A Well Oiled Machine That Keeps Surprising To The Upside: Palo Alto Networks (NASDAQ:PANW)

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The Box Is Dead, Long Live The Box!

As everyone knows, you don’t want to own hardware systems companies. Low levels of intellectual property, terrible balance sheets arising from inventory and all that old fashioned stuff, poor gross margins, no revenue visibility, and vulnerable to being eroded by the next box company that comes along with a sharp-looking case and a couple fancy ASICs in side.

We agree with this.

It’s just that the logic doesn’t apply to Palo Alto Networks, which is a box company. And that’s because the management team have worked very hard to scrub all trace of your regular box company economics from the financial statements. Not in an FTX/SB-F – kind of way; in a let’s-just-make-the-economics better kind of way.

Here’s the numbers up to and including the quarter just reported (ending 31 October 2022), plus management’s guide for the next quarter (ending 31 Jan 2023).

This thing is a machine.

The company doesn’t publish all of its numbers until the 10-Q is out in a couple days (the orange cells above show where we have used trend-based estimates). We’ll update this article once the full set is available – they won’t change the story, which is:

• TTM revenue growth sits at 28% vs. peak TTM growth of 30% two quarters ago; quarter vs. PY quarter growth at 25% vs. peak of 32% this time last year. This is very strong compared to other tech companies – look at NVDA for instance (here).
• TTM EBITDA just hit an all time high of c.$1.2bn.
• TTM unlevered pretax cash flow was in the region of $1.3-1.4bn (will update once we have the true change in working capital and depreciation numbers) which is close to a record high.
• The company has >$2.2bn net cash on the balance sheet and has over $7bn of already-invoiced future revenue – that’s the deferred revenue element – on the books. Which means that something like 1.2x TTM revenue has already been sold. Nice.
• The total book of signed contracts (RPO, = the deferred revenue plus contracts that have yet to be billed to customers) we don’t have yet but we expect will exceed $8bn, in the region of 1.5x TTM revenue.

Here’s that RPO data up to last quarter – again we’ll update when the full 10-Q is published.

And here’s the valuation the market is asking you to pay.

8x revenue and 33x cash flow in exchange for 28% growth and solid cash flow margins. That’s punchy but not terrible for buyers.

The stock offers a nice risk/reward setup if you don’t mind buying at Wave 4 lows (usually better to buy at Wave 2 lows because the risk/reward level is to your benefit).

You can open a full page version of this chart, here.

We think a good way to play this name is to buy around here ($157ish) with a stop-loss-limit placed somewhere close below that W4 low, and to gun for a price target of $250 or so, which would mean the W5 target would be around the 0.618 extension of Waves 1+3 combined.

Just keep reminding yourself it’s a box company and that one day it will be devoured by software. Just not today.

Cestrian Capital Research, Inc – 17 November 2022.