.I like the focus on consistent profitability metrics improvement as the business scales up.
The recent stellar margin expansion suggests that the company is able to deliver operating leverage, and profitability is poised to continue improvement as revenue sustains its growth trajectory.
The current earnings season suggests that investors are
more concerned with guidance than the past quarter’s performance.I think that PANW’s management’s guidance is unlikely to disappoint.
According to a report from Canalys, 2023 is a very challenging year for businesses from the IT security perspective as the number of cyberattacks is growing.That said, I do not expect the demand for cybersecurity solutions to soften, and PANW’s strong revenue growth in recent quarters suggests that its offerings are appealing to customers.
The company’s massive investments in R&D showcase its commitment to staying at the forefront of the emerging industry’s trends.PANW
recently unveiled its Strata Cloud Manager, the industry’s first artificial intelligence [AI] -powered Zero Trust management and operations solution.The company’s announcement of the intent to acquire a cloud security start-up, Dig Security, suggests that investments in AI are not over.
The transformation of the company’s products to make it more autonomous and effective with the help of AI looks like a solid move, which aligns with the evolving technological landscape.PANW has a strong track record of successful acquisitions, which fueled the company’s previous revenue growth as business combinations consistently enhanced its innovation pipeline.That said, I expect the management to share their expectations about the potential synergies from this acquisition during the upcoming earnings call, which will likely add optimism to investors.
From a more quantitative perspective, the stellar remaining performance obligation [RPO] dynamics.Positive RPO trends mean the improving backlog of committed revenue from existing contracts.This provides greater visibility and predictability of revenue, and that is also the big reason why I believe PANW is able to achieve forecasted revenue growth in Q1 of fiscal 2024.
Last but not least, PANW has a stellar
earnings surprise history, which also gives me the high conviction that the upcoming quarter’s earnings release will likely disappoint investors.The company never missed the EPS consensus estimates over the last sixteen quarters and there were only two slight revenue misses.To conclude, the strong positive earnings surprise track record, together with industry tailwinds, PANW’s strong commitment to enhancing its offerings, and strong backlog, make me very optimistic regarding the closest quarterly earnings release.
Valuation update
The stock rallied by 83% year-to-date, significantly outperforming the broader U.S.market.
Seeking Alpha Quant assigns the stock the lowest possible “F” valuation grade because ratios are multiple times higher than the sector median across the board.
On the other hand, current valuation ratios look somewhat reasonable compared to historical averages.
Based on the multiples analysis, the stock looks overvalued, but I prefer to trust discounted cash flow [DCF] simulation more regarding growth companies like PANW.I use the same 10% WACC as I did in my previous analysis of the company.I use a 14.1% TTM FCF ex-SBC margin for my base year and expect two percentage points yearly expansion.Revenue
consensus estimates forecast a 13% CAGR, which I consider fairly conservative to incorporate into my DCF simulation.
According to my calculations, the business’s fair value is a hundred billion dollars, indicating a 27% more upside potential.
That said, my target price for PANW stock is $320.
Risks update
My DCF simulation is based on a number of assumptions, and each of them significantly affects the valuation.For example, if I implement even slightly less optimistic revenue growth and FCF expansion assumptions, this will significantly undermine the fair value.In case a 10% revenue growth CAGR for the decade is implemented together with a 150 basis points yearly FCF expansion, the fair value of the business decreases to $69 billion.That said, potential investors should be aware that the company’s valuation will suffer in case long-term consensus revenue and earnings estimates are downgraded.
As a cybersecurity company, PANW faces substantial cybersecurity risks.In the event of a security breach at a customer or within the company’s own systems, the company’s reputation as a trusted and innovative cybersecurity company might be ruined.This can lead to adverse financial consequences, including potential legal liabilities and a loss of customer confidence.
The highly competitive landscape in the industry demands an unwavering commitment to data protection from cybersecurity companies.
Bottom line
To conclude, PANW is still a “Strong Buy”.The company continues experiencing massive revenue growth momentum, and the management is laser-focused on profitability improvement and product innovation.Recent developments suggest that the upcoming quarter’s earnings release will not disappoint investors.Moreover, my valuation analysis suggests that there is still more than 20% upside potential, which makes PANW an appealing investment opportunity.
Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours.I wrote this article myself, and it expresses my own opinions.I am not receiving compensation for it (other than from Seeking Alpha).I have no business relationship with any company whose stock is mentioned in this article.
Seeking Alpha’s Disclosure: Past performance is no guarantee of future results.
No recommendation or advice is being given as to whether any investment is suitable for a particular investor.Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole.Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank.Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
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