Should investors buy this cybersecurity stock following its latest pullback in anticipation of better times ahead?
Artificial intelligence (AI) was supposed to be a big deal for cybersecurity companies, but a closer look at the quarterly results that Palo Alto Networks (PANW 0.59%) has delivered so far this year indicates the company has failed to make the most of this technology.
Palo Alto stock was punished severely in February this year following the release of its fiscal 2024 second-quarter results as the company’s billings growth showed signs of weakness. That wasn’t surprising; billings point toward the health of a company’s future revenue pipeline, with the metric referring to sales contracts that will eventually be booked as revenue.
Palo Alto’s billings grew at a slower pace than its revenue during that quarter, prompting the cybersecurity specialist to offer incentives and freebies to customers to help drive sales. So, it wasn’t surprising to see investors hitting the panic button once again following the release of Palo Alto’s fiscal Q3 earnings report (for the three months ended April 30, 2024) on May 20.
The stock fell as billings growth slowed down further. Let’s take a closer look at Palo Alto’s numbers and check if the stock’s poor returns in 2024 are justified.
Are investors looking at the wrong metric?
Palo Alto reported fiscal Q3 revenue of $2 billion, an increase of 15% from the year-ago period. The cybersecurity specialist’s non-GAAP (adjusted) net income increased 20% year over year to $1.32 per share. The numbers exceeded Wall Street’s expectations of $1.25 per share in earnings on $1.97 billion in revenue.
Additionally, Palo Alto’s fiscal Q4 guidance of $1.41 per share in profit on $2.16 billion in revenue was in line with consensus estimates. That would translate into a 10.5% increase in revenue compared to the year-ago period, but earnings would decline slightly from the year-ago period’s level of $1.44 per share.
However, Palo Alto’s billings left a lot to be desired. The company’s total billings increased just 3% year over year in the previous quarter to $2.33 billion. That was a stark slowdown when compared to the 16% year-over-year growth in billings Palo Alto clocked in the second quarter of the fiscal year.
Management admitted that the company is witnessing “significant volatility in our billings,” and attributed that to “an increase in factors impacting payment terms on a quarterly basis.” CFO Dipak Golechha pointed out that some of the company’s large customers are “opting for deferred payments over the term of their purchase instead of paying upfront as they grapple with the higher cost of money.”
That’s the reason why Palo Alto is stressing that investors watch another metric, remaining performance obligations (RPO), which the company says “captures the full value of our contracts independent of customer billing terms.” In simpler words, RPO refers to the total value of a company’s future contracts that are yet to be fulfilled.
Palo Alto’s RPO increased 23% year over year last quarter to $11.3 billion, exceeding the growth in its top line. The stronger growth in the RPO suggests that Palo Alto’s future revenue pipeline is indeed improving. Additionally, Palo Alto’s focus on integrating AI across its portfolio could lead to further improvements in its revenue pipeline.
Management sees a total addressable market (TAM) worth $15 billion in AI-related cybersecurity. The company has taken a host of measures of late to capitalize on this opportunity. For instance, Palo Alto has introduced three solutions — AI Access, AI SPM, and AI Runtime — that will enable its clients and their employees to safely adopt AI applications. Palo Alto’s offerings will help organizations protect their AI apps, data, and models, while also ensuring that apps are securely configured and deployed.
The company has also introduced Precision AI, a platform that automates threat detection, prevention, and remedy. Management said it is witnessing “strong early customer engagement with these offerings.” It is also worth noting that these AI-focused cybersecurity products will be made generally available to customers in July.
Given that the adoption of AI in cybersecurity is forecast to increase at an annual rate of 24% through 2030, it won’t be surprising to see Palo Alto’s business gaining momentum once these products are made generally available.
Is the stock worth buying?
Though Palo Alto’s future revenue pipeline seems to be improving, as is evident from the growth in its RPO, and it is sitting on a solid catalyst in the form of AI, the fact that the stock is richly valued cannot be ignored.
Palo Alto stock is trading at 45 times trailing earnings, and a forward earnings multiple of nearly 51 points toward a contraction in its bottom line. The sales multiple is also expensive at 14. The U.S. technology sector, on the other hand, sports a price-to-earnings ratio of 45 and a sales multiple of 7.4.
Considering Palo Alto’s slowing revenue growth and the near-term weakness in its earnings, it would be better for investors to wait for catalysts such as AI to supercharge its growth. That’s because this cybersecurity stock may not be able to deliver much upside from current levels considering its rich valuation and the slower growth that it is forecasting in the ongoing quarter.