Unveiling Palo Alto Networks’ Stock Performance: A Story of Bearish Fumbles and Bullish Hopes

On February 21, Palo Alto Networks‘ (NASDAQ: PANW) experienced a devastating 28% drop following the release of their second-quarter fiscal 2024 results. The company recorded a 19% year-over-year rise in revenue to $1.98 billion, surpassing analysts’ expectations by $10 million. Furthermore, its adjusted earnings per share surged 39% to $1.46, exceeding the consensus forecast by $0.16.

However, the joy was short-lived as Palo Alto Networks made a puzzling move by revising its annual guidance and unveiling a drastic shift in its long-term strategy. Let’s delve into the bear and bull scenarios to determine the investment merit of its now-fallen shares.

Image source: Getty Images.

Unveiling the Key Figures

The beginning of fiscal 2024 saw Palo Alto Networks grappling with a notable deceleration in billings and revenue growth. Externally, macro headwinds caused challenges in securing customers for extended contracts in the cybersecurity sphere, compounded by fierce competition. Despite the downturn in revenue growth, Palo Alto tightened its belt and cut down expenses to bolster its operating margins.

Data source: Palo Alto Networks. YOY = Year-over-year.

Examining the Bearish Scenario for Palo Alto

Palo Alto’s adjusted guidance alteration took investors by surprise. The company now foresees a mere 10%-11% growth in billings for the year. This significant slash from their earlier projection of 16%-17% growth, which in itself was lower than the initial rosy anticipations of 18%-20% at the close of fiscal 2023, rattled market bulls.

As competition stiffens, Palo Alto cited a strategic realignment towards consolidating customers onto an integrated platform to diminish reliance on smaller cybersecurity players for specific services. Although this strategy aims to bolster its competitive moat and fortify ecosystem stickiness, its initial implementation through trials and deferred revenue agreements will not provide an immediate lift to billings growth.

CEO Nikesh Arora revealed during the conference call that customers transitioning to its platform will enjoy a fee holiday initially, which will impede billings and revenue growth for the subsequent “12 to 18 months.” Despite these headwinds, Palo Alto continues to sport a high valuation at 49 times forward earnings and 11 times current-year sales. Insider selling activity also remains elevated, further clouding the stock’s attractiveness.

Glimmers of Optimism: The Bullish Case for Palo Alto

The company’s transition towards a “platformization” strategy is expected to yield dividends in the long run, propelling growth in next-gen security services such as Prisma cloud security tools and Cortex AI threat detection offerings. Palo Alto aims to achieve $15 billion in annual recurring revenue by fiscal 2030, a significant leap from the $3.49 billion NGS ARR recorded in the second quarter of fiscal 2024. Additionally, a shift towards over 90% recurring revenue and a growth in the adjusted operating margin to the “low to mid 30s” by fiscal 2030 signals a promising trajectory.

Short-term metrics like expanding operating margins, stable adjusted free cash flow margin, and anticipated earnings per share growth between 23%-25% contribute to a positive narrative. CEO Arora emphasized that the downgraded billings guidance stems from strategic recalibration as opposed to a demand outlook shift.

In Conclusion: Is Palo Alto Worth Considering?

A shareholder since early 2021, I have witnessed Palo Alto Networks evolve into a significant position in my portfolio over the past three years. While I offloaded a portion of my holdings post-earnings to explore alternative investment avenues, I maintain vested interest in the unfolding “platformization” narrative at Palo Alto Networks.

Despite its appeal as a sturdy cybersecurity player, sustained investor interest may take time to reignite until signs of stabilized revenue growth emerge. Hence, the bears may linger for now, but a resurgence of bullish sentiment could well be on the horizon.

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Leo Sun holds positions in Palo Alto Networks. The Motley Fool has positions in and recommends Palo Alto Networks. The Motley Fool abides by a disclosure policy.

Views and opinions expressed are solely those of the author and may not align with those of Nasdaq, Inc.