Cheaper Than MSFT With Better Growth

Investors can’t get enough of Microsoft (MSFT), with its AI, growth, and splendid margins.

Yet, financial pros couldn’t hide their excitement for Palo Alto Networks (PANW) after the company’s latest earnings release.

You see, PANW trades at the same price-to-cash flow multiple as MSFT but has nearly double the growth.

And that’s just the start.

Palo Alto Network’s Business

While AI is this month’s hot topic, the cybersecurity market has grown 10.6% per year over the last five and is expected to do 13.8% through the end of the decade.

PANW serves its customers’ cybersecurity needs through a combination of hardware and software solutions.

Their main products include:

• Secure Access Service Edge (SASE) – Cloud-based platform that combines network and security services to secure and provide access to applications and data across a network.
• Cortex – AI platform that automates security ops and threat detection.
• Prisma Cloud – Comprehensive multi-cloud security platform that provides visibility, protection, and compliance for cloud-native applications, data, and infrastructure. 

Source: PANW Q4 ’23 Investor Presentation

PANW has been working to transition to more subscription-based services, which come with a high (roughly 80%) gross margin compared to a hardware-centric model.

That’s helped the company overdeliver on its 2023 results and offer an impressive forecast for 2024.

Source: PANW Q4 ’23 Investor Presentation

Financials

Source: Stock Analysis

We didn’t realize that PANW has only had one year with sub-20% YoY revenue growth.

At the same time, the company dramatically improved margins, taking negative operating and profit margins to their highest levels in over a decade.

While free cash flow dropped during the pandemic, it’s nearing record levels.

The company has more cash than debt, leaving it plenty of room for acquisitions and share repurchases.

Valuation

Source: Stock Analysis

Despite all the upside, PANW trades at a price-to-cash flow ratio similar to MSFT and only slightly higher than Fortinet (FTNT) and Oracle (ORCL).

PANW’s forward non-GAAP P/E ratio at 43.3x still isn’t cheap. But then again, MSFT and ORCL are older companies that have fully depreciated their assets and don’t offer as much share-based compensation, both non-cash related items.

Growth

Source: Seeking Alpha

PANW has some of the most consistent revenue growth we’ve seen. Given the growing cybersecurity needs, we don’t see that changing anytime soon.

Other companies like Zscaler (ZS) and FTNT certainly have growth. But, ZS isn’t profitable on paper and trades at nearly 2x the price-to-cash flow ratio as PANW. FTNT is on par with PANW in both areas.

Profitability

Source: Seeking Alpha

What’s interesting is that despite a decent gross margin, PANW’s EBIT and EBITDA margins are anemic compared to most of its peers.

Yet, it’s free-cash-flow margin is in line.

So, it really comes down to the company’s non-cash items, including share-based compensation, depreciation and amortization, and acquisition-related costs.

Our Opinion 8/10

We believe that PANW is a bit overpriced. However, we expect any decent market pullback would send shares below $200, which would be a solid spot to begin taking a position.

Management continues to make the right moves here, and we expect margins to keep improving. Plus, we expect them to do more to maintain their growth than FTNT.

Therefore, we’re more interested in PANW than any of its peers.

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