Palo Alto Networks' (PANW +5.78%) stock price plummeted 28% on Feb. 21 in response to the company's latest earnings report. In the second quarter of fiscal 2024, which ended on Jan. 31, the cybersecurity company's revenue rose 19% year over year to $1.98 billion and exceeded analysts' estimates by $10 million. Its adjusted earnings grew 39% to $1.46 per share and cleared the consensus forecast by $0.16.
Palo Alto's headline numbers seemed healthy, but it followed up its earnings beat with a reduction to its full-year guidance and a jarring shift in its long-term strategy. Let's review the bear and bull cases to see if its fallen shares are worth buying.
Image source: Getty Images.
The key numbers
Palo Alto's billings and revenue growth decelerated significantly in the first half of fiscal 2024. That slowdown can be attributed to the macro headwinds, which made it harder for cybersecurity to lock customers into longer-term contracts, and stiff competition. But as its top-line growth cooled off, it reined in its spending to strengthen its operating margins.
|
Metric |
Q2 2023 |
Q3 2023 |
Q4 2023 |
Q1 2024 |
Q2 2024 |
|---|---|---|---|---|---|
|
Billings Growth (YOY) |
26% |
26% |
18% |
16% |
16% |
|
Revenue Growth (YOY) |
26% |
24% |
26% |
20% |
19% |
|
Adjusted Operating Margin |
22.8% |
23.6% |
28.4% |
28.2% |
28.6% |
|
Adjusted EPS Growth (YOY) |
81% |
83% |
80% |
66% |
39% |
Data source: Palo Alto Networks. YOY = Year-over-year.
The bear case when it comes to Palo Alto
That slowdown wasn't surprising, but Palo Alto's revised guidance cut stunned the bulls. For the full year, it expects its billings to only rise 10%-11%. That's a drastic reduction from its previous full-year outlook for 16%-17% billings growth -- which had already been cut from its sunnier outlook for 18%-20% growth at the end of fiscal 2023.
As a result, Palo Alto expects its revenue to only rise 15%-16% for the full year, which is well below its prior outlook for 18%-19% growth and analysts' expectations for 19% growth.
Palo Alto attributed that slowdown to tougher competition and a strategic "shift" toward consolidating its customers onto a single unified platform to eliminate their dependence on smaller cybersecurity companies for specific services. It expects that strategy to widen its moat and increase the stickiness of its ecosystem, but it will initially be driven by trials and deferred revenue deals, which won't boost its near-term billings growth.
NASDAQ: PANW
Key Data Points
During the conference call, CEO Nikesh Arora said those customers wouldn't pay any fees for a "period of time" after locking themselves into its platform, and that shift would curb its billings and revenue growth over the "next 12 to 18 months."
Investors might have been forgiving of that loss-leading strategy if Palo Alto's stock were trading at lower valuations. But even after its post-earnings decline, it still doesn't look cheap at 49 times forward earnings and 11 times this year's sales. Its insiders have also sold nearly 10 times as many shares as they bought over the past 12 months.
The bull case for Palo Alto
On the bright side, Palo Alto expects this "platformization" strategy to pay off over the long term and spur its higher-growth next-gen security (NGS) services -- which include its Prisma cloud security tools and Cortex AI threat detection tools -- to generate $15 billion in annual recurring revenue (ARR) by fiscal 2030. That would be more than four times higher than its $3.49 billion in NGS ARR at the end of the second quarter of fiscal 2024. It also expects more than 90% of its revenue to be recurring by fiscal 2030 as its adjusted operating margin rises to the "low to mid 30s."
Moreover, its near-term operating margins, free cash flow (FCF), and earnings per share (EPS) are all rising. From fiscal 2023 to fiscal 2024, it expects its adjusted operating margin to expand from 24% to 26.5%-27%, its adjusted FCF margin to stay nearly flat at 38%-39%, and its adjusted EPS to rise 23%-25% -- which matches analysts' expectations for 24% growth. It's stayed profitable on a generally accepted accounting principles (GAAP) basis for seven consecutive quarters.
Those healthy bottom-line numbers suggest Palo Alto still has plenty of pricing power and that it can afford to throttle its own billings growth to lock more customers into its ecosystem. During the call, Arora said the company's lower near-term billings guidance was "not a consequence of a change in the demand outlook" but rather a deliberate shift in its long-term strategy.
Is Palo Alto worth buying right now?
I've owned shares of Palo Alto Networks since early 2021, and its rally over the past three years turned it into one of my largest positions. I admittedly sold 17% of my shares after the latest earnings report to free up cash for other stocks, but I'm still keeping my remaining shares and waiting to see how its "platformization" strategy plays out.
Palo Alto is still a good long-term play on the cybersecurity market, but it could remain out of favor this year until its top-line growth stabilizes again. So for now, the bears could remain in charge -- but the bulls should eventually return.
