Is Palo Alto Networks Stock a Buy Now?

Palo Alto Networks' (PANW 0.39%) stock surged 11% during after-hours trading on May 19 following its third-quarter earnings release.

The cybersecurity company's revenue rose 29% year over year (YOY) to $1.39 billion, beating analysts' estimates by $28 million as its billings increased 40% to $1.8 billion. Its net loss narrowed from $145 million to $73 million.

On a non-generally accepted accounting principles (non-GAAP) basis, which excludes its stock-based compensation (SBC) and other one-time expenses, its net income rose 38% to $193 million, or $1.79 per share, which also exceeded analysts' expectations by $0.11.

Image source: Getty Images.

Palo Alto's growth rates were robust, but is its stock worth buying as rising interest rates and other macro headwinds rattle the markets? 

What does Palo Alto Networks do?

Palo Alto Networks operates three main cybersecurity ecosystems: Strata, the network security platform powered by its next-gen firewall appliances; Prisma, which houses its cloud-based security services; and Cortex, which operates its AI-powered endpoint security services.

Palo Alto serves more than 85,000 customers across over 150 countries. It generates most of its revenue from Strata, but it's also aggressively expanded Prisma and Cortex -- which it calls its "next-gen security" (NGS) services -- with nearly $3 billion in acquisitions in fiscal 2020 and 2021.

The expansion of its NGS segment is widening Palo Alto's moat against cloud-native challengers like CrowdStrike and AI-powered competitors like SentinelOne. It's also been rolling out more "zero trust" services, which treat everyone as a potential threat, to keep pace with cloud-based zero trust platforms like Zscaler.

How fast is Palo Alto Networks growing?

Palo Alto has consistently generated double-digit billings and revenue growth over the past year, even after it stopped making big acquisitions.

Data source: Palo Alto Networks. YOY = year over year.

A lot of that growth was driven by larger enterprise customers. Its total number of "active millionaire customers," meaning those that spent over $1 million on bookings over the past four quarters, rose 29% YOY during the third quarter as its number of large deals (worth over $5 million) jumped 73%.

For the fourth quarter, Palo Alto expects its billings to grow 24%-26% YOY and for its total revenue to increase 25%-27%. For the full year, it expects its billings to grow 30%-31% and for its revenue to rise about 29%.

The NGS segment continues to expand

A few years ago, the bears claimed Palo Alto's growth would stall out as ambitious challengers like CrowdStrike disrupted Strata's on-site appliances.

However, the aforementioned expansion and growth of Palo Alto's NGS ecosystem silenced those critics. In the third quarter, its annual recurring revenue (ARR) from NGS services rose 65% YOY to $1.61 billion, or 31% of its total revenue over the past four quarters. That percentage has consistently risen over the past year.

Data source: Palo Alto Networks. TTM = trailing 12 months. NGS = next-gen security. ARR = annual recurring revenue.

During the third quarter, Prisma and Cortex grew their active customer bases by 23% and 64% YOY, respectively.

Stable margins and earnings growth

Palo Alto's non-GAAP operating and adjusted free cash flow (FCF) margins both expanded YOY during the quarter. Its non-GAAP earnings-per-share (EPS) growth has also accelerated over the past two quarters.

Data source: Palo Alto Networks. Non-GAAP = non-generally accepted accounting principles. YOY = year over year. FCF = free cash flow. EPS = earnings per share.

Palo Alto expects its non-GAAP EPS to grow 41%-43% in the fourth quarter and to increase about 21% for the full year. It also plans to end the year with an adjusted FCF margin of 32%-33%, compared to 32.6% in fiscal 2021.

During its earnings presentation, Palo Alto declared it was resistant to most macroeconomic headwinds -- and that geopolitical conflicts, cross-border cyberattacks, and supply chain disruptions would actually generate tailwinds for its business. It's also well insulated from inflation since most companies won't reduce their cybersecurity spending just because they're grappling with higher costs.

It's still reasonably valued 

Palo Alto isn't growing as rapidly as CrowdStrike, SentinelOne, and Zscaler, but all three of those high-growth peers still trade at double-digit price-to-sales ratios. Palo Alto trades at just eight times this year's sales.

Palo Alto is also narrowing its GAAP losses by reining in its SBC expenses and limiting its new acquisitions, but its three aforementioned peers all posted widening GAAP losses in their latest quarters.

Therefore, I believe Palo Alto remains one of the best long-term plays in the cybersecurity sector, and it's definitely still worth buying at these levels.