Amidst the turbulence experienced by tech stocks in recent months, Palo Alto Networks (NASDAQ:PANW) has stood out with its impressive performance in the cybersecurity sector. While many enterprise-oriented tech stocks have seen their share prices plummet, Palo Alto Networks has managed to maintain a YTD gain of over 70%. However, the question now arises: can this outperformance continue?
One of the key factors driving Palo Alto Networks’ appeal is its profitability growth. With double-digit top-line growth supported by IT network hardware catch-up post-pandemic, the company has seen a five-point expansion in operating margins this year, accompanied by continuous growth in EPS. Palo Alto Networks also boasts a massive total addressable market (TAM) of over $200 billion across its three main verticals.
However, this strong performance has resulted in a high valuation that is becoming increasingly difficult to justify. At the current share price of just above $240, Palo Alto Networks has a market cap of $74.41 billion and an enterprise value of $70.96 billion after factoring in cash and convertible debt. Looking ahead, the company has forecasted an 18-19% YoY revenue growth for FY24, with operating margins and EPS also expected to increase. This puts Palo Alto Networks’ valuation multiples at 8.7x EV/FY24 revenue, 22.8x EV/FY24 adjusted FCF, and 45.0x P/E.
Considering the decelerating revenue and billings growth from the 20s to the teens, it becomes questionable whether it’s wise to pay a premium for a company whose fundamentals are showing signs of slowing down. While Palo Alto Networks has achieved significant execution success in a challenging environment, it appears that the stock may not have much upside potential from its current high valuation.
Recent trends also demonstrate billings deceleration for Palo Alto Networks, with top-line metrics being impacted by post-pandemic demand slowdown. The company’s financials reveal a 26% YoY revenue growth in its most recent quarter (Q4), but billings growth has significantly slowed down to 18% YoY. Billings growth is considered a better indicator of a subscription software company’s growth trajectory because it captures deals signed in the quarter and their future revenue recognition. Furthermore, the company has witnessed success in selling to large enterprise clients, even as it faces challenges in dealing with budget scrutiny and delayed payment terms.
While Palo Alto Networks has managed to maintain strong profitability metrics, such as adjusted FCF margins of 39% and pro forma operating margins of 24%, caution is necessary when considering its premium valuation. The company’s strength and execution are already reflected in its high P/E ratio and forward revenue multiple.
In conclusion, Palo Alto Networks’ performance and execution cannot be overlooked, but its premium valuation combined with decelerating growth raise concerns about the stock’s future potential. Caution is advised, and investors should monitor the stock closely before making any investment decisions.
