Palo Alto Networks Inc (NYSE:PANW) stock capped off a good last day of trading after Citi upgraded the stock from “neutral” to “buy” on Friday, raising its price target from $147 to $160. That’s roughly 16% upside if you don’t want to do the math.
PANW stock is also getting a little help from CNBC’s Jim Cramer, who said that Citi’s upgrade was a good call. The overall bullish sentiment caused shares to rise by about 4% in Friday’s session and another 1.4% Monday.
About a month ago, after Palo Alto Networks’ blowout third-quarter report, I made the case for PANW being a $200 stock by the end of fiscal 2018. I am sticking with my guns on that call, as PANW offers compelling upside potential at these levels. Here’s why.
Cyber Security Stocks Will Head Higher
It seems like every week we get reminders of just how important cybersecurity is in today’s cloud-powered world. Last week, a ransomware attack dubbed “Petya” affected companies across the globe. This week, those companies are starting to report the damages.
Mondelez International Inc (NASDAQ:MDLZ) just announced that the cyber attack will negatively impact its Q2 revenue growth rate by 3%. United Kingdom-based Reckitt Benckiser Group Plc said it expected sales to be negatively affected by 110 million pounds this year as a result of Petya.
The WannaCry attack in May was bad, but this most recent attack is much worse. It underscores just how many dollars are at risk in these attacks.
That means its time to buy cybersecurity stocks, but not just any cybersecurity stock. Its time to PANW stock, the undisputed leader in its space.
PANW Will Be the Big Winner
As I stated about a month ago, there are four reasons to buy PANW over other cybersecurity stocks.
- The company is a global growth story. In Q3, the company recorded the second-highest new customer adds in its history, and that growth came from all over the globe. PANW counts 86 Fortune 100 companies and 1,200 Global 2,000 companies as its customers. Moreover, considering the recent cyber attacks have been global in scale, it is good to see that PANW’s international growth is on fire. On the Global 2,000 list, PANW added 40 customers in Q3 alone.
- PANW has a high retention rate among its biggest customers. All top 25 lifetime value customers again made purchases in Q3. The company is growing a high-retention user base, and that makes the runway for growth look particularly long and attractive.
- Palo Alto Networks’ revenue growth is largely being driven by subscription services. Palo Alto Networks’ SaaS-based revenue grew 55% in Q3, and thats high-margin stuff, so PANW is locking in high-margin revenue dollars for many years to come.
- And PANW is a high-margin business across the board. PANW’s gross margins bounce between 75% and 78%. The high gross margin rate allows the company to invest during this high-growth era without sacrificing positive cash flow.
Reasonable Valuation for PANW
Even with all these positives, PANW stock remains reasonably valued for a hyper-growth tech company.
Palo Alto Networks has a very strong balance sheet, with just under $1.4 billion in cash and cash equivalents versus roughly $520 million in debt. That gives PANW a net cash positioning of around $850 million, or about $9.40 per share. Backing that out of the current stock price, PANW’s enterprise value is about $128 per share. That is about 39-times the current consensus FY18 EPS estimate.
Analysts are projecting roughly 31.5% earnings growth per year over the next five years. A 39-times multiple on 31.5% earnings growth means the stock is trading at a slight premium to its growth. That is reasonable for an industry leader supported by very strong secular growth trends.
Moreover, Palo Alto Networks tends to beat analyst estimates on the bottom line, implying that both FY18 EPS estimates and long-term growth estimates are light. That means the realistic forward P/E multiple is something less than 39, and the realistic forward growth potential is something more than 31.5%.
All in all, no matter which way you look at it, PANW continues to trade a very reasonable valuation, especially considering where the stock has traded in the past. This stock has been reasonably awarded a roughly 60-times trailing price-earnings multiple.
If the company can maintain that P/E multiple by the end of FY18 and meet consensus EPS estimates, that would imply a near-$200 stock in little over 12 months (60 x $3.26 = $195.60).
With PANW stock, investors are getting strong, secular growth at a reasonable price. That makes PANW stock a buy here.
As of this writing, Luke Lango was long PANW.
