7min read Palo Alto Networks ($PANW(PANW)) is well-positioned in the cybersecurity space, leveraging its disruptive platform to navigate the evolving threat landscape and capitalize on market consolidation opportunities. The company's strategic focus on expanding its Total Addressable Market (TAM) with a Next-Gen Security Platform is expected to sustain its growth, particularly with a forecast of durable 20%+ free cash flow growth over the next three years.
The company will report its Q3 earnings results next Monday, May 20 after the market closes. We take a closer look to see if investors should be long the name ahead of the print.
Palo Alto Networks continues to expand its market share across multiple security categories, bolstered by its platformization efforts, which are enhancing its large deal pipeline and mitigating migration costs for customers through favorable pricing. Notably, following a significant data breach at United Healthcare, Palo Alto Networks was selected as an incident response provider, turning the affected subsidiary, Change Healthcare, into a significant client.
Additionally, there is a positive uptick in public sector engagement, highlighted by increased involvement in the Thunderdome project—a substantial five-year initiative aimed at modernizing the Department of Defense's network security infrastructure.
As we approach the fiscal third quarter (FQ3) results, the outlook appears favorable, underpinned by conservative estimates and strong large deal momentum. Channel checks suggest an above-average billings beat for FQ3, which could de-risk the fiscal fourth quarter (FQ4) and set the stage for revenue acceleration in FY25. The consensus suggests billings growth will exceed management's guidance of 2-4% year-over-year.
Despite the stock's modest gains since last quarter and mixed investor sentiment influenced by weaker results from industry peers, expectations for a substantial billings increase in FQ3 are set to potentially boost the stock further. However, a mere modest beat might not lead to significant market movement due to the stock's reasonable valuation at 25 times its expected CY25 free cash flow. The anticipated 20% year-over-year growth in contractual revenue obligations and a projected 41% year-over-year growth in Next Gen Security (NGS ARR) for FQ3 underline the company's robust performance trajectory despite a challenging expenditure environment witnessed in Q1 across the sector.
Q3 Guidance
For Q3 FY24, the company forecasts total billings to range between $2.30 billion and $2.35 billion, representing a year-over-year increase of 2% to 4%. Additionally, PANW anticipates a significant 13% to 15% year-over-year increase in total revenue, which is expected to fall between $1.95 billion and $1.98 billion. The earnings per share (EPS) are projected to be between $1.24 and $1.26, showing a growth of 13% to 15% compared to the previous year. The adjusted free cash flow margin for the quarter is expected to remain robust at approximately 38% to 39%.
For the entire fiscal year 2024, PANW expects total billings to be in the range of $10.10 billion to $10.20 billion, marking a 10% to 11% increase from the previous year. The Next-Gen Security Annual Recurring Revenue (ARR) is projected to grow impressively by 34% to 35%, reaching between $3.95 billion and $4.00 billion. Total revenue for FY24 is anticipated to range from $7.95 billion to $8.00 billion, indicating a 15% to 16% year-over-year increase. Operating margins are expected to improve, with non-GAAP figures projected to be between 26.5% and 27.0%. EPS for the year is forecasted to be between $5.45 and $5.55, demonstrating a substantial improvement of 23% to 25% year-over-year.
Q2 Earnings Recap
Palo Alto Networks (PANW) experienced a significant drop in stock price, falling 27% following its Q2 earnings report, despite a beat on EPS and in-line revenue. The drop was primarily driven by weaker than expected Q3 guidance and a downward revision of the full-year FY24 revenue and billings forecasts.
On a positive note, PANW's Network Security segment showed robust growth, marking the fifth consecutive quarter of over 50% ARR growth in its SASE business. Notably, over 30% of new SASE customers in Q2 were entirely new to PANW. The Prisma Cloud division also saw strong performance, achieving its highest new ACV growth in five quarters after significant investments in customer acquisition during the first half of the year.
Another highlight was the improvement in margins, with non-GAAP operating margin increasing by nearly 600 basis points to 28.6%. PANW also continued to secure large deals, including numerous $1+ million contracts and 10 transactions exceeding $20 million during the quarter. The top ten highest spending customers increased their expenditure by 36% during the period.
However, challenges were noted, particularly in the U.S. federal government market, where several large projects failed to close, contributing to a significant shortfall in business. This trend is expected to continue into the second half of the year. PANW attributed the overall reduction in billings and revenue guidance not to a drop in demand but to a strategic shift towards platformization and consolidation, alongside activating its AI leadership.
Despite these strategic shifts, PANW said it faced spending fatigue from customers who are increasingly concerned about rising cybersecurity costs without a corresponding decrease in breaches. This has led to a demand for more value from cybersecurity investments. This sentiment, combined with the unexpected cut in billings guidance and ongoing weakness in the government sector, left investors disappointed, particularly after high expectations were set in the previous quarter's earnings call.
Possible Breakout?
Shares of PANW are pushing up through the 20-weekly moving average ahead of its Q3 report. The stock has traded in a tight range between $270-310 since its Q2 post-earnings sell off. The move suggest that sellers are unwilling to part ways with the stock below the $270 area.
Shares have pressed higher by approximately 30 points over the past two weeks ahead of this print. A solid performance by the company should see the stock start to fill the gap down from the $375 area prior to its last report.
PANW is currently trading at its highest level since early March.
Peer Comparisons
In a comparative analysis of key cybersecurity stocks, Palo Alto Networks (PANW) stands out in several respects according to the provided data:
Performance Metrics:
1-month Performance: PANW has shown a significant rebound with a 12.60% increase, which is competitive with Crowdstrike's 13.59%, and notably better than other peers like Fortinet, Zscaler, and Cloudflare, which posted gains of -5.36%, 4.76%, and -17.88% respectively.
