Palo Alto Networks Could Be Worth $383 Per Share, 28% Upside From Here

Palo Alto Networks (PANW) could be worth $383, up over 28% from today, despite its rise from recent lows. This is based on the cybersecurity company's huge free cash flow (FCF) and FCF margins. Moreover, shorting OTM puts is a good income play for shareholders as they wait for PANW stock to hit this target.

As of Friday, Dec. 22, PANW stock closed at $298.21 per share, up from its Aug 17 low of $207.17. Moreover, since the company released its earnings on Nov. 15, PANW stock is up 16.4% from $256.18.

Free Cash Flow Could Power 30% Higher

I discussed the company's stellar results including its 20% revenue rise and free cash flow (FCF) margins in my Nov. 17 Barchart article, “Palo Alto Networks Delivers Huge 41% FCF Margins…” In that article, we argued that PANW stock could be worth $378.34 per share.

Here's why. In short, the company delivered 41.1% adjusted FCF margins in the past 12 months. That can be seen on page 28 of its presentation deck. Adjusted FCF for the year ending Oct. 31, 2023, was $2.963 billion on $7.207 billion in trailing 12-month (TTM) revenue. That works out to be 41.1% of its revenue.

We can use that FCF margin to estimate the future value of the stock. For example, analysts now project that revenue next year will reach $9.68 billion (representing an 18.3% gain over $8.18 projected for this year ending Oct. 31, 2023).

Therefore, using a 41% FCF margin, we can project that adj. free cash flow could rise to $3.969 billion (i.e., 0.41 x $9.68b). That represents a 34% gain over the TTM adj. FCF figure of $2.963 billion we mentioned earlier.

This is useful for us since we can use that FCF estimate to value PANW stock.

PANW Stock's Value Based on FCF Yield

For example, even though Palo Alto Networks still does not pay a dividend, let's assume it pays out 100% of that FCF to its shareholders. What will the dividend yield be for the stock?

Microsoft (MSFT) has a similar FCF margin (36.6%) as I described  in my Dec. 11 article, “Microsoft Could Be Worth Over $500 Per Share Based on Its Massive Free Cash Flow.” Moreover, it pays out about a quarter (actually 24.3%) of its FCF (i.e., $5.05 billion/$20.7 billion) in dividends. And its dividend yield is now 0.80%. That implies that if it paid out 100% of its FCF the dividend yield would be about 3.3% (i.e., 0.008/=.243=0.033).

That implies that we can use a 3.3% dividend yield to value PANW stock. So, for example, if we divide our estimate of $4 billion billion in adj. FCF by 3.3% we get a target market cap of $121.2 billion (i.e., $3.969b/0.033 = $121.2 b).

That means that if Palo Alto Networks rises to a $121.2 billion market cap and it pays out 100% of its FCF, PANW stock would have a 3.3% dividend yield. This is the same as valuing PANW stock with a 3.3% FCF yield. 

Palo Alto Network's market cap today is $94.4 billion. So, this implies that PANW stock could rise by 28.4% (i.e., $121.2b/$94.4b). In other words, PANW stock could be worth 28% more at $382.90 per share (i.e., $298.21 x 1.284 = $382.90 per share).

Shorting OTM Puts for Extra Income

One way for existing shareholders to make money while they wait for the stock to rise is to short out-of-the-money (OTM) puts for extra income. This is a way to generate a pseudo-dividend since PANW stock has no dividend yield right now.

For example, look at the expiration period ending Jan. 12, which is three weeks from now. This shows that the $280 strike price put option, which is over 6% below today's price, has a $2.10 premium. That represents an immediate yield of 0.75% (i.e., $2.10/$280.00).

Moreover, the $285 strike price, which is 4.43% out-of-the-money, the premium is significantly higher at $3.15. That means that the put short-seller can generate an immediate yield of 1.10% (i.e., $3.15/$285.00).

PANW Puts - Expiring Jan. 12, 2024 - Barchart - As of Dec. 22, 2023

This works out to an annualized expected return (ER) of 7.70% (i.e., 1.10% x 17) as there are 17 periods of three weeks in a year. The risk is that the stock falls by 4.43% to the strike price. In that event, the short-seller of these puts would be obligated to buy shares at the $285.00 strike price.

But that may not be such a bad thing, especially since we have shown that PANW stock could be worth $383 per share sometime in the next year. In other words, the short-seller could hold on to their new shares and wait for the stock to rise. They could also sell covered calls against these new shares to generate more income.

The bottom line is that PANW shareholders have ways to generate income while they wait for the stock to rise to its target price.

On the date of publication, Mark R. Hake, CFA did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.