I've had my eye on Palo Alto Networks (PANW +1.58%) for a little while now. It's a global leader in cybersecurity, a sector I believe is growing increasingly important as digital transformation takes hold, bringing more business processes online and increasing cyber risks. I like its three-platform strategy, which gives it a strong competitive position. I'm even more impressed with its financials, which feature a cash-generating business and solid balance sheet.
One thing I didn't love was its stock price before its recently completed three-for-one stock split. Pre-split, shares traded at more than $550 apiece. Now that shares have split and fallen a bit alongside the market, they're down to around $165 a share. The cybersecurity leader made the move to make its stock more accessible to all employees and investors, which it has accomplished. It's now easier to purchase without using fractional shares if you're only investing a few hundred dollars at a time, like me. Here's why I can't wait to add shares to my portfolio now that they're trading at a lower price.
NASDAQ: PANW
Key Data Points
An enormous opportunity
I like to invest in large trends with long growth tailwinds, which certainly describes cybersecurity. The numbers are staggering and frightening. Cybercrime cost the global economy an eye-popping $6 trillion last year, double its total from 2015. Cybersecurity Ventures sees that number growing at a 15% annual clip over the next five years, topping $10 trillion by 2025.
Cybersecurity companies are reporting staggering rises in attacks. Cloud security leader Zscaler's (ZS +6.79%) annual ThreatLabz report showed a 29% surge in global phishing attacks on its cloud network last year to a record 873.9 million. Its ransomware report noted that those attacks spiked by 80%. Meanwhile, fellow cloud security leader CrowdStrike (CRWD +3.21%) reported a 50% year-over-year increase in attempts of hands-on, interactive intrusions.
With attacks and costs increasing, companies need to beef up their network security to protect their data. They must upgrade their legacy systems to next-gen security built to stop today's threats. That plays right into the approach of Palo Alto Networks, which has an integrated three-platform strategy to help customers consolidate and simplify their security architectures.
The numbers tell the story
While some companies tell a great story about their market potential, Palo Alto Networks lets its numbers do the talking. The company recently reported its fiscal 2022 results, which were exceptional. Total revenue jumped 29% year over year to $5.5 billion. A big driver was its next-gen security solutions, which grew its annual recurring revenue (AAR) base by 60% to $1.9 billion. It expects both numbers to continue rising in its 2023 fiscal year. It projects 25%+ revenue growth and a 37%-40% rise in next-gen security ARR.
The most impressive number, in my view, was its adjusted free cash flow margin, which clocked in at 33.3%, meaning it turned one of every three dollars of revenue into free cash. The company expects that number to improve to 33.5%-34.5% in the 2023 fiscal year, positioning it to generate even more free cash flow. Palo Alto's ability to generate free cash enabled it to end the year with a solid balance sheet. It had over $3.6 billion of cash and short-term investments against a similar amount of senior convertible notes.
The company's strong cash position and growing free cash flow give it a competitive advantage in today's uncertain economic environment and capital markets. It has the financial strength to repurchase shares and make new investments, which rivals with less financial flexibility will struggle to do in the current environment. It's reportedly using some of that flexibility to acquire cybersecurity start-up Apiiro for about $600 million to further expand its capabilities. With capital market conditions deteriorating, Palo Alto could capitalize on additional opportunities to put its financial strength to work in enhancing its capabilities.
An irresistible opportunity
Palo Alto Networks has the financial fortitude to capitalize on the enormous opportunity in cybersecurity. With its shares now more accessible following its recent stock split, I plan to add a couple to my portfolio and slowly build a position. It looks like a compelling opportunity since shares trade around 27 times free cash flow, or about a 4% free cash flow yield. While that's not a screaming bargain, it's in line with the Nasdaq's average even though Palo Alto is growing faster at a faster pace.