3-month Performance: Over the last quarter, PANW experienced a decline of -15.88%, which, while substantial, is less severe than Zscalers -27.90% and Cloudflares -28.37% drops. This positions PANW in a relatively stable spot amidst a volatile market segment.
Year-to-Date (YTD): PANW has seen a modest year-to-date gain of 5.07%, outperforming Fortinet, Zscaler, and Cloudflare, which have recorded -13.90%, -17.58%, and -10.21% respectively. This YTD performance signals stronger resilience or recovery in comparison to these competitors.
Forward Price/Earnings (P/E) Ratio: PANWs forward P/E stands at 50.0x, which is lower than Crowdstrikes 69.7x and Zscalers 55.6x, but higher than Fortinet's 31.1x and Cloudflares 99.2x. This suggests that PANW is considered less pricey than Crowdstrike and Cloudflare from an earnings perspective, but investors are willing to pay more for PANWs future earnings compared to Fortinet.
Price to Sales (P/S) Ratio: With a P/S ratio of 13.3x, PANW trades at a premium compared to Fortinet's 8.6x but is more modestly valued relative to Crowdstrikes 27.0x and Cloudflares 18.3x. This indicates that PANW's sales are valued more conservatively than Crowdstrike and Cloudflare but more richly than Fortinet.
PANW has a market cap of $100.2 billion, making it one of the largest companies in this peer group, surpassed only slightly by Crowdstrike ($CRWD(CRWD)) at $82.6 billion. Compared to other peers like Fortinet ($FTNT(FTNT))($46.6 billion), Zscaler ($ZS(ZS)) ($27.4 billion), and Cloudflare ($NET(NET)) ($25.4 billion), PANWs market cap reflects its substantial scale and investor confidence.
Valuation Metrics:
Market Capitalization:
Overall, PANW exhibits a strong market position with robust short-term performance and substantial investor valuation, although its forward P/E ratio suggests a middle-ground valuation compared to its peers, indicating balanced growth expectations amidst a competitive landscape.
Crowdstrike Earnings from May 6
CrowdStrike's (CRWD) fourth quarter earnings report displayed remarkable resilience and growth in the cybersecurity sector, dispelling the concerns of spending fatigue suggested by Palo Alto Networks in February. CRWD reported a record net new Annual Recurring Revenue (ARR) of $282 million and an operating margin of 25%, significantly outperforming expectations. The company's strong results not only boosted its own stock but have also positively influenced other cybersecurity firms, alleviating broader market fears of a spending slowdown. CEO George Kurtz described the macro environment as stable, with consistent deal scrutiny expected to continue, suggesting that PANW's recent struggles might be more isolated issues rather than industry-wide. Kurtz emphasized CrowdStrike's competitive edge, attributing its success to the Falcon platform's unique capability to provide comprehensive security solutions—including identity protection, cloud security, and next-gen SIEM—through a single platform. This integrated approach has proven effective, as evidenced by significant large deal closures and the achievement of record net new ARR.
Zscaler Results from May 1
Zscaler (ZS) reported a positive beat-and-raise financial outcome, demonstrating robust growth and a bullish outlook on cybersecurity spending. Despite these strong results, the stock faces pressure due to its high price-to-sales ratio of around 20x, combined with concerns over its growth trajectory as the company shifts to a new go-to-market strategy. These factors have slightly overshadowed the positive earnings report. This response comes in the context of broader market unease, initially sparked by Palo Alto Networks' (PANW) negative guidance in February, which led to widespread selling across the cybersecurity sector. However, ZS remains confident in the continued strong demand for cybersecurity solutions, suggesting that its challenges are more about strategic transitions than market demand.
Conclusion
Palo Alto Networks heads into its Q3 earnings with some momentum as recent peer reports suggest PANW may have been overly cautious in its commentary but there are some company-specific issues in play as the its platformization leads to some near term turbulence in results.
Palo Alto Networks is recognized as one of the leaders in the cybersecurity industry. Its comprehensive suite of solutions, including advanced firewalls and cloud-based offerings, positions it well to capitalize on the growing demand for cybersecurity solutions globally. With its focus on next-generation security platforms, including its well-regarded Prisma and Cortex products, PANW stays ahead of evolving cyber threats, making its offerings essential for modern enterprises.
Palo Alto Networks has consistently shown strong revenue growth, underpinned by a high rate of recurring revenue, which is a positive indicator of financial stability and customer retention. The company's ability to expand its margins over time also speaks to its operational efficiency and cost management prowess.
As digital transformation accelerates, so does the complexity and frequency of cyber threats. Palo Alto Networks is well-positioned to benefit from this trend, thanks to its extensive product portfolio that addresses a wide range of cybersecurity needs across different industries and geographic regions.
The company's investments in artificial intelligence and automation are enhancing its security platforms, making them more effective against a broad spectrum of cyber threats and thereby increasing their appeal to potential and existing customers. Palo Alto Networks boasts a diverse and growing customer base, including many Fortune 100 companies. High retention rates and the ability to upsell to its existing customers are indicative of the value that its solutions provide.
As cybersecurity threats continue to evolve, investing in a cybersecurity firm can be seen as a risk management strategy within a broader investment portfolio, given the sector's critical importance and growth potential. Investing in PANW offers exposure to a key player in a vital and expanding industry.
For these reasons we like being long PANW heading into next weeks print.