Given the recent share price decline, should investors buy this cybersecurity stock in anticipation of an upcoming recovery?
Artificial intelligence (AI) was supposed to be a big deal for cybersecurity companies, but a closer look at Palo Alto Networks' (PANW 0.59%) quarterly financial results so far this year shows the company is failing to make the most of the technology.
Palo Alto's stock price fell sharply in February after the company reported its fiscal second-quarter 2024 earnings, as the company showed signs of weakening revenue growth. This was not surprising: revenue indicates the health of a company's future revenue pipeline, and this metric refers to sales contracts that ultimately become revenue.
Palo Alto's billings for the quarter grew at a slower pace than its revenue, leading the cybersecurity specialist to offer incentives and free services to customers to boost sales. So it's no wonder investors panicked again after Palo Alto released its third-quarter financial results (for the three months ending April 30, 2024) on May 20.
The stock price fell as revenue growth slowed further. Let's take a closer look at Palo Alto's numbers to see if the stock's lower return in 2024 is justified.
Are investors looking at the wrong metrics?
Palo Alto reported third-quarter revenue of $2 billion, up 15% from the same period last year. The cybersecurity specialist's non-GAAP (adjusted) net income rose 20% year over year to $1.32 per share. The figures beat Wall Street expectations of $1.25 per share in earnings and $1.97 billion in revenue.
Additionally, Palo Alto's fourth-quarter guidance of $1.41 per share earnings on $2.16 billion in revenue is in line with consensus estimates, implying a 10.5% increase in revenue compared to the same period last year, but a slight decline in earnings from $1.44 per share in the same period last year.
But Palo Alto's revenue disappoints: The company's revenue last quarter increased just 3% year over year to $2.33 billion. That's a significant slowdown compared to the 16% year over year revenue growth Palo Alto posted in its fiscal second quarter.
Management acknowledged that the company is experiencing “significant fluctuations in billings,” citing “an increase in factors affecting payment terms from quarter to quarter.” CFO Deepak Gorecha noted that some of the company's largest customers are “experienced with high capital costs and are choosing to defer payments over the life of the purchase rather than paying up front.”
That's why Palo Alto emphasizes that investors should look at another metric: remaining performance obligation (RPO), which the company says “captures the full value of our contracts, independent of customer billing terms.” Simply put, RPO is the total value of a company's future contracts that have yet to be fulfilled.
Palo Alto's RPO grew 23% year over year to $11.3 billion last quarter, outpacing revenue growth. Strong RPO growth suggests Palo Alto's future revenue pipeline is certainly improving. Additionally, Palo Alto's focus on integrating AI across its portfolio could lead to further revenue pipeline improvements.
Management believes the total addressable market (TAM) for AI-related cybersecurity will reach $15 billion. The company has recently taken various steps to capitalize on this opportunity. For example, Palo Alto introduced three solutions (AI Access, AI SPM, and AI Runtime) that enable customers and their employees to securely adopt AI applications. Palo Alto's products help organizations protect AI apps, data, and models while ensuring that apps are configured and deployed securely.
The company also introduced Precision AI, a platform that automates threat detection, prevention, and remediation. Management said it is seeing “strong early customer interest in these products.” It's also worth noting that these AI-focused cybersecurity products are expected to be generally available in July.
Considering that the adoption of AI in cybersecurity is predicted to grow at a rate of 24% per year through 2030, it's no wonder that Palo Alto's business will gain momentum as these products become generally available.
Is this stock worth buying?
Palo Alto's future revenue pipeline appears to be improving, as evidenced by the growth in RPO, and is built on a strong catalyst: AI, but the fact that the stock is valued at a premium cannot be ignored.
Palo Alto shares trade at 45 times its past year earnings and nearly 51 times forward earnings, suggesting the company's bottom line is shrinking. Its sales multiple is also too high at 14. Meanwhile, the U.S. technology sector trades at 45 times earnings and 7.4 times sales.
Given Palo Alto's slowing revenue growth and near-term weakness in earnings, investors would be better off waiting for a catalyst like AI to accelerate growth, as this cybersecurity stock may not be able to deliver significant upside from current levels given its high valuation and projected slowing growth in the current quarter.
