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Palo Alto Networks' Cybersecurity Growth Outlook Disappoints -- Here's What You Need to Know

Motley Fool - Sat Nov 25, 2023

Palo Alto Networks (NASDAQ: PANW) just gave the latest indication that the economy is slowing. Much like its large cybersecurity peer Fortinet (NASDAQ: FTNT), more modest growth is on the way for Palo Alto as customers look to save some cash amid ongoing global concerns, from war to higher interest rates.

Nevertheless, Palo Alto Networks is still in tip-top shape to lead the cybersecurity industry. Is the stock still a great buy right now? Here's what you need to know.

Palo Alto Networks warns on customer billings

A few weeks ago, Fortinet disappointed investors with another lackluster report that indicated growth is slowing. This is particularly the case for Fortinet and its slant toward hardware-based sales (firewalls, devices that protect a physical location like an office or data center). After several years of booming sales tied to necessary network expansions during the pandemic, that part of Fortinet's business is now in a downturn.

Palo Alto Networks is also headed for a slowdown, but CEO Nikesh Arora firmly believes this is merely "cosmetic" due to the timing of customers paying invoices.

At any rate, the slowdown is worth noting. First-quarter fiscal 2024 (the three months ended in October 2023) revenue increased 20% year over year to $1.88 billion. This beat the outlook Arora and the top team provided three months ago. However, billings (invoices sent but not yet paid by customers) growth for full-fiscal year 2024 is expected to rise 16% to 17%. This is a downgrade from the previous expectation for fiscal 2024 billings growth of 19% to 20%.

Is the cybersecurity market in trouble?

Despite some concerning trends in customer spending habits, cybersecurity very much remains a secular growth trend. Billings growth may be moderating, but it still indicates that global organizations overall need lots more cybersecurity to combat never-ending attacks. Data theft is rising, and the ransoms paid to bad actors are also up. Palo Alto Networks' services are thus trending in the right direction.

But the need for more and better digital security doesn't mean the need for cost savings is out the window. These same at-risk organizations are looking for ways to conserve cash as they manage economic risks, especially from the higher interest rate environment we are now in (higher rates make business projects more expensive to fund). That's where a company like Palo Alto Networks comes in. It offers big bundles of various security services (bundling can reduce complexity and cost, versus hiring many smaller cybersecurity vendors), as well as loads of AI (a way to automate cybersecurity tasks).

It's all in the name of "doing more with less," and as the largest cybersecurity company pure-play by sales and market cap, Palo Alto Networks is primed to continue leading the way forward. The company expects to deliver average annual billings growth in a range of 17% to 19% through fiscal 2026, so even its slowdown for 2024 keeps it within striking distance of this goal.

Is the stock a buy?

Palo Alto Networks stock has soared in the last few years (up nearly 170% over the last 36 months), and after the earnings update, the valuation is higher than it's been in a while. Shares currently trade for nearly 31 times trailing 12-month free cash flow.

Given the recent downgrade to growth over the next year, I'm hitting pause on this top cybersecurity stock. I already have a full position, so I see no need to add more at this more premium price. Nevertheless, I'm plenty confident in Palo Alto Networks' ability to grow profitably in the years to come, and am happy to keep it as part of my portfolio.

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Nicholas Rossolillo and his clients have positions in Fortinet and Palo Alto Networks. The Motley Fool has positions in and recommends Fortinet and Palo Alto Networks. The Motley Fool has a disclosure policy.

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