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...
This morning, both analysts announced they are upgrading the computer firewall maker and all-around security specialist, with BMO giving Palo Alto an outperform rating and UBS making a buy recommendation. BMO is furthermore assigning shares a $240 price target, according to TheFly.com, and while UBS is pegging them at $250.
Here's what you need to know.
BMO does a U-turn
BMO's upgrade is perhaps the more surprising of today's two endorsements. Two months ago, BMO was one of several analysts that cut price targets on Palo Alto Networks despite the company's strong fiscal Q1 earnings report. Now BMO is reversing course, upping its price target and upgrading the stock.
BMO sees a "healthy" network firewall market benefiting Palo Alto Networks "over the next several years," and supporting 9% sales growth in fiscal 2020 as the company adds new customers and expands sales to existing customers. This, in the analyst's view, gives Palo Alto stock "meaningful upside potential" -- as much as an 18% potential profit off today's prices.
UBS seconds that emotion
UBS, too, is feeling optimistic about Palo Alto. Although the stock has gained 32% over the past year, the analyst argues the shares nonetheless sell at an unjustifiably "discounted" valuation that is "near five-year troughs." It's not entirely clear what metric UBS is referencing when making this argument. Palo Alto Networks is not currently GAAP profitable, for example. The analyst may be referencing Palo Alto's enterprise value-to-forward-sales ratio, which at 5.4 currently, is actually a bit below the stock's lowest valuation over the past five years (5.45, as confirmed by data from S&P Global Market Intelligence).
Whatever UBS' basis for making the claim of "trough" valuation, UBS seems convinced Palo Alto Networks will soon dig itself out of the ditch. Echoing BMO's sentiment, UBS says that demand for network security looks "stable/better," which should support growth at the network security provider.
A third voice
One final point bears mentioning in this chorus of analyst upgrades: Last week, Stifel Nicolaus published the results of its latest quarterly survey of 30 North American security providers. Now, Stifel didn't upgrade Palo Alto, but the analyst did highlight it as a company "particularly" likely to benefit from "robust" corporate spending on firewalls "through 2019."
This tallies with overall sentiment regarding the company: S&P Global data shows analysts on average predicting a 30% increase in pro forma earnings for Palo Alto this year, and a 22% profits growth rate for the company over the next five years.
What that means for investors
Granted, with Palo Alto Networks currently unprofitable under GAAP, it's not entirely clear what "profits" Wall Street thinks will be growing. Be that as it may, the company did generate positive free cash flow of $901 million over the past 12 reported months.
Weighed against its $19.3 billion market capitalization, or its even more attractive, debt-adjusted enterprise value of just $17.7 billion, Palo Alto Networks stock sells for only 21.4 times free cash flow, or an enterprise value-to-FCF ratio of 20. Both numbers compare well to analysts' projected 22% earnings growth rate. Now, all Palo Alto Networks needs to deserve the buy ratings...is produce the growth.
We should get our first evidence of whether it did that when fiscal Q2 2019 earnings come out late next month.
Check out the latest Palo Alto Networks earnings call transcript.