Cyber-security has been on fire, so its no surprise that Palo Alto Networks Inc (NYSE:PANW) crushed Q3 estimates on Thursday. PANW stock soared more than 17%.
That is a sharp run-up, and I usually don’t like to chase rallies, but Palo Alto Networks is still well off the $150-level it was at in February.
With secular tailwinds positioned to accelerate cyber-security awareness and adoption, I think this sudden change in investor sentiment around PANW stock is just the beginning of a longer uptrend.
Here’s why.
PANW Stock: Cyber-Security Has Secular Tailwinds
The cyber-security market is just starting to heat up. From the hacks during the U.S. Presidential Election to the more recent WannaCry attack, corporations and individuals alike continue to be reminded that protection is king in our increasingly digital world.
Those reminders serve as secular tailwinds for the entire cyber-security space. That is why cyber-security stocks across the board have been in rally mode recently. The whole sector is up, and while there might be enough room for multiple winners, the cyber-security market undoubtedly faces the risks of saturation and product “commoditization”. That means that investors need to pick the right companies in order to fully reap the benefits of a cyber-security boom.
Palo Alto Networks Is a Winner
Enter Palo Alto Networks, an undisputed leader in the space and the player most likely to reap those secular benefits.
PANW stock has four attractive features as an investment opportunity.
Firstly, the company is a global growth story. Palo Alto Networks’ impressive Q3 results underscore a secular growth story that is happening pretty much everywhere. In Q3, the company recorded the second-highest new customer adds in its history.
In fact, “Palo Alto Networks now has over 39,500 customers worldwide”, including 86 Fortune 100 companies and 1,200 Global 2,000 companies. On the Global 2,000 list, PANW added 40 customers in Q3 alone, underscoring a powerful international growth story in Europe (revenues +32%) and Asia (+33%).
Secondly, PANW is positioned for long-term revenue growth due to its high customer retention rate. All top 25 lifetime value customers again made purchases in the quarter. That means that Palo Alto Networks is not just growing a user base, but growing a high-retention user base. Growth of a high-retention user base ensures that the company’s revenue growth trajectory has a long run-way.
Thirdly, PANW is an annual recurring revenue (or ARR) growth story. A significant portion of the company’s revenue growth is coming from subscription services. Palo Alto Networks’ SaaS-based revenue was up 55% in the quarter. That is a high-margin ARR stream, so that means the company is locking in dollars on an annually recurring basis. Strong user growth, high retention rates and growth in ARR streams is a tri-fecta for long-term financial success.
Fourthly, its a high-margin business. PANW’s gross margins are bouncing between 75% and 78%. That is super high, and it allows for the company to invest a tremendous amount during its high-growth era without sacrificing positive cash flow. Palo Alto Network’s cash flows are surprisingly strong for a hyper-growth company. As growth settles, the operating expense rate will fall, and the high gross margins will flow through to huge bottom-line profits.
Bottom Line on PANW Stock
PANW stock was near $200 at the end of 2015. With secular tailwinds propping up growth in the cyber-security market and growth at Palo Alto Networks firing on all cylinders, I don’t see any reason why the stock can’t trade that high in a year’s time.
Right now, PANW stock is trading around 62-times trailing earnings. If the stock can sustain a 60-times price-to-earnings multiple and net consensus earnings-per-share of around $3.20 next year, that is a near-$200 stock right there.
I think that is totally possible, and believe the right move here is to the buy Palo Alto Networks.
As of this writing, Luke Lango was long PANW.
