Brief Review of Palo Alto Networks’ FY-2024 Q1 Earnings Report
Going into its FY-2024 Q1 report, Palo Alto Networks (NASDAQ:Panwa) was projected to deliver revenue and normalized EPS of $1.84 billion and $1.16, respectively.
While Palo Alto Networks beat the consensus street ratings on top and bottom lines [revenue: $1.88B (up +20% y/y), normalized EPS: $1.38]the stock is down nearly -6% to $240 per share at the time of writing.
Despite facing challenging macroeconomic conditions, Palo Alto Networks’ business remained incredibly resilient in the first quarter, with total revenue growing +20% year-over-year to $1.88 billion powered by Next Generation Security ARR, grew +53% year-over-year to $3.2 billion.
During the quarter, Palo Alto Networks’ business mix continued to shift toward higher margin, recurring revenue from software, which now accounts for 83% of total sales. And, as a result of this change, PANW’s margin profile is free Cash flow generation and EPS improved further in the first quarter.
According to Nikesh Arora [PANW’s CEO]Demand for cybersecurity solutions is stronger than ever, and Palo Alto Networks’ platform approach is paying off big:
An unprecedented level of attacks is driving strong demand in the cyber security market. We continue to execute on the platform as customers recognize the benefits we can provide in simplifying security architectures and achieving better security outcomes.
In light of reporting a strong quarter, Palo Alto Networks management reiterated for the full year [FY2024] revenue guidance of $8.15-8.20 billion and increased profitability [Operating margin & EPS] instruction. However, Mr. The market appears to be upset about a somewhat weaker-than-expected billings number for the first quarter [$2.02B vs guided range of $2.05-2.08B] and FY-2024 [new guide: $10.7-10.8B vs. previous guide: $10.9-11.0B].
While the number of invoices is an important measure of future revenue growth, I believe that RPO [remaining performance obligations] is a much better metric to gauge future sales, and PANW absolutely met that figure, with RPO growing to $10.8 billion (26% y/y) in the first quarter. Additionally, I think the volatility we’re seeing in Palo Alto Networks billings is due to temporary rate-driven weakness, as explained very well by PANW management in call earnings:
In the first quarter, cost of money remained an ongoing discussion, and significant customer focus on this topic is becoming the new normal. The way it plays out in our business is that there is always a payoff in the duration discussions in the final negotiations. Given our strong balance sheet, we can use a mix of strategies to navigate the environment. This includes annual billing plans, funding through PANFS and partner funding. While this does not affect the demand of our business or the impact on annual revenue or annual metrics, it creates variability in the total billing more than before depending on the financing used or the duration of the contracts.
I am not concerned about the demand for cyber security, for this quarter and the quarters ahead, although my concern about our ability to execute, Billing variability is a pure consequence of the payment conversation we are having with our customers and this is borne out by the fact that we continue to see strong RPOs and low churn suggesting this is a cosmetic impact to our business.
As I began my remarks, the first quarter was the first quarter that we delivered on the three-year plan that we presented in August. We’re driving profitable growth, investing in innovation, next-generation security, and the industry’s largest dedicated security organization while leveraging the scale of Palo Alto Networks. Demand for cyber security is strong given the backdrop of attacks, the ever-increasing focus and scrutiny around cyber risk, execution continues to be paramount given the macro conditions and we will continue to adapt and respond to changes in environment.
We will manage long-term growth, operating margin and free cash flow, and ensure we continue to transform the business and generate revenue predictably. You will also see this through the RPO and most importantly our current RPO. Our long-term forecast thesis remains intact, while we expect short-term variability in billings, we do not expect this to have a significant impact on our ability to meet our three-year targets.
– Nikesh Arora, CEO
As I see it, Mr. Market is responding to this updated billing guide from Palo Alto Networks. The company is clearly firing on all cylinders as evidenced by the better-than-expected revenue and EPS performance, and robust growth in RPO.
At the end of the first quarter, Palo Alto Networks’ cash and short-term investments stood at $3.9 billion, which is enough to cover the upcoming payment of $1.95 billion in convertible debt. In addition, PANW has created adj. free cash flow of $2.96 billion over the past twelve months and looks set to generate $3-3.1 billion in adj. FCF during FY-2024 based on adj. FCF guidance of 37-38%.
In my opinion, Palo Alto Networks is a fantastic cash cow. While management still plans to spend $1 billion annually on M&A (as broken out on the earnings call), we can continue to expect opportunistic stock returns from the company. Rather than looking at a glass-half-empty picture based on weaker-than-expected billings guidance for FY-2024, I prefer to look at strong-than-expected revenue, EPS and RPO at Palo Alto Networks. Yes, the Q1 report wasn’t perfect, but it certainly doesn’t deserve such a negative reaction. Let’s now evaluate the long-term risk/reward of Palo Alto Networks using the TQI Valuation Model.
Fair value and expected returns of PANW
Assuming an exit multiple of 25x P/FCF, Palo Alto Networks stock could rise from $240 to $532 at a CAGR rate of 17.25% through 2028-2929. With PANW’s expected CAGR returns exceeding my investment hurdle rate of 15% (and handily beating the long-term S&P 500 (SPY) returns of 8-10% per year), I like the risk/reward of Palo Alto Networks stock at current levels.
Final Thoughts: Is Palo Alto Networks a buy, sell or hold report after Q1 FY-24?
In recent months, shares of Palo Alto Networks have shown strong technical momentum; however, PANW stock is down ~6% in the after-hours session as of this writing. If this sell-off holds, PANW will miss the 50-DMA support level and there is a good chance that the technical gap in the low $200s will be filled in the near-to-medium term.
Additionally, the weekly RSI and MACD indicators are showing negative divergence, which means a much deeper pullback is possible. In the event of a hard downturn in the economy, I could see a broad market decline. And in such a scenario, we could have a much better acquisition opportunity for Palo Alto Networks in the next year or so.
That said, Palo Alto Networks is a high-quality cybersecurity company that’s growing at a healthy clip while generating tons of cash. Frankly, I would rather buy a great company at a reasonable price than a reasonable company at a good price. And Palo Alto Networks fits very well into the former category.
Overall, I am satisfied with Palo Alto Networks’ performance for Q1 FY-24, despite rate (interest) driven billing weakness. On the back of this post-ER decline, the long-term risk/reward for PANW stock is quite attractive. Therefore, I will start a new long position in PANW, with the idea of building the position slowly through staggered accumulation over a period of 6-12 months.
Main takeaway: I rate Palo Alto Networks a Buy at $240, with a preference for slow and volatile accumulation.
Thanks for reading and happy investing. Please share your thoughts, concerns and/or questions in the comments section below.