Whatta quarter!
It's been tough to stay long cybersecurity stocks. Former Sarge fave Zscaler (ZS) reports next week. That one became a casualty earlier this year as market conditions forced a narrowing of my book, and a beefing up of cash levels. My only two longs in the space, a space I continue to have long-term confidence in, were that one and Palo Alto Networks (PANW) . That one, I had hung onto despite recent performance as I did not want to take my exposure down to zero and PANW peaked far later than did most of the firm's competitors.
For the firm's fiscal third quarter, Palo Alto Networks posted adjusted EPS of $1.79 (GAAP EPS: $-0.74) on revenue of $1.39B. The firm beat Wall Street on both the top and bottom lines, as the adjusted EPS number was good for year over year growth of 29.7% as revenue grew 29.9%. Billings increased 40% over the one year ago period to $1.8B, while remaining performance obligation also increased 40% (to $6.9B). If one is wondering about the tremendous gap between adjusted and GAAP results, the firm took an adjustment of $2.53 per share for "share-based compensation" related charges.
Guidance
For the current quarter: Palo Alto sees total billings landing in between $2.32B and $2.35B, which would be good for y/y growth of 24% to 26%, total revenue of $1.53B to $1.55B (growth of 25% to 27%), and adjusted EPS of $2.26 to $2.29. Wall Street had been at $2.22 on this metric.
For the full year (already three quarters in): Palo Alto sees total billings landing in between $7.106B and $7.136B, which would be good for y/y growth of 30% to 31%, total revenue of $5.4881B to $5.501B (growth of roughly 29%) and above consensus view of $5.47B. The firm also sees adjusted EPS of $7.43 to $7.46, and adjusted free cash flow margin of 32% to 33%. Wall Street had been at $7.29 on EPS.
Wall Street
I can find eight sell-side analysts that are both rated at four or five stars by TipRanks and have opined on PANW since earnings were released last night. All eight of these analysts rate the stock at a "Buy" or their firm's equivalent. The average target price of the eight is $621.25, with a high of $720 (Gray Powell of BTIG), and a low of $580 (Dan Ives of Wedbush). That high is $95 above the second highest target price here, which makes it sort of an outlier. Omitting the high and low, the average of the other six targets is $611.67.
Dan Ives wrote in a note to his firm's clients, "The shift to cloud is a massive tailwind for (PANW) as the company is in the right spot at the right time to benefit from this multi-year tidal wave of cyber-security enterprise spending, despite macro jitters right now clouding the street's view of the stock/sector." Despite this, Ives cut his target price to $580 from $660 in order to reflect the lower multiples this market is awarding to software and cybersecurity companies.
Balance Sheet
This is where what was a great quarter gets tricky for me. As a trader, I rely almost entirely on technicals and trend. As an investor, fundamental analysis becomes at least as important (actually more so) than anything else. Palo Alto ended the quarter (April 30th) with a net cash position of $3.875B, bringing current assets up to $5.698B. Current liabilities are running at $7.677B, bloated by growth of more than $2B in convertible senior notes (yes, listed as current). This leaves the firm with a current ratio of 0.74, which you know I don't like.
The firm stands with total liabilities of $11.1B, which includes a "goodwill" entry of $2.731B and other intangibles worth $412M. Total liabilities add up to $8.7B. This includes no net convertible senior notes as they have all been deemed current. As mentioned above, this is a tricky balance sheet, because the debt obligations are in the here and now, making for a current ratio that would imply potential trouble should the environment change for the worse. That said, the firm's cash position is larger than the entire entry for net convertible notes ($3.676B). I think I am going to give this balance sheet a passing grade, despite failing on a key metric of mine because they have the cash on hand to cover their tail.
My Thoughts
Obviously this was a nice quarter, and the guidance is fabulous. The war in Ukraine, what seems like a permanent global condition of growing cyber-crime and nefarious activities by a number of national actors, ensures in my opinion that there will be a need for ever improving provisions of cybersecurity software. As Dan Ives mentioned, valuations are contracting. PANW still trades at 58 times forward looking earnings. Zscaler trades at something like 240 times. That means it still takes a bit of guts and some nose holding to keep these stocks on board in this environment. It's as if we almost have to make an exception for cybersecurity because we know that there will be ongoing growth in demand.
My idea is to hold a smallish long position in PANW and to trade a small portion of almost equal size around the core long. This way, I can only be "half-in" when it gets messy, but never actually takes exposure down to zero in an area of some conviction. Now what to do with ZS? Next Thursday. You know I won't be able to resist.
