Summary
- Palo Alto Networks had an impressive quarter and the management offered upbeat guidance for FY23.
- The company’s Prisma Cloud platform continues to deliver, and the SASE vertical appears to be the next growth driver.
- However, from a valuation standpoint, it's better to wait for a pullback in Palo Alto Networks before initiating a position for the long-term.
Investment Thesis
Palo Alto Networks, Inc. (PANW) had yet another phenomenal quarter, one that was topped by upbeat guidance from the management. The company’s Prisma Cloud platform continues to deliver and the SASE vertical appears to be the next growth driver. However, from a valuation standpoint, the company appears to be fairly valued with little upside from current levels.
A Snapshot Of Palo Alto Networks' Yet Another Impressive Quarter
PANW had yet another impressive quarter. Revenue came in at $1.55 billion, up 27.2% YoY, beating analyst estimates by nearly $6.5 million. EPS came in at $2.39, once again beating analyst estimates by $0.11. The development that got everyone really excited, however, was the upbeat guidance for both Q1 and for FY23 overall. The company now expects total revenue for FY23 to come in between $6.85 and $6.9 billion and EPS is expected to come in between $9.4 and $9.5, which implies a jump of anywhere between 24 and 26% YoY. At a time when forward guidance from a lot of companies has been anything but impressive, providing such positive and upbeat guidance is proof that the company continues to grow irrespective of the macro headwinds.
Palo Alto Networks Operates In An Industry Poised For Explosive Growth
PANW operates in an industry that’s poised for explosive growth, especially as more and more companies shift to the cloud. Globally, revenue in the Cybersecurity market is expected to reach approximately $160 billion in 2022 after which, it is expected to grow at a CAGR of 13.33%, and reach approximately $299 billion by 2027. With government investments in this space expected to ramp up as the Russia-Ukraine conflict intensifies, these numbers are not surprising. A digital defense report from Microsoft, published in 2021, indicated that 58% of nation-state cyberattacks observed by Microsoft came from Russia, a figure that is likely to increase given the conflict. Analysts see the cyber sector growing an additional 2 to 3% from the Russia-Ukraine conflict, on top of the 20% growth expected in 2022. All of this is great for PANW.
Within the United States, according to Statista , the revenue generated by the cybersecurity industry is expected to grow at a CAGR of 12.4% from nearly $65 billion to nearly $116.3 billion by 2027. And if one considers the cloud security segment, which has been one of the key markets for PANW, then according to Statista , revenue is expected to grow at a CAGR of 46.25% from approximately $610 million, projected in 2022, to $4.05 billion by 2025.
The top-down analysis, overall, suggests that there is much to be loved when it comes to the growth aspects of PANW, especially given the potential of the industry that it operates in.
SASE Vertical Is The Next Growth Engine For Palo Alto Networks
One of the company’s verticals that is quietly growing is the Secure Access Service Edge, or SASE (pronounced “sassy”). SASE is a cloud-based security model , which simplifies an organization’s network infrastructure and security management. SASE allows for more streamlined network and security services and eliminates the need for VPNs compared to traditional network infrastructure. According to Gartner , the market for SASE is expected to grow at a CAGR of 36%, reaching almost $15 billion by 2025. Gartner expects that the buyers of SASE will comprise of single vendor and dual-vendor approaches.
It’s a good thing then that PANW’s SASE vertical is well positioned to capitalize on this growth given where it is today. In the fourth quarter , the overall active SASE customer base for Palo Alto Networks grew by 51% and the total number of deals in excess of $1 million was up 83% year-over-year. Furthermore, according to the management , over 30% of the company’s new SASE customers were new to Palo Alto Networks. This suggests that the platform appears to have enough strength to grow on its own.
Prisma Cloud Gets Even Better Thanks to the Acquisition of Bridgecrew
PANW’s cloud security vertical, Prisma Cloud, continues to deliver. The platform, born out of PANW’s multiple acquisitions done in the past, is approaching a total customer base of 2,000. The company, last year, acquired Bridgecrew , which enables the company to now offer security solutions across the development life cycle (build and run).
This allows the company to service those customers that are looking for a more platform approach, which in a multi-cloud environment, appears to be the norm. The acquisition of Bridgecrew, therefore, appears to be yet another smart move by Nikesh Arora and Co.
Valuation
Author (Data Obtained from Refinitiv)
According to Refinitiv, the company’s stock was up above 9% last week on the back of the strong earnings and is already up more than 17% in the last month. The stock is currently trading at a forward P/E of 58x, which is expensive. However, as seen from the chart, PANW’s peers like Zscaler (ZS) and CrowdStrike Holdings, Inc. (CRWD) trade at much higher multiples. So, compared to some of its peers, PANW appears to be relatively inexpensive. Yes, you have Cisco Systems (CSCO) trading at 13x, but the company’s growth potential is nowhere near compared to PANW.
However, historically, according to Refinitiv, PANW has always traded at a forward P/E that is in the mid-to-high 50s, so based on the current multiple, the stock is fairly valued. Therefore, while the company has tremendous growth potential in the years to come and while the company appears to be inexpensive relative to its peers, based on its own historical trading range, the company’s valuation is fair. Therefore, initiating a position, for the long-term, at these levels doesn’t make sense. The only rationale for doing so would be the strong momentum that the company is currently experiencing on the back of strong earnings.
Risk Factors
Given the macro headwinds, expect some pullback in customer orders, which could be a significant headwind for the company in the near term. Then there’s the matter that the company’s Cloud platform, Prisma Cloud, was a result of a number of acquisitions done in the past. The ability of the company to grow organically will be put to the test now, especially given that the M&A market is taking a breather . With Bridgecrew, it appears that the company has all the relevant pieces put in place, but can it grow organically? That remains the question.
Concluding Thoughts
Nikesh Arora and his team are building something phenomenal at Palo Alto Networks and are well-positioned for a multi-year growth cycle. However, from a valuation standpoint, I think the company is fairly priced at the current levels, and initiating a position now doesn’t make much sense. Given the macro environment that we currently find ourselves in, I think there will be plenty of opportunities to invest. And when a meaningful pullback does occur, there shouldn’t be any hesitation to get a piece of this cybersecurity leader.
For further details see:
Palo Alto Networks: Limited Upside At Current Levels