May is turning out to be a bad month for Palo Alto Networks (PANW -1.71%) The cybersecurity specialist's stock has pulled back this month for no apparent reason.
But this latest weakness in Palo Alto stock could be a buying opportunity for savvy investors, because the company's upcoming fiscal 2019 third-quarter earnings report could swing the momentum back in its favor. Here's what investors can expect from Palo Alto when it reports earnings on May 29.
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Great expectations
Wall Street expects Palo Alto to deliver earnings of $1.25 per share on revenue of $704 million. The company's revenue and earnings per share stood at $567 million and $0.99 in the year-ago quarter.
So Palo Alto is expected to deliver terrific growth once again. However, investors should note that Wall Street's expectations are slightly above the midpoint of Palo Alto's own guidance. The company has called for revenue of $697 million to $707 million, with earnings in the $1.23- to $1.25-per-share range.
But the company is capable of meeting the market's expectations thanks to solid growth in its customer base and a massive cross-selling opportunity.
Plenty of catalysts
Palo Alto has a history of trouncing Wall Street's earnings estimates, so don't be surprised to see the company repeating that performance.
The company ended the second quarter with 59,000 customers (a 23% year-over-year jump) and that number will be higher in the third-quarter report thanks to its acquisition-led expansion strategy.
For instance, the company spent $560 million to acquire Demisto earlier this year to enhance its artificial intelligence (AI) capabilities. Demisto has more than 150 customers, more than 25% of which are Fortune 500 companies.
So the acquisition of Demisto will bring new customers into Palo Alto's fold, though that's just one way the company is going to benefit from this move. Demisto is known for providing security orchestration, automation, and response solutions (SOAR) to businesses.
SOAR ensures that low-level cybersecurity events are tackled automatically by the system after collecting data regarding impending threats from several sources. So SOAR allows enterprises to automate their cyberdefenses, and 95% of the security alerts are handled automatically, leaving the security teams to focus only on mission-critical events.
Artificial intelligence is gradually becoming a bigger part of the cybersecurity landscape, with research company MarketsandMarkets projecting that AI in cybersecurity will grow at a compound annual growth rate of 31% through 2025. The Demisto acquisition will strengthen Palo Alto's offerings and help it attract more customers.
Apart from boosting the customer base and enhancing its capabilities in the AI space, acquisitions like Demisto open up a nice cross-selling opportunity for Palo Alto.
Given the lower cost of cross-selling, it's not surprising that Palo Alto's selling, general, and administrative expenses have been declining as a percentage of sales.
PANW SG&A Expense (% of Annual Revenues) data by YCharts.
The chart above clearly shows that the lower overheads are helping Palo Alto reduce its losses. The company's strong bottom-line momentum is expected to continue, as analysts polled by Yahoo! Finance expect strong growth in its adjusted earnings for the next two fiscal years.
In all, Palo Alto Networks is following the right strategy to increase its foothold in the cybersecurity business. The company is sitting on a net cash position of nearly $1.3 billion, which it can use to make more acquisitions and increase market share.
With that in mind, investors should use the recent weakness in Palo Alto Networks stock to build their long positions. The company's growth strategy should not only help it trump Wall Street's expectations next week but also pave the way for long-term growth.
