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This Cybersecurity Play Is Winning

By Harsh Chauhan – May 29, 2020 at 7:41AM

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The side effects of the novel coronavirus pandemic have turned out to be tailwinds for this cybersecurity stock.

While the COVID-19 pandemic has brought several businesses to their knees, the increasing adoption of telecommuting and online education are turning out to be tailwinds for Palo Alto Networks (PANW 1.04%).

The cybersecurity specialist's fiscal third-quarter results turned out to be significantly better than expectations. The shift to a remote working model led to a bump in demand for Palo Alto's security solutions as organizations scrambled to protect their employees and data from malicious attacks.

Let's see what's working for Palo Alto and why the company is confident of sustaining its momentum.

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Palo Alto's growth hits a higher gear

Palo Alto Networks' third-quarter revenue shot up 20% annually to $869.4 million, easily surpassing the higher end of the company's guidance range of $835 million to $850 million. Adjusted earnings of $1.17 per share also exceeded Palo Alto's expectation of $0.97 per share by a huge margin.

In fact, Palo Alto finished the quarter with $1.02 billion in billings, an increase of 24% over the prior-year period. This was the second-highest quarterly billings on record for Palo Alto. The spike in billings is a positive indicator of the company's long-term growth, as the metric is an indicator of future revenue.

Palo Alto's deferred revenue jumped 28% year over year to $3.38 billion, outpacing actual revenue growth. Deferred revenue is the money collected by a company in advance for services that will be rendered at a future date. It is recognized on the income statement once the services are actually delivered.

The impressive jump in Palo Alto's deferred revenue isn't surprising, as it added 2,500 new customers during the quarter. What's more, the company's customers spent more money on its offerings. This is evident from the lifetime value of the company's top 25 customers, which increased 21% year over year.

The good part is that Palo Alto expects the momentum to continue. It anticipates $920 million in revenue at the midpoint of its guidance range this quarter, a jump of nearly 15% from the prior-year period. The company has also raised its full-year guidance.

Don't be surprised to see Palo Alto outperform expectations once again, as organizations have accelerated their move to the cloud and reduced their physical footprint because of pandemic-related restrictions.

Cybersecurity prospects are looking up

According to the FBI, cyberattacks have quadrupled amid the novel coronavirus pandemic. Not surprisingly, organizations are now looking to ramp up their cybersecurity spending.

A survey carried out by technology research firm HFS Research in April found out that 70% of the organizations surveyed were looking to increase their cybersecurity spending this year. Palo Alto is already benefiting from this trend, adding 1,000 new customers to its GlobalProtect remote working solution last quarter.

The company is now looking to add new features to its next-generation firewall service. However, investors should note that all this growth is coming at a cost.

Palo Alto's third-quarter gross margin dropped 130 basis points year over year to 75.2%. Operating margin was down 450 basis points from the prior-year period, as operating expenses shot up 23.5% annually during the quarter. Clearly, Palo Alto is going all out to acquire new customers. This may turn out to be a smart move if the company is able to lock in customers for the long run.

Is it still a buy?

Palo Alto Networks stock has surged remarkably in the past couple of months, but it continues to remain attractive from a valuation perspective. Its price-to-sales ratio of 7 is lower than the five-year average multiple of 9. The stock trades at 42 times forward earnings estimates. This is lower than the five-year average of 53.

In the end, investors shouldn't forget that Palo Alto is delivering impressive growth in tough times. The company outperformed expectations last quarter and bumped its full-year guidance, and the prospects of the space it operates in are looking up. These are the reasons why anyone looking to add a cybersecurity stock to their portfolio should take a closer look at Palo Alto Networksgrowth pick.

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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