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Cybersecurity Risks Are Greater Than Ever. That's Lifting Palo Alto Networks' Stock Higher

By Nicholas Rossolillo - May 28, 2021 at 7:00AM

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In the wake of the digital transformation's recent acceleration, the need for strong cyber defenses has only increased.

If 2020 was the year that accelerated the business world's digital transformation, then 2021 could go down as the year when all that new digital tech gets put to the test by cyberattacks. Major attacks taking advantage of the SolarWinds software hack and the recent shutdown of energy infrastructure major Colonial Pipeline by a ransomware attack illustrate the vulnerabilities of companies, governments, and other organizations today.

It should surprise no one, then, that leading cybersecurity firm Palo Alto Networks (PANW 2.01%) is having a busy year. Its stock price is up 54% over the last 12 months and is sitting close to its all-time high. With demand for its services greater than ever, the company remains a top choice for those looking to bet on the cybersecurity industry.

A hacker in a hooded sweatshirt using a laptop.

Image source: Getty Images.

A busy quarter for cyberattacks

Palo Alto Networks has been hard at work protecting its customers. CEO Nikesh Arora said on the last earnings call that there has been an acceleration in cyberattacks since the start of 2021. Specifically on ransomware -- the real-world consequences of which were demonstrated so effectively by the temporary shutdown of parts of Colonial Pipeline's massive fuel distribution network -- Arora said, "the average ransom paid in 2020 tripled from 2019, and in 2021, it's more than doubled again."  

The result of those intensifying threats has been an acceleration in Palo Alto's operating results. Revenue grew 24% year over year to $1.07 billion during its fiscal 2021 third quarter (which ended April 30), and adjusted net income increased by 22% to $140 million. A steady diet of acquisitions over the last few years has helped Palo Alto Networks maintain its pace of double-digit percentage sales growth, but demand for cybersecurity software has nonetheless been high given all the criminal activity. Billings (revenue plus change in deferred revenue, an indicator of the company's growth trajectory and business health) were up 27% in fiscal Q3. In all, fiscal 2021 has been a great year for Palo Alto Networks thus far.  

Metric

Nine Months Ended April 30, 2021

Nine Months Ended April 30, 2020

Change

Revenue

$3.04 billion

$2.46 billion

24%

Adjusted net income

$452 million

$340 million

33%

Billings

$3.58 billion

$2.91 billion

23%

Data source: Palo Alto Networks.  

Momentum is expected to stay strong through the current quarter. Fiscal Q4 revenue is forecast to be up at least 23% year over year to $1.165 billion. Shares trade for 8.5 times expected full-year revenue and 61 times adjusted earnings per share -- premium valuations, to be sure, but not totally unreasonable ones given the rate at which Palo Alto is growing.

A controversial strategy paying off

Palo Alto Network's strategy of acquiring smaller peers to increase its security platform's capabilities isn't without its detractors. Purchasing existing companies can get expensive. Nearly $1 billion in cash has been eaten up off the balance sheet in the last year alone. (The company had cash and short-term equivalents of $2.95 billion at the end of April, compared to $3.75 billion at the start of its 2021 fiscal year). Share-based compensation (distributed both to employees and company directors) has also jumped to $697 million so far this year compared to $504 million through the first three-quarters of 2020.  

The strategy is nevertheless working. Arora had this to say on the earnings call:

Organizations run their operations on technology that is decades old, sometimes predating the internet. They continually bolt on new technologies to automate facilities and make them compatible with the modern internet, but those platforms are inherently insecure. At the same time, cyberdefenses are fragmented, making it very challenging to block sophisticated attacks and lengthening mean time to discovery and repair.  

In other words, a one-stop platform that can address the security needs of complex (and often out-of-date) operating systems is a must. Palo Alto Networks' acquisition-happy approach has helped keep it a top-of-mind security software vendor. And for those concerned with profitability, the torrid pace of acquisitions in the last few years hasn't completely destroyed shareholder value like some feared it would. Free cash flow per share is up 35% over the last five-year stretch.  

As its spending on acquisitions moderates, I expect Palo Alto Network's bottom line per-share metric will quickly rebound. But at the end of the day, the company is helping address a myriad of cybersecurity risks that are threatening its customers right now -- and that's good news for the stock long term.

Nicholas Rossolillo and his clients own shares of Palo Alto Networks. The Motley Fool owns shares of and recommends Palo Alto Networks. The Motley Fool has a disclosure policy.

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