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Why Palo Alto Networks Stock Can Go Higher

By Harsh Chauhan – Updated Apr 24, 2019 at 4:16PM

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The cybersecurity specialist's upcoming earnings report could give it a nice shot in the arm.

Palo Alto Networks (PANW 1.04%) has started 2019 on a bright note, and its shares now trade close to their 52-week high. The cybersecurity specialist has scripted a remarkable turnaround in recent months after appearing to lose momentum in the second half of 2018. That momentum will be put to the test when the company releases its fiscal second-quarter results on Feb. 26.

Investors are probably expecting another round of solid results and strong guidance from Palo Alto, and the company looks all set to deliver the same. Here's why.

Hand drawing stock chart on a clear board.

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Expect solid growth once again

Wall Street expects Palo Alto Networks to report earnings per share of $1.22 on revenue of $682 million this quarter. That would compare favorably to the year-ago quarter's revenue of $542 million and EPS of $0.97. The consensus estimates are at the higher end of Palo Alto's guidance range, which called for revenue between $675 million and $685 million and adjusted EPS of $1.20 to $1.22.

But Palo Alto has a history of comfortably beating analysts' expectations. It has done just that in each of the last four quarters, thanks to the rapid growth of its customer base and because it has been able to extract more business from existing clients.

Palo Alto ended the first quarter with 56,500 customers, up about 25% year over year. That was identical to the growth it had recorded in the prior 12-month period. More importantly, its clients have ramped up their spending on the company's offerings. As of the first quarter, the lifetime value of Palo Alto's top 25 customers had shot up 45% year over year, outpacing its overall revenue growth. At the same time, the company reduced its spending on sales and marketing on a year-over-year basis.

The lifetime value of a customer denotes the business Palo Alto has received from a particular client after deducting client acquisition and servicing costs. The rapid increase in this metric indicates that customers are buying more of the company's cybersecurity offerings, and the drop in marketing expenses means that it is having more success in cross-selling its solutions.

This has been made possible by Palo Alto's strategy of branching out into several cybersecurity niches, thereby giving customers the opportunity to buy several solutions from one vendor. This has been beneficial for both customers and the company. Palo Alto's latest big move indicates that it will continue following this tried-and-tested strategy.

Check out the latest Palo Alto earnings call transcript.

Another impressive move

Palo Alto's strategy of acquiring companies that complement its cybersecurity business has paid off handsomely so far, as seen from the increases in its customer count and spending in recent quarters. So it is not surprising to see the company shelling out $560 million to acquire Demisto, a provider of security orchestration, automation, and response (SOAR) capabilities.

Palo Alto believes that Demisto brings the company "closer to using AI and machine learning to help further automate significant parts of the company's customers' security operations." As a result, Demisto should bolster Palo Alto's position in the artificial intelligence-driven cybersecurity market, which is growing at an annual rate of 31.4% and could hit $34.8 billion in revenue by 2025, according to one estimate.

What's more, Demisto currently serves more than 150 customers, more than a quarter of which are Fortune 500 companies, including large healthcare, technology, and financial-services organizations. This means Palo Alto can now sell its existing solutions to these large customers while also offering Demisto's capabilities to its existing customer base.

Palo Alto expects to close the acquisition in the current quarter, so its guidance could turn out to be better than expected thanks to the synergies that Demisto is supposed to bring. Looking further ahead, there's a strong chance that Palo Alto will be able to sustain its impressive growth rate, which should pave the way for further upside for investors.

Harsh Chauhan has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Palo Alto Networks. The Motley Fool has a disclosure policy.

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