Brief Review Of Palo Alto Networks’ Q1 FY-2024 Earnings Report

Heading into its Q1 FY-2024 report, Palo Alto Networks (NASDAQ:PANW) was projected to deliver revenues and normalized EPS of $1.84B and $1.16, respectively.

While Palo Alto Networks beat consensus street estimates on both 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 of writing.

Despite facing challenging macroeconomic conditions, Palo Alto Networks’ business remained incredibly resilient in Q1, with total revenues growing +20% y/y to $1.88B powered by Next-Gen Security ARR rising +53% year-over-year to $3.2B.

During the quarter, Palo Alto Networks’ business mix continued shifting towards higher margin, recurring software revenues, which now make up 83% of total sales. And, as a result of this shift, PANW’s margin profile, free cash flow generation, and EPS improved further in Q1.

According to Nikesh Arora [PANW’s CEO], the demand for cybersecurity solutions is stronger than ever and Palo Alto Networks’ platform approach is winning big time:

An unprecedented level of attacks is fueling strong demand in the cybersecurity market. We continue to execute on platformization as customers recognize the benefits we can provide in simplifying security architectures and driving better security outcomes.

In light of reporting a strong quarter, Palo Alto Networks’ management reiterated full-year [FY2024] revenue guidance of $8.15-8.20B and raised profitability [Operating margin & EPS] guidance. However, Mr. Market seems to be upset about a somewhat weaker-than-expected billings number for Q1 [$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 billings number is an important measure of future revenue growth, I believe RPO [remaining performance obligations] is a far better metric to gauge future sales, and PANW absolutely delivered on this figure, with RPO growing to $10.8B (up 26% y/y) in Q1. Furthermore, I think the volatility we are seeing in Palo Alto Networks’ billing is down to temporary rate-induced weakness as explained very well by PANW’s management on the earnings call:

In Q1, the cost of money remained a constant discussion and customers’ significant focus on this topic is becoming the new normal. The way it manifests itself in our business is that there’s always a payment in duration discussions in final negotiations. Given our strong balance sheet, we can use a mix of strategies to navigate the environment. This includes annual billing plans, financing through PANFS, and partner financing. Whilst this does not impact our business demand or the impact to annual revenue or annual metrics, it does create variability on total billings more than before depending on financing used or the duration of contracts.

I’m not concerned about the demand for cyber security, for this quarter and upcoming quarters, though my concern about our ability to execute, the billings variability is a pure consequence of the payment conversation that we’re having with our customers and this is validated by the fact that we continue to see strong RPO and low churn suggesting this is a cosmetic impact to our business.

As I began my remarks, Q1 was the first quarter of us delivering on the three-year plan we presented in August. We’re driving profitable growth, investing in innovation, next-generation security, and the industry’s largest dedicated security go-to-market organization, at the same time, 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 the environment.

We will manage for long-term growth, operating margin, and free cash flow, and ensure we continue to transform the business and build revenue predictably. You will also see this through RPO and most importantly our current RPO. Our long-term forecast thesis remains intact whilst we expect short-term variability in billings, we don’t expect this to have a meaningful impact on our ability to deliver our three-year targets.

– Nikesh Arora, CEO

As I see it, Mr. Market is overreacting to this updated billings guide from Palo Alto Networks. The company is clearly firing on all cylinders as evidenced by better-than-expected revenue & EPS performance, and robust growth in RPO.

As of the end of Q1, Palo Alto Networks’ cash and short-term investments stood at $3.9B, which is ample cover for its upcoming convertible debt payment of $1.95B. Furthermore, PANW has generated adj. free cash flows of $2.96B over the last twelve months and looks set to generate $3-3.1B in adj. FCF during FY-2024 based on management’s adj. FCF guide of 37-38%.

In my view, Palo Alto Networks is a fantastic cash cow. While management still plans to spend $1B per year on M&A (as shared on the earnings call), we can continue to expect opportunistic share buybacks from the company. Instead of taking a half-glass-empty view based on a weaker-than-expected billings guide for FY-2024, I prefer looking at strong-than-expected revenue, EPS, and RPO growth at Palo Alto Networks. Yes, the Q1 report wasn’t perfect, but it surely doesn’t deserve such a negative reaction. Let us now evaluate Palo Alto Networks’ long-term risk/reward using TQI’s Valuation Model.

PANW’s Fair Value And Expected Returns

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% by 2028-29. With PANW’s expected CAGR returns exceeding my investment hurdle rate of 15% (and comfortably beating long-term S&P 500 (SPY) returns of 8-10% per year), I like the risk/reward on Palo Alto Networks’ stock at current levels.

Concluding Thoughts: Is Palo Alto Networks A Buy, Sell, Or Hold After Q1’FY-24 Report?

In recent months, Palo Alto Networks’ stock has shown strong technical momentum; however, PANW stock is down ~6% in the after-hours session as of writing. If this sell-off sticks, PANW will lose the 50-DMA support level, and there’s a good chance that the technical gap in the low $200s gets filled in the near-to-medium term.

Furthermore, weekly RSI and MACD indicators are showing negative divergence, which means a much deeper pullback is possible. In the event of a hard landing in the economy, I can see a broad market decline. And in such a scenario, we could get a far better buying 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 whilst generating tons of cash. Frankly, I would rather buy a great company at a reasonable price than a reasonable company at a great price. And Palo Alto Networks fits very well in the former category.

Overall, I am satisfied with Palo Alto Networks’ Q1 FY-24 performance despite the (interest) rate-induced billing weakness. On the back of this post-ER dip, the long-term risk/reward for PANW stock is quite attractive. Hence, I am going to start a new long position in PANW, with the idea of building up the position slowly via staggered accumulation over a 6-12 month period.

Key Takeaway: I rate Palo Alto Networks a “Buy” in the $240s, with a preference for slow, staggered accumulation.

Thanks for reading, and happy investing. Please share your thoughts, concerns, and/or questions in the comments section below.