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Palo Alto Networks Is Finishing 2018 Strong

By Nicholas Rossolillo - Dec 7, 2018 at 6:02AM

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But is the stock worth your money?

While 2018 is likely to finish out as a win for cybersecurity company Palo Alto Networks (PANW -0.68%), with shares up 23% so far this year at the time of this writing, the stock is still down roughly 25% from its all-time highs, reached over the summer.

The reasons for the decline are diverse -- including a tough autumn quarter for technology stocks in general -- but can be summed up this way: The stock's valuation was simply too high a few months ago.

Nevertheless, after investors hit the reset button and Palo Alto delivered another knockout quarter to start its new fiscal year, the cybersecurity leader looks like a buy.

A new year's resolution worthy of note

After topping $2 billion in annual revenue for the first time in the 2018 fiscal year (a 29% increase over the prior period), Palo Alto got its 2019 fiscal year started right. Revenue for the October-ended fiscal first quarter was up 31% to $656 million. Gross profit margin was at 72%, up from 71.8% a year ago, boosted by expansion in higher profit subscription-based services.

The results easily beat management's outlook given a few months before. For the current quarter, Palo Alto said revenue would grow by 24% to 26% year over year, perhaps setting up another easy hurdle to clear. Adjusted earnings are expected to grow at least 24% as well. In keeping with CEO Nikesh Arora's statement shortly after taking the helm on making profitable growth a priority, unadjusted net loss in the most recent quarter narrowed to $38 million from $63 million last year.

An illustrated shield over numbers in boxes, representing cybersecurity protecting data.

Image source: Palo Alto Networks.

2018 -- a year of transition?

While Palo Alto is a leader in cybersecurity, especially on the cloud computing front, the company still has work to do to secure its future. As businesses transition their tech operations from on-premises software to cloud-based ones, the cybersecurity industry has also needed to shift its focus to meet these increasingly complex security needs.

To address that issue, Palo Alto made several acquisitions in 2018. Back in the spring, it bought cloud security firm for $300 million. More recently, it purchased the firm RedLock for $173 million, which it has been integrating with to create a new offering for its customers. The new service -- geared specifically toward the cloud, Internet of Things, and the new 5G mobile network -- will roll out at the beginning of 2019.

In short, Palo Alto is making progress in evolving its business to meet the high-tech needs of its customers. But is this still-unprofitable company worth your while? I think so. After its last quarter, price to free cash flow (which only includes basic operating expenses and capital expenditures) sits at 18.2. Wall Street analysts think that unadjusted profitability is right around the corner, too, with a 12-month forward P/E currently at 29.1.

Those may look like rich valuations for a company that isn't in the black yet. But with revenues growing well into the double digits and the cybersecurity industry overall in growth mode as technology advances, the stock looks like a fair value. While shareholders should expect volatility from a company like Palo Alto, chances are that it will be much larger than it is today in a decade's time -- making the recent pullback in this stock look like a buying opportunity.

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