Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking one high-profile Wall Street pick and putting it under the microscope...
Cybersecurity specialist Palo Alto Networks (PANW 0.88%) reported its fiscal Q1 2019 earnings yesterday. The results were pretty impressive. Expected to earn $1.05 per share on revenue of $631.9 million, Palo Alto instead reported EPS of $1.17 (albeit, pro forma) on $656 million in revenue.
Furthermore, the company announced new guidance for its second fiscal quarter of 2019 that likewise exceeded estimates. According to management, Palo Alto is on a path toward earning $1.20 per share or better (analysts are only looking for $1.20, period), with sales likely to come in close to $680 million -- ahead of the average analyst estimate of $669 million.
So why is it that everyone and his brother on Wall Street seems to be cutting their price targets on Palo Alto Networks stock today?
Cutting Palo's price targets
No fewer than five separate stock analysts -- BMO Capital, Citigroup, Credit Suisse, Jefferies, and Piper Jaffray -- have announced price target cuts on Palo Alto, according to a survey of recent analyst actions on StreetInsider.com (subscription required). The cuts these analysts are announcing land all over the map -- falling all the way to $160 at ultra-conservative Credit Suisse, but slipping only a bit to a still-staggering price target of $249 a share at uber-optimistic Jefferies. (For context, Palo Alto Networks stock costs less than $178 today.)
But why are these analysts cutting targets at all, given the blowout quarter Palo Alto just reported, and its rising guidance as well?
Credit Suisse explains: "We maintain our respect for PANW's market leadership, strong execution and superlative messaging." Regardless, Credit Suisse's big-picture thesis is that Palo Alto's firewall technology is at risk of becoming irrelevant "in a cloud-first world," and this threatens the company's prospects over the longer term.
Upgrading Palo Alto stock
Not everyone is as worried about this as Credit Suisse is, however. Fool.com contributor Harsh Chauhan, for example, recently pointed out how Palo Alto Networks may be getting ahead of this threat by acquiring companies that play more to this "cloud-first world" that Credit Suisse mentions. In fact, Palo Alto bought cloud infrastructure security specialist Evident.io just earlier this year, and the company now "aims to offer an integrated cloud security service that brings a plethora of features -- such as real-time security, advanced threat detection, analytics, and compliance monitoring -- onto a single dashboard."
Between this, the earnings beat, and the guidance raise we saw yesterday, two other analysts are getting downright optimistic about Palo Alto Networks. While others were cutting their price targets, you see, today analysts at both Gabelli and First Analysis upgraded their ratings on Palo Alto stock -- to buy and outperform, respectively.
First Analysis writes, in a note covered by TheFly.com, that it was impressed by Palo Alto's "strong" Q1 results and guidance that exceeded estimates.
Gabelli, too, is optimistic: "We have a favorable view of Palo Alto Networks' market leadership, technology platform, and competitive security platform. We believe Palo Alto Networks can continue to deliver outstanding strong sales growth, win market share and expand its operating profitability." Moreover, the "shares are attractive again at its current valuation."
The upshot for investors
So Wall Street is split on Palo Alto Networks right now, with some analysts fearing the company's recent outperformance will give way to irrelevance in this fast-changing tech industry, while others see no such slowdown in sight -- and see Palo Alto Networks as a bargain-priced. Which view should investors cleave to?
If you ask me, the latter looks more likely. According to most analysts who follow the stock, Palo Alto Networks is on track to grow its profits at about 22% annually over the next five years, and recent results show no reason to doubt that. Palo Alto's revenue grew 31% year over year in the most recent quarter, and its deferred revenue (payment received, but for services not yet provided and so not yet billed) grew 34%. Pro forma profits surged 56% in Q1, while the company's GAAP loss shrank by 41%.
Granted, we don't yet have an up-to-date free cash flow number on Palo Alto (because management didn't include a cash flow statement in its earnings release, tsk, tsk). Still, at last report the company was generating cash profits at the rate of $925 million per year (according to data from S&P Global Market Intelligence). On Palo Alto's $15 billion debt-adjusted market cap, that works out to an enterprise value-to-free-cash-flow ratio of just 16.2.
I think that's a very attractive price to pay for a company that just beat earnings estimates so soundly -- and lifted its guidance, to boot. You can find me down in the camp of investors "upgrading" Palo Alto Networks today.