Palo Alto Networks Still Has Gas In The Tank (Earnings Preview) (NASDAQ:PANW)

Palo Alto Networks (NASDAQ:PANW) is actively positioning itself as a three-platform cybersecurity business across the network, cloud, and AI-driven SecOps. Despite the near-term pricing headwinds for customers budgeting for their security departments, cyber threats are continuously becoming more sophisticated and leveraging tools that make detection that much more challenging across multiple nodes. I believe Palo Alto is in a prime position across the various segments of IT infrastructure to properly provide the security necessary to defend against these threats while allowing for firms to automate and reduce costs if moved onto the all-in-one platforms offered by Palo Alto. As we near Palo Alto’s q2’24 earnings release on February 20, 2024, I anticipate that the firm may be near its peak share price on a technical basis; however, on a long-term fundamental scale, I expect PANW shares to have room for share price appreciation. I provide PANW shares a BUY recommendation with a price target of $427.05/share at 14x eFY25 sales with any pullback being a buying opportunity for shareholders.

Management anticipates a huge market opportunity over the next 4 years through 2028 across their three-platform model, consisting of Zero Trust Platform, Code to Cloud Platform, and Autonomous Security Ops Platform with expected TAMs of $80b, $40b, and $90b, respectively. I believe that the heightened interest in GenAI will drive a lot of growth across Palo Alto’s platforms. As GenAI has opened a new social engineering-style attack vector, I believe Palo Alto’s AI-enabled security features will be emphasized in the purchasing cycle. I believe that a lot of Palo Alto’s growth will derive from their AI/ML & cloud security features, such as XSIAM in Cortex, their AI-enabled cloud manager in platform in Prisma, as well as their enterprise DLP platform. One of the biggest driving forces behind this expectation is that threats are becoming more sophisticated and faster with GenAI as companies seek to leverage their large data lakes to internally develop some form of GenAI, whether on-prem or on a cloud-based platform.

Palo Alto had completed their acquisition of Dig Security, a data security platform that functions across all verticals, including public & private cloud and SaaS platforms. Going back to the last point, as firms seek to more heavily leverage their data, securing these large data sets will be vital for maintaining trade secrets, customer accounts, etc. Dig Security further bolsters Palo Alto’s position in data security with this platform and brings in a competing platform to CrowdStrike’s (CRWD) Falcon Data Protection offering. This platform has a huge opportunity as management at CrowdStrike estimates the TAM for AI-native security platforms to reach $225b in 2028.

Analysts on the q1’24 earnings call remained stuck on hardware sales, despite the clear image that Palo Alto is heavily focused in software features. Though selling an appliance earns Palo Alto the one-time fee, the firm remains focused on upselling their software and subscription-based services that provide ARR outside of the longer duration hardware refresh cycle.

Macroeconomic

Management remains cautious on macroeconomic factors as they navigate through a foggy environment. With CPI data coming in higher than expected at 3.1% growth vs. the consensus estimate of 2.9%, Fed Chair Jerome Powell suggested that March may be too soon to lower rates, reaffirming his higher for longer statements, despite analysts’ expectations. This can bring challenges to businesses when considering major technology purchases, as management at Palo Alto had alluded to in their q1’24 earnings call. Management mentioned some degree of flexibility in deal negotiations and payment plans, whether the purchaser finances through PAN-FS or with partner financing. With higher rates comes a higher cost to finance, which I believe might prolong the sales cycle and potentially lead to shorter duration contracts with fewer upfront payments. Though this may appear as a negative factor for total billings, this may benefit Palo Alto in future periods as the firm is less compelled to discount products & features and can potentially escalate prices year-to-year.

On a more positive note, Gartner’s forecasted IT spend to grow 8% in 2024, in part driven by GenAI to bridge the IT talent gaps. The research firm reported that 80% of CIOs are expecting to increase spending on cyber/information security in 2024 as “AI has created a new security scare for organizations.” Considering these two points, Palo Alto’s network security copilot could potentially fulfill these two themes with its intuitive features. Management anticipates significant growth in their network security platform, growing from 1,700 in 2023 to potentially address 10,000+ potential customers. Despite the optimism in new spending, Gartner mentioned that CIOs are hesitant to investing in new projects and initiatives and will likely remain cautious through 2025. Projects will primarily be focused on cost savings initiatives, and efficiencies and automation.

Another major pillar is Palo Alto’s Code-to-Cloud Platform, which I believe will significantly benefit from cloud applications and further adoption of GenAI. It’s no secret that legacy applications can pose a significant security risk in their own respect. Designing cloud applications to talk with legacy applications can create even more security risks as those legacy apps are now exposed to a public platform. Further stretching into continuous integration & development, or CI/CD, while using DevOps or Agile development methodologies can escalate these risks even further. Palo Alto’s Code-to-Cloud platform covers each of these challenges as a development platform for cloud-based applications, ensuring security is built in from day #1.

From a financials perspective, I anticipate top line growth to normalize from its high octane growth rate. I do anticipate modest margin expansion as more firms seek to unify their security platforms with a single vendor. Margins should benefit as Palo Alto scales across multiple verticals within the security department.

Overall, I believe Palo Alto has a compelling business strategy with their three-platform model. Leveraging multiple layers across the network, on-prem and cloud infrastructures, as well as their automated SecOps platform, I believe that Palo Alto has an edge in the enterprise cybersecurity space. One of the downside risks in my line of sight is that CrowdStrike has put AI at the forefront of their entire product suite years in advance of Palo Alto and may have the name-brand-edge in the category. Price point may also be a challenge as new customer acquisition and financing inquiries have made a significant appearance in q1’24.

Valuation & Shareholder Value

PANW shares have consistently traded in the middle of the pack when considering its peer competitors. PANW shares are currently trading at the higher end of their historical averages at 16.11x.

Forecasting out to eFY25 revenue, I believe there remains value to extract from Palo Alto’s growth trajectory. Considering the firm’s growth strategy, platform consolidation, M&A activity, and their three-platform model, I believe Palo Alto brings a lot of value to new and existing customers as firms seek to reduce costs and enhance automation. I believe the 14x eFY25 sales is an appropriate valuation for PANW shares, providing a price target of $427.05/share. I provide PANW a BUY recommendation.

Tactical Trading

On a technical basis, I believe that PANW shares are at or near the top of Wave V when using Elliot Wave Theory. This may lead to a near-term pullback in the share price towards $300/share before rerouting up to my price target. I believe this will pose a great buying opportunity in building a position. For those seeking to actively trade PANW shares, this recent run-up may be a good time to reduce one’s position and rebuild at the projected lower price. As a disclaimer, technical trading isn’t a one-for-one scale and is purely based on historical trading data, so be sure to budget the proper amount of risk before buying or selling into or out of a position.