The end of May was especially busy for Palo Alto Networks (NYSE: PANW). Besides reporting on its fiscal 2019 third quarter, the cybersecurity company announced two new acquisitions: container security outfit Twistlock for $410 million in cash, and serverless application security start-up PureSec for an undisclosed sum.
Palo Alto continues to grow by leaps and bounds, and is using its success to scoop up fast-growing peers, to extend its lead in protecting all sorts of business operations from those with nefarious intentions. Investors were ho-hum on the news, though, setting up a buy-the-dip situation for those willing to take a longer-term view.
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The year so far in review
Palo Alto Networks’ revenues rose 28% during the three months ended April 30, to $727 million. Adjusted earnings grew 26% to $1.31. Neither headline number is anything to complain about, but both were nevertheless a deceleration from the growth rates posted so far during the company’s 2019 fiscal-year tour.
Though momentum cooled, the upshot is that the third quarter exceeded management’s guidance given a few months prior. Palo Alto has a history of setting a low bar for itself, and that could be the case again headed into the fourth quarter. Revenue was forecast to be up 20% to 21% year over year, and adjusted earnings up just 10% to $1.41. Granted, the earnings guidance includes a negative $0.12-per-share impact from the acquisition of Demisto and the proposed takeovers of Twistlock and PureSec, and another $0.02 impact from U.S.-China trade-war tariffs. But the steep slowdown in guidance seems to be what has investors fretting.
Why this is one cheap stock
Palo Alto is benefiting from the growing importance of cybersecurity around the globe, and the advent of cloud computing is making securing critical operations even more complicated for businesses. Thus, its stock could have years’ worth of double-digit growth ahead as global enterprises look to keep themselves safe. Add in the company’s proclivity for making strategic takeovers, and there are a lot of reasons to like Palo Alto’s prospects.
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Nevertheless, investors are growing increasingly impatient with the unadjusted bottom-line losses. Before backing out stock-based compensation and other one-time items, the security enterprise has lost $61 million so far this year. Unadjusted profits are right around the corner, though, as that loss has narrowed from the $129 million loss at the same point a year ago. In short, Palo Alto is nearing profitable scale, but it isn’t about to take its foot off the gas.
A better metric for looking at the company is free cash flow, or money left over after basic operations and capital expenditures are paid for. Even while investing heavily via acquisition, Palo Alto is knocking on the door of $1 billion a year. Based on the last 12-month stretch, the stock is valued at 24.9 times price to free cash flow — premium pricing, but not overly much considering how fast the cybersecurity firm is expanding.
Thus, with Palo Alto Networks still in high-growth mode, the recent 25% dip in share price looks like an opportune time to buy.
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Nicholas Rossolillo and his clients own shares of Palo Alto Networks. The Motley Fool owns shares of and recommends Palo Alto Networks. The Motley Fool has a disclosure policy.
