Palo Alto Networks on track for seventh straight session of losses; stock hovers near Dec lows

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Palo Alto Networks (NASDAQ:PANW) were on track to record their seventh consecutive session in losses on Friday, with its last session in green being Dec. 26, 2023.

Shares of the cybersecurity firm fell 0.34% to $282.35 by 1529 ET on Friday. Over the seven-day slump, PANW stock has lost about 6.2%.

However, on a 12-month reading, Palo Alto Networks has doubled in value, but at its current level, the stock is hovering near its lowest level since early December.

Looking at Seeking Alpha's Quant ratings, Palo Alto Networks had a Hold rating with a score of 3.46 out of 5. The company was graded an A+ on profitability and an A on momentum, but an F on Valuation, a grade that has remained consistent in the last six months.

Turning to the Wall Street community, about 39 sell-side analysts surveyed in the last 90 days rated PANW as a Buy or higher, while another eight recommended a Hold call on the company. One analyst marked Palo Alto as a Sell.

Seeking Alpha analysts generally saw the Santa Clara-based company as a Hold. SA Analyst Julian Lin downgraded the company to Hold from Buy, stating, "While I continue to view PANW as being a top cybersecurity operator, I can no longer stand by the valuation".

"Between the cybersecurity focus, net cash balance sheet, high growth rates, and GAAP profitability, it is no surprise that PANW has commanded a premium valuation relative to peers. The stock recently traded hands at a blistering 11x sales", the analyst added.

Palo Alto Networks: Valuation Concerns Overshadow 2024 Bullish Commercial Momentum

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Palo Alto Networks (NASDAQ:PANW) stock is poised to be a commercial winner in 2024: As suggested by various CIO surveys, Cybersecurity demand is expected to accelerate momentum in 2024, likely setting up Palo Alto for a close to 20% topline expansion. On that note, investors should consider that Palo Alto's incremental revenue should be highly value accretive for shareholders, as the cybersecurity giant is generating about 0.33 cents of free cash flow for every dollar of incremental sales. However, despite the favorable business backdrop, PANW shares are trading too expensive to warrant an investment, in my opinion. On updated valuation estimates, I now estimate PANW's intrinsic worth at about $162/ share.

Last time I covered Palo Alto stock, I mistakenly argued that a guidance cut would be incoming, following a negative cross read from Fortinet's (FTNT) Q2 results. In this article, I adjust my view to a stronger-than expected commercial backdrop.

For context, Palo Alto stock has strongly outperformed the broad equities market YTD, also when compared to the "Tech" benchmark. Since the start of the year, PANW shares are up about 113%, compared to a gain of approximately 25% for the S&P 500 (SP500) and a gain of close to 55% for the Nasdaq tech-heavy Nasdaq 100 (QQQ).

Seeking Alpha

As we approach 2024, I see a supportive backdrop for IT budgets. This perspective anchors on various Q3 conference call discussions about gradual shortening sales cycles for new clients and the compression of billing cycles for existing customer base. The set-up going into 2024 looks especially attractive for Cybersecurity spending. Investors should consider that not only is the year 2024 likely seeing geopolitical tensions, but also by emerging security challenges anchored on the evolution of GenAI, e.g. deep-fakes, data poisoning, adversarial attacks, etc. Moreover, Palo Alto management has previously highlighted that as of first quarter FY 2024, ransomware attacks have increased 37% YoY, while attack speed on data exfiltration has accelerated from 9 days two years ago to 2 days as of today.

PANW FY24Q1 reporting

On that note, I point out insights derived from the Piper Sandler 2024 CIO Survey (research note dated 11th December), which suggests that Security spending is the top investment priority for 2024, with 89% of respondents expecting an increased spend, and 22% expecting material (>25%) increases in spending over the coming year. Moreover, within the Security spending vertical the top spending categories were Cloud Security, Endpoint Security, Threat Intelligence, as well as Network Detection & Response -- capabilities that play into Palo Alto's strengths.

A similar takeaway about a bullish spending backdrop for Cybersecurity was confirmed by UBS Evidence Lab AI Survey (research note dated 17th December). According to the survey's insights, the advent of GenAI will result in expanding IT budgets, with Security being a key concern in relation to GenAI applications:

It was clear from the survey results that it wasn’t just Microsoft that was being used to secure AI applications, most were using multiple vendors. Among the “pure-play” security firms, Zscaler and Palo Alto Networks were by far the most frequently-cited, and they both screened well on forward adoption plans as well. Nearly a quarter of our respondents plan to use Zscaler to secure access to GenAI applications and 19% plan to use Palo Alto.

Lastly, there's an emerging trend indicating a desire among software buyers to streamline their vendor relationships. This trend hints at the likelihood of a consolidation wave within the SaaS enterprise sector in 2024, including Cybersecurity. In fact, the Cybersecurity vendor landscape looks quite fragmented, with Palo Alto Networks, Zscaler, SentinelOne, CrowdStrike, Fortinet, Microsoft, Cisco, Okta, etc. While Palo Alto may not necessarily be a major buyer in 2024, with only about $1.7 billion of net cash on the balance sheet, I argue that a consolidation should be supportive for the industry's competitive backdrop.

Palo Alto Networks' portfolio of cloud security solutions aligns seamlessly with the 2024 escalating demand for cloud protection; and I broadly agree with analyst consensus projections that Palo Alto's topline in FY 2024 should expand at about 20% YoY vs FY 2023.

Seeking Alpha

On revenue, analyst consensus broadly aligns with PANW management guidance, who sees revenues for FY 2024 in the range of $8.15 to 8.2 billion. Moreover, management has projected that operating income growth will outpace topline expansion, with operating margin estimated +190 to 240 basis points. If this projection would materialize, PANW's earnings per share could be up 22-25% YoY, reaching about $5.46 at midpoint.

PANW FY24Q1 reporting

Reflecting a bullish backdrop, and in line with updated analyst consensus EPS estimates for PANW through 2025, I adjust my residual earnings model for the company's stock: For FY 2024, I now estimate that Palo Alto's EPS will likely fall within the range of between $5.3 and 5.7 (non-GAAP). For FY 2025, and FY 2026 I set my EPS expectation at $26.4 and $7.8, respectively. Lastly, while I maintain my terminal growth rate input at about 150 basis point above expected nominal U.S. GDP growth, at 4.25%, I reduce my cost of equity assumption by 50 basis points, mostly as a consequence of the pending Fed rate cut projections.

On the backdrop of the adjustments highlighted above, I now calculate a fair implied stock price for PANW stock equal to $162.22, suggesting approximately 38% downside based on fundamentals.

Note: the table enclosed references calendar year, not financial year!

PANW financials, author's estimates and calculation

Below also the sensitivity table, which tests different assumptions for cost of equity (row) as well as terminal growth rate (column).

PANW financials, author's estimates and calculation

Going into 2024, Palo Alto is seen leveraging strong momentum in Cybersecurity budgets to achieve strong topline and earnings growth, estimated at 20% and 23.5% YoY respectively. However, although I like the commercial backdrop, it is impossible for me to justify either a "Buy" or "Hold" rating for a stock that is trading at a 11x FY 2024 EV/Sales and 43x FY 2024 EV/EBIT. On updated valuation estimates, I now estimate PANW's intrinsic worth at $162; and as a function of valuation, I assign an Underweight/ Sell rating.

Palo Alto Networks Inc.

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