Since Nikesh Arora took over as CEO in 2018, Palo Alto Networks (PANW 0.85%) has raced to strengthen its cybersecurity products to meet the challenges of today's IT infrastructures. The company has done well. For its last fiscal year ended July, Palo Alto Networks delivered a 27.5% year-over-year increase in revenue to $2.9 billion. Its stock rose to a 52-week high of $251.11 on Feb. 19, before the coronavirus pandemic sent stocks into a bear market.

Is there enough growth ahead to make Palo Alto Networks a buy? Let's dive into company details to answer that question.

Businessman clicking on a padlock icon floating in air connected to other icons representing a computer, email, and the cloud.

Image source: Getty Images.

How Palo Alto Networks succeeds

Palo Alto got its start in 2005 selling an enterprise firewall product that intelligently screened for malicious network traffic. It was more sophisticated than what was possible from the basic firewalls of the time, during an era when most employees worked from a business location.

Thanks to the arrival of cloud computing and mobile devices, today's workforce does not need to work from the confines of an office, making cybersecurity more difficult. To meet this and other IT security challenges, Palo Alto Networks assembled new cloud-based cybersecurity products, such as its Prisma cloud security suite unveiled in May 2019, and its artificial-intelligence powered threat-detection product, Cortex.

Aside from its core firewall products, the company sells its solutions using a software-as-a-service (SaaS) subscription model, which allows it to earn recurring revenue from its customer base.

This approach has served Palo Alto Networks well. For the second quarter of fiscal 2020, it generated $342.6 million from its subscription offerings, compared with $246.5 million from its firewall products. The company earned an additional $227.6 million by offering support services. In total, Palo Alto took in $816.7 million in Q2 revenue, up 15% from the second quarter of 2019.

The company also benefits from playing in a large market. Cybersecurity is a crucial component for any business connected online. That's why, according to Gartner Research, the cybersecurity industry will be worth $188.8 billion in constant currency by 2023.

Limits to growth

Palo Alto Networks may be a victim of its own cloud-centric solutions' success. Revenue is steadily rising but its growth rate is slowing.

Quarter Revenue Year-Over-Year Increase
Q2 2020 $816.7 million 15%
Q1 2020 $771.9 million 18%
Q4 2019 $805.8 million 22%
Q3 2019 $726.6 million 28% 
Q2 2019 $711.2 million 30%

Data source: Palo Alto Networks.

This is partly due to a 9% year-over-year decline in firewall product revenue. Arora stated on the Q2 earnings call that incentives were not properly aligned to drive greater firewall segment sales, and the company is addressing this by installing a new head of its firewall division, and by adding new capabilities to the product line.

Another factor in its decelerating growth rate is competition. Several cybersecurity companies are competing with Palo Alto, such as Check Point Software Technologies and CrowdStrike. But the competition is also an opportunity. Palo Alto Networks acquired a number of smaller cybersecurity companies over the last two years, the most recent being CloudGenix on April 21, to enhance and grow its products in both capabilities and customers.

Even with acquisitions, the company ended the first half of fiscal year 2020 with $435.8 million in free cash flow and $2 billion in cash. Palo Alto Networks is in a solid financial position. As a result, the company announced an accelerated share repurchase of $1 billion to take place during its third quarter. This adds to the $1 billion share repurchase program announced in February 2019. In the Q2 earnings call, Arora stated the move was to reward shareholders, and he also felt the company was attractively valued.

My verdict

Despite decelerating growth, the company possesses many strengths. Its financial health is solid, allowing it to execute acquisitions. Its CEO wants to deliver benefits to shareholders, such as share repurchases. Its comprehensive suite of cybersecurity products generates recurring SaaS revenue in an industry that's in demand. Given these factors, Palo Alto Networks is a solid company to invest in.