Palo Alto Networks tumbles on earnings again. It’s another chance to buy
Another earnings report, another sell-off in extended trading for Palo Alto Networks . But like the two releases preceding Monday night’s results, we’re looking at the decline as buying opportunity for long-term investors. Revenue during the cybersecurity company’s fiscal 2024 third quarter increased 15% year over year to $1.985 billion, beating the consensus estimate of $1.967 billion that was compiled by LSEG. Adjusted earnings per share grew 20% to $1.32 in the three months ended April 30, ahead of estimates of $1.25 per share, LSEG data showed. Total billings increased a meager 3% year over year to $2.33 billion, missing estimates of $2.34 billion, according to FactSet. However, Palo Alto’s remaining performance obligation (RPO) accelerated to a 23% year-over-year growth rate, up from a 22% rate in the prior quarter. Palo Alto Networks Why we own it: We believe cybersecurity is a secular growth market as bad actors are relentless and companies simply cannot afford to not invest in defense. It is a never-ending arms race. We believe Palo Alto Networks, in particular, is uniquely positioned to win due to its best-in-class tools and broad product portfolio that allows it to provide an all-encompassing “platform” solution to cybersecurity. Competitors: CrowdStrike, Fortinet, Cisco Systems Last buy: April 8, 2024 Initiation: Feb. 15, 2023 Bottom line This was a strong quarter from Palo Alto Networks, despite what the stock reaction might suggest. And we’re ultimately inclined to view the stock’s pullback as a buying opportunity — just like we did in November and then again February . While billings trends are not what Wall Street wants to see, the question for investors is this: Do you buy into CEO Nikesh Arora’s view that billings is not as meaningful a metric as it once was, and instead our focus should be on remaining performance obligation trends? It’s a key question bulls and bears are sure to battle over because billings slowed materially while RPO showed a sequential acceleration. In our view, Aurora’s reasoning is sound. Billings represent the total amount of dollars actually invoiced in a given period; RPO represents the total value contracted during the quarter. Understandably, investors prefer billings because it’s more concrete. After all, things like churn and cancellations are risks to a company actually realizing its RPO as revenue down the line. The problem with billings right now is the cost of money — thanks to the highest federal funds rate in two decades — which is leading to increased negotiations on billings terms and financing options. As a result, we understand management’s desire to de-emphasize billings and instead focus on RPO. We can’t dismiss the billings dynamic entirely, but we are highly encouraged by the slight uptick in RPO growth. It should also be noted that management actually added to its billing backlog in the third quarter, an indication of strong demand despite some noisiness in the reported figure. Against this backdrop, management’s forward guidance also looks good, with fourth-quarter revenue and earnings projected to match expectations. Its outlook for billings is a tad bit light, but again, we’d argue results — and guidance — for this metric need to be taken with a grain of salt in this high-rate world. That’s especially true given the divergence between billings and RPO. On the earnings call, Arora offered a favorable update on the company’s decision to accelerate its “platformization” strategy, which tanked the stock 28% in a single session following its February earnings report . Essentially, management is offering concessions to customers that used multiple cybersecurity vendors to get them to migrate over to Palo Alto’s platforms. The company decided to take some short-term pain in hopes of securing long-term gain, with growth accelerating once the more promotional period is behind it. “I’m delighted to report, despite the concerns around our platformization approach after our last quarter, the customer feedback has been nothing but encouraging. We have initiated way more conversations in our platformization than we expected,” Arora said. “If meetings were a measure of outcome, they have gone up 30%, and a majority of them have been centered on platform opportunities. In short, demand is robust, and my expectation is that we will continue to see it be that way over the next many quarters.” These comments from Arora figure into our opportunistic view on the stock’s slide in extended trading. What we heard on the call is highly encouraging, billings weakness aside. The company is signing large, long-term deals, and customers are taking to the idea of — and clearly understanding the need for — platformization, especially with bad actors now leveraging the power of artificial intelligence. On the call, management highlighted several deals in which Palo Alto displaced the competition not only because of its best-in-class solutions, but also because of its ability to actually offer a platform strategy rather than piecemeal solutions. Arora also offered a bullish update on Palo Alto’s work with UnitedHealth in response to the disruptive cyberattack at its Change Healthcare subsidiary, though he didn’t name the company directly. “A large health care company experienced a breach and engaged our Unit 42 incident response services. After we helped the customer remediate and get back online, we were able to educate the customer on the benefits of platformization,” Arora said. “The customer fully platformized with us, standardizing our network security, Prisma Cloud and Cortex. This transaction was the largest in the history of Palo Alto Networks at nearly $150 million” of total contract value. In general, we have no doubt that cybersecurity is a secular growth market that will remain in demand, and at the company level, we think Palo Alto Networks has both the tools to address customer needs and a good strategy in place to ensure they remain a top player for years to come. With management noting platformization conversations are materializing faster than expected, we aren’t overly concerned about Monday’s night stock move and see longer-term upside ahead. At the same time, we recognize Wall Street’s current focus on billings. That’s why we’re keeping our 2 rating on Palo Alto as we look for shares to stabilize before stepping in to repurchase the stock we sold higher last week ahead of the report . We made the sale out of discipline because the stock had climbed more than 17% over a roughly six-week period prior to the trade. It’s another reason why we’re able to look at the sell-off through a buyer’s lens. Guidance For its fiscal 2024 fourth quarter, the company expects (all estimates are sourced from FactSet): Total billings in the range of $3.43 billion and $3.48 billion, a slight beat at the midpoint versus estimates of $3.45 billion. Total revenue of $2.15 billion to $2.17 billion, which at the midpoint is in line with the estimate of $2.16 billion. Non-GAAP earnings per share are expected in the range of $1.40 to $1.42, in line with estimates of $1.41, at the midpoint. For the full-year fiscal 2024, management expects: Total billings in the range of $10.13 billion to $10.18 billion, which represents a slight increase at the midpoint compared with a prior range of $10.1 billion to $10.2 billion. Investors may be taking issue with the cut at the high end. At the midpoint, the revised guide also represents a miss versus the $10.17 billion the Street was looking for. Total revenue of $7.99 billion to $8.01 billion, up from the prior range of $7.95 billion to $8 billion, and ahead of expectations of $7.99 billion. Non-GAAP earnings per share are expected in the range of $5.56 to $5.58, up from the prior range of $5.45 to $5.55. That’s ahead of the $5.52 per share consensus estimate. Adjusted free cash flow margin of 38.5% to 39%, which is an improvement from prior guidance of 38% to 39%. (Jim Cramer’s Charitable Trust is long PANW. See here for a full list of the stocks.) 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Signage outside Palo Alto Networks headquarters in Santa Clara, California, U.S., on Thursday, May 13, 2021.
David Paul Morris | Bloomberg | Getty Images
Another earnings report, another sell-off in extended trading for Palo Alto Networks. But like the two releases preceding Monday night’s results, we’re looking at the decline as buying opportunity for long-term investors.
