What’s behind Palo Alto’s earnings sell-off — and how to proceed
Shares of Palo Alto Networks fell more than 4% on Wednesday, even though the cybersecurity provider reported strong quarterly results the previous evening. This next day’s move might seem a bit odd, given that the company not only beat expectations for the reported quarter but also issued ahead-of-expectations guidance for the current quarter. So what is the culprit? This may have to do with Palo Alto’s long-term outlook and the fact that stocks are extremely hot; This is a setup that always raises the stakes and increases the likelihood of a post-earnings pullback. On Tuesday night, Palo Alto raised its outlook for hardware growth over the next few quarters; Consider firewall boxes installed in data centers, corporate campuses, and industrial environments. However, on the earnings call, the management team reiterated its guidance on next-generation security annual recurring revenue (NGS ARR) for fiscal 2030; This is a collection of businesses focused on subscriptions to cloud native services, excluding hardware and legacy products. This metric leverages Palo Alto’s “platformization” effort, with customers committing to using multiple types of products. Cyber is a historically fragmented industry and companies are seeking consolidation. “Going forward, we are confident of surpassing 4,000 platformizations by fiscal 2030, providing primary momentum towards our $20 billion target for NPP ARR,” said CEO Nikesh Arora. Also, during the Q&A session, Arora was asked about demand and specifically what the team sees in terms of AI-driven demand. As long-term investors, we generally liked what he said about the rise in the forever or “ultimate” value of the business. However, it may not have sounded good to the hot money of short-term traders looking for momentum names. They’ve helped this stock rise nearly 86% in two months (and roughly 65% in the last month alone). It’s a notable rise after the stock was lumped into the broader software-as-a-service, or SaaS, group and was crushed by fears of AI disruption. According to the FactSet transcript, Arora said during the call: “Six months ago cybersecurity stocks were doomed because AI was going to protect every single one of us and we were all out of a job, right? And suddenly we’re hiring more people. AI isn’t taking away jobs. And suddenly, you can’t run a cybersecurity scenario without using a platform cybersecurity provider. … If I were you, understand that’s a big takeaway.” [as an analyst]If you consider, like many SaaS companies, that the terminal value of cybersecurity is lost, I understand that this terminal value is here to stay. You’ve actually created a longer-term G in your model for the long-term growth rate for cybersecurity. I think to the extent that you feel demand for someone is going to weaken in Q4 or Q1 or Q2, it’s not going to weaken. Now, I’m not going to get off my skis and start numbering the kitchen sink for cybersecurity companies because there’s still a process, a mechanism, a cycle that people adopt, and there’s execution and deployment. So… am I seeing good demand? Yes. … Do I believe this demand will continue for a long time? Yes. … Do I expect an unexpected decline next quarter, the next quarter? No. I expect strong growth.” While that’s a lot to unpack, we thought it might be useful to provide his expanded answer. Let’s simplify his argument a bit. What he’s saying is that selling off cybersecurity stocks this year is clearly wrong because the growth driver we’ve long discussed is clearly AI. Long-term shareholders got the validation they were looking for. But the hot money didn’t get the upward guidance revision they wanted to keep the momentum alive. In fact, Arora directly pointed out that they’re likely to get a windfall of earnings growth next quarter, or incredible earnings growth, as we’ve seen from AI computing hardware players like Dell and HP Enterprise. He said it would be wrong to expect growth momentum. In other words, anyone who sat on the stock and thought Palo Alto would guide by nearly 30 percentage points ahead of estimates is wrong: On Monday night, HP Enterprise released its current-quarter earnings per share forecast of 90.5 cents, according to FactSet. Below we have a 10-year chart showing the forward earnings multiple for Palo Alto shares, according to 12-month earnings estimates on FactSet, which is acceptable if you think earnings estimates will see a major upward revision. But if you’re a short-term investor, that’s not much comfort for you, especially in the last year when Palo Alto shares were trading at around 56 times forward earnings. This was also just before the “AI eats software” scare hit the market. At the beginning of this year, Palo Alto’s P/E ratio fell as low as 38 before hitting the highs of over 70 seen before the press. The estimates used for could have been higher, making the stock look cheaper in hindsight. But as a result, investors woke up to the idea that shares were actually rising thanks to multiple expansion. Of course, trading at 38 times forward earnings was just a bit better than we thought when the stock had a P/E ratio of 56. That doesn’t mean we don’t like Palo Alto or that the stock is likely to rise, at least for now. It doesn’t mean we don’t think so, which is why we raised our price target on Tuesday night. As the data center build progresses and earnings have a chance to catch up with the price action, it also means there’s no need to rush out and buy shares on Wednesday, especially as cybersecurity specialist CrowdStrike reported after the closing bell. This is another one we’ve long said we don’t like. Overall, the stock has fallen 6.8% in February and three times in November in the last four earnings reports. 7.4% but then it has historically rebounded It took 72 trading days for the stock to rise 10% from the close on the earnings date So Jim Cramer said he’s prepared to wait a day before pushing the stock from its current 3 to 2 A long-term story with a growing addressable market for cybersecurity, you’re trying to manage the position by selling extreme moves and rebuilding on pullbacks (Jim Cramer’s Charitable Trust is long). It is PAWNW. See here for a full list of stocks.) 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