PANW Earnings Preview- Can the cybersecurity play justify its valuation?

Palo Alto Networks (PANW) is set to release its Q4 FY2024 earnings tonight after the close, with analysts expecting the company to report EPS of $1.41 and revenue of $2.16 billion, representing 10.8% year-over-year growth. The company’s management has guided for revenue between $2.15 billion and $2.17 billion and normalized EPS in the range of $1.40 to $1.42, closely aligning with consensus estimates. Despite these projections, PANW’s recent rally has been driven more by multiple expansions than by fundamentals, leading to concerns about its rich valuation, particularly with a forward P/E multiple of 55.4x.

Ransomware attacks are on track to make 2024 the worst year yet, surpassing 2023's record, as online gangs, often based in Russia, increasingly target companies and demand large payments, usually in cryptocurrency like Bitcoin. According to Chainalysis, inflows of cryptocurrency to ransomware attackers rose 2% year-over-year in the first half of 2024, totaling $459.8 million. The year has already seen the largest ransomware payment ever recorded at approximately $75 million, with the median payment for severe strains spiking to $1.5 million by mid-June, highlighting the escalating severity of these attacks and the potential benefits for cybersecurity stocks.

Shares of cybersecurity stocks have been on the rise due to the uptick in ransomeware. Shares of CRWD fell to $285 on August 15 but have rallied back to the $340 area which lines up as a key resistance level for the stock. A strong report could lead to a breakout but investors will be paying close attention to that rich valuation.

PANW's management has provided cautious guidance for FY2024, expecting billings between $3.43 billion and $3.48 billion, which reflects a growth of 9% to 10% year-over-year. The company's revenue growth has moderated in recent quarters, and billings performance has been inconsistent, raising questions about the sustainability of its current valuation. Despite this, the company is expected to re-accelerate its growth in FY2025, but the current valuation may not fully account for the near-term challenges.

A critical element of PANW's strategy is its push towards "Accelerated Platformization," which involves customers signing longer contracts and standardizing on PANW’s platforms. This strategy is seen as essential for the company’s long-term growth, despite its short-term impact on top-line growth. The platformization approach is designed to create a more integrated and scalable cybersecurity solution, positioning PANW to capitalize on the growing demand for comprehensive cybersecurity services.

The importance of this strategy cannot be overstated, as it aligns with the broader industry trend of vendor consolidation and increased demand for platform-based solutions. While the initial impact on revenue growth has been modest, the long-term potential is significant, with PANW expected to see a re-acceleration in growth to mid-teens levels within the next 9-15 months. The strong customer response to this strategy underscores its potential to drive sustainable growth in the future.

However, the rich valuation of PANW remains a concern. With a forward P/E multiple of 55.4x, the stock appears overvalued relative to its near-term growth prospects. While the company’s long-term outlook remains positive, driven by its platformization strategy and AI potential, investors may need to weigh the high valuation against the expected moderation in growth over the next few quarters.

Redburn-Atlantic recently downgraded Palo Alto Networks (PANW) to Neutral, expressing skepticism about the company's ability to achieve the sharp reacceleration in dollar growth expected by consensus from FY26 onwards, citing the broader optimization and deflationary challenges in the industry. In contrast, DA Davidson initiated coverage with a Buy rating, highlighting PANW's strong position in the cybersecurity market, particularly its platformization strategy, which, while impacting near-term billings growth, supports long-term robust growth in bookings and free cash flow margins. Both firms acknowledge the potential of PANW's platformization strategy, but Redburn-Atlantic is more cautious about its near-term impact and the likelihood of returning to pandemic-era growth levels.

Palo Alto Networks reported mixed Q3 results, with a smaller-than-usual EPS beat of $0.07 and revenue rising 15.3% year-over-year to $1.98 billion, in line with expectations. The company provided in-line guidance, which was a relief given previous guidance cuts in two of the last three quarters. Geographically, the Americas grew 15%, EMEA 20%, and JPAC 8%, with lower product bookings in JPAC offset by higher subscription bookings. Non-GAAP operating margin improved by 200 basis points to 25.6%, and the company slightly narrowed its FY24 billings guidance. Despite the modest earnings beat, the stock reacted negatively, likely due to investor concerns about the billings guidance and the relatively small EPS upside.

However, PANW's management offered reassurance during the earnings call, particularly around its platformization strategy, which has received positive customer feedback despite earlier investor concerns. The company highlighted continued strong demand for cybersecurity, driven by an ongoing stream of cyberattacks, including those aided by AI, and expressed confidence that spending in the sector would remain robust. Additionally, PANW's new partnership with IBM is expected to accelerate its platformization efforts by leveraging IBM's industry-specific capabilities and large consultant base. Overall, while the earnings report was decent, investor expectations for a stronger performance and better guidance left the market somewhat disappointed.