Palo Alto Networks aims at cyber security leadership

Key Points

• Palo Alto Networks had a solid quarter, but a planned business shift hurts the outlook. 
• Analysts are lowering their ratings and price targets, weighing on the market. 
• The business is strong and will recover, but the stock price may not see new highs for some time. 

Palo Alto Networks NASDAQ: PANW significantly shifted, causing the entire cyber security universe to move lower. The shift is toward platformization. The goal is to attract more long-term business by consolidating existing services and products into a signal platform and enticing them with freebies. Already the cybersecurity market leader, Palo Alto Networks wants to ensure it retains its position. 

However, the impact of the news is far-reaching. It has shares of Palo Alto and other cybersecurity leaders down double-digits, and they are likely to stay down for the foreseeable future. 

The reason for the share price implosions is revenue and earnings. The impact to Palo Alto will last twelve to eighteen months and trim 5.6% off of this year’s expected billing. The impact on the industry is a need to offset market share losses Palo Alto Network’s move may cause, potentially resulting in a significant downshift in revenue and earnings expectations for all cyber stocks.

Analysts’ sentiment shifts for Palo Alto Networks

The analysts have supported Palo Alto Networks, but the sentiment is shifting along with the business change.  While some have come out to defend the move and the stock’s long-term outlook, more have come out to downgrade their rating or lower their price targets. 

Among the most prominent are downgrades to Hold from Buy or Outperform equivalents from Piper Sandler, Rosenblatt Securities, and Loop Capital. The takeaway from their notes is that a high degree of uncertainty has entered the picture, results will be hampered for the foreseeable future, and both raise issues with valuation and price multiples. Trading at 65X earnings, it is a highly valued stock to have its growth slowing and the outlook trimmed. 

Palo Alto Networks has a solid quarter, reaffirms profit guidance

Palo Alto Networks had a solid quarter in FQ2, showing strength across its three platforms. The company reported $1.98 billion in net revenue, a gain of 19.3% over last year. The revenue outpaced the Marketbeat.com consensus by a slim margin and is compounded by solid margins. Segmentally, Products grew by 10.7%, led by a 21.6% increase in Services. The remaining performance obligation, a leading indicator for revenue growth, increased by 22%. 

The margin news is mixed, but gross margin improvement offset increased costs to leave the adjusted and GAAP earnings above forecast. Adjusted earnings grew 40% YOY to $1.46 per share, outpacing consensus by $0.16. The strength should have led management to increase the guidance, but the shift in business strategy offset it. 

Guidance is good, albeit tainted by uncertainty. The company reaffirmed its outlook for adjusted EPS, which has a midpoint slightly below the consensus estimate. The risk for investors is slowing organic growth will be compounded by the strategy to shift, resulting in underperformance in the back half of the fiscal year. 

The technical outlook: Palo Alto Networks is heading lower 

Palo Alto Networks business may not feel the impact feared by the market, but it won’t help the share price. The stock is down more than 25% in a single day, creating a solid engulfing pattern that consumes two and half months of trading. This signal creates a significant overhang of investment dollars, now showing losses. It will take a substantial shift in market sentiment to overcome the overhang, setting the stock price up for deeper declines. The next best target for solid support is near $230 or about 15% additional downside. 

The factor which will support the price is the balance sheet. The company is in a strong financial position and can afford to invest in its future. Critical details at the end of Q2 include a significant increase in cash, inventory, and current and total assets offset a slight increase in liability. The result is that shareholder equity more than doubled.