Palo Alto Networks (PANW 0.91%) expects artificial intelligence (AI) to become a key growth driver for the company in the long run, which is not surprising as this technology is expected to play a central role in shoring up cyber defenses and help organizations protect their networks from bad actors. However, a closer look at the company's latest quarterly results indicates it has a lot of work to do before it can make the most of the AI-related cybersecurity opportunity.
Bloomberg Intelligence forecasts that generative AI-driven cybersecurity spending could jump to $3.1 billion in 2027 from just $9 million in 2022. By 2032, generative AI-based cybersecurity spending is predicted to touch nearly $14 billion. This explains why Palo Alto management discussed the company's AI-related potential in detail on the latest earnings conference call, suggesting that this technology could drive healthy growth in the company's revenue by 2030.
However, the fact that Palo Alto stock fell a whopping 22% following the release of its fiscal 2024 second-quarter results (for the three months ended Jan. 31, 2024) on Feb. 20 cannot be ignored. Let's see why that was the case and whether AI could indeed help Palo Alto regain investor confidence.
Palo Alto Networks' guidance cut spooked investors
Palo Alto's fiscal Q2 revenue increased 19% year over year to $2 billion, while billings increased at a slower pace of 16% to $2.35 billion. The cybersecurity specialist's non-GAAP (adjusted) net income was up 39% year over year to $1.46 per share. The numbers were better than analysts' expectations of $1.30 per share in earnings on revenue of $1.97 billion.
However, Palo Alto couldn't top its strong quarterly performance with a robust outlook. It predicts revenue to increase at a slower pace of 13% to 15% in the current quarter to a range of $1.95 billion to $1.98 billion. Consensus estimates were looking for $2.04 billion in revenue from Palo Alto in the current quarter.
Additionally, Palo Alto sees its billings increasing just 2% to 4% in the fiscal third quarter to between $2.3 billion and $2.35 billion, lower than the $2.62 billion consensus estimate. Given that Palo Alto's billings are an indicator of its future revenue, the market didn't take kindly to the fact that the company reduced its full-year billings guidance.
Palo Alto now expects fiscal 2024 billings to land between $10.1 billion and $10.2 billion, lower than the prior estimated range of $10.7 billion to $10.8 billion, and up just 10% to 11% over fiscal 2023. It has also reduced its revenue expectation to $7.95 billion to $8 billion from the earlier range of $8.15 billion to $8.2 billion. Based on its latest forecast, Palo Alto's revenue would increase between 15% and 16% in the current fiscal year.
There are a few silver linings
For a stock that's trading at an expensive 13 times sales as compared to its five-year average price-to-sales ratio of 8.8, it wasn't surprising to see investors hitting the panic button following Palo Alto's guidance cut. However, the positive takeaway from Palo Alto's latest earnings report was an increase in its remaining performance obligations (RPO), a metric that refers to the total value of the company's future contracts, and which, according to CEO Nikesh Arora, is a better indicator of future growth potential.
More specifically, Palo Alto's RPO jumped 22% year over year last quarter to $10.8 billion, outpacing the growth in its revenue and billings. Meanwhile, the annualized recurring revenue (ARR) from Palo Alto's next-generation security (NGS) offerings -- which include the Prisma cloud security platform and the AI-powered Cortex platform that provides endpoint detection and response, security automation, and external threat protection -- increased an impressive 50% year over year to $3.5 billion last quarter.
Palo Alto management predicts that AI adoption in cybersecurity could take its ARR from NGS products to $15 billion in 2030. That would be nearly 5 times the ARR Palo Alto's NGS products are currently generating.
The company expects its total addressable market to increase between $13 billion and $17 billion thanks to AI. What's more, Palo Alto says that it achieved more than $100 million in AI-specific ARR in the second quarter. Management also points out that it has "aggressive plans to roll out additional AI-based offerings by the end of this fiscal year."
As a result, it won't be surprising to see Palo Alto regain its mojo and start growing at a faster pace as it rolls out more AI-specific products. That's the reason why savvy investors may want to take advantage of the pullback in this cybersecurity stock and buy it considering that it could step on the gas in the future.
