Is It Too Late to Buy Palo Alto Networks Stock?

Palo Alto Networks' (PANW 0.91%) stock dropped 6% during after-hours trading on Nov. 15 in response to the cybersecurity leader's latest earnings report. For the first quarter of fiscal 2024, which ended on Oct. 31, its revenue rose 20% year over year to $1.88 billion and exceeded analysts' estimates by $60 million.

On a generally accepted accounting principles (GAAP) basis, Palo Alto's net income surged nearly tenfold from $20 million to $194 million and notched up its sixth consecutive quarter of GAAP profitability. On a non-GAAP basis, its net income jumped 75% to $466 million, or $1.38 per share, and cleared the consensus forecast by $0.22.

Image source: Getty Images.

Those headline numbers seemed stellar, but a reduction to its full-year billings guidance spooked the bulls. Does that pullback indicate it's too late to buy Palo Alto's stock? Or is it a great buying opportunity for investors who can tune out the noise?

Another quarter of slower but stable growth

Like many of its cybersecurity peers, Palo Alto's growth in billings and revenue decelerated over the past year as the macro headwinds drove many companies to curb their spending. Large companies generally won't lower their existing digital defenses just to save a few dollars, but they'll still be hesitant to sign new contracts.

Data source: Palo Alto Networks. YOY = Year-over-year. Table by author.

Palo Alto expects its billings to rise 15% to 18% year over year in the second quarter and 16% to 17% for the full year. That represents a significant reduction from its prior full-year billings forecast for 18% to 20% growth.

It mainly blamed that slowdown on higher interest rates, which made it tougher to secure longer-term contracts while driving more customers toward "deferred billings plans," to be paid off at a later date.

It expects its revenue to grow 18% to 20% year over year in the second quarter and 18% to 19% for the full year. That matches its previous full-year forecast, but its billings reduction suggests investors should brace for slower revenue growth in fiscal 2025, since it takes some time for billings to be actually recognized as revenues.

Its high-growth businesses are still expanding

Palo Alto splits its business into three main ecosystems: Strata, which houses its next-gen firewall and on-site network security services; Prisma, which handles its cloud-based security services; and Cortex, its AI-driven threat detection platform.

Most of Palo Alto's recent growth has been driven by Prisma and Cortex, which it collectively calls its "next gen security" (NGS) services. Its annual recurring revenue (ARR) from its NGS services grew 53% year over year to $3.2 billion in the first quarter and accounted for 44% of its trailing 12-month revenues. That only represents a mild slowdown from its 56% year-over-year growth in NGS ARR in the fourth quarter of fiscal 2024.

Prisma's growth should widen Palo Alto's moat against CrowdStrike and other cloud-native competitors. Cortex can help it keep pace with SentinelOne and other AI-oriented cybersecurity companies.

Its margins are still healthy

As Palo Alto's top-line growth cooled off, it expanded its operating margins by generating a higher mix of revenue from its higher-margin software (as opposed to its lower-margin appliances), reducing its supply chain costs, and slowing down its hiring. That's why it's still generating high-double-digit non-GAAP earnings growth.

Data source: Palo Alto Networks. Table by author.

Palo Alto expects its non-GAAP EPS to grow 55% to 58% in the second quarter, and to rise 22% to 25% for the full year. It expects its non-GAAP operating margin to rise from 24% in fiscal 2023 to 26% to 26.5% in fiscal 2024, and for its adjusted free cash flow (FCF) margin to dip slightly from 39% in fiscal 2023 to 37% to 38% in fiscal 2024.

Those stable margins, along with its commitment to staying profitable on a GAAP basis by reining in its stock-based compensation, arguably make Palo Alto a more stable play than many of its higher-growth peers. CrowdStrike still hasn't generated a full year of GAAP profits yet, while SentinelOne remains unprofitable by both GAAP and non-GAAP measures.

It's not too late to buy Palo Alto Networks

At $240 a share, Palo Alto trades at 44 times the midpoint of its fiscal 2024 earnings. CrowdStrike, which is growing faster, trades at 57 times forward earnings. Fortinet, which expects to grow at a much slower rate than Palo Alto this year, trades at 30 times forward earnings.

In other words, Palo Alto still looks reasonably valued relative to its industry peers and growth potential. The next few quarters could be bumpy, but I'm confident Palo Alto's growth will accelerate again once the macro environment improves.