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Today Palo Alto Networks (PANW), the cybersecurity software firm, reported positive and strong free cash flow (FCF) and FCF margins for its fiscal quarter ending April 30. Moreover, given the company's FCF margin guidance, the stock looks cheap.
PANW stock is down 2.55% in midday trading on May 21 at $317.07 per share. However, PANW stock is still up 18% in the last month and a half from $268.58 where it closed on April 8.
Strong Results for the Quarter
In short, the company reported strong results, both for revenue (+15% Y/Y) and its all-important free cash flow (FCF) number for the quarter (+22.6% Y/Y). Moreover, on a trailing 12-month (TTM) basis, its FCF margins were very strong.
It's important to view Palo Alto Networks' results on a full-year basis. This is because much of the company's revenue and adjusted FCF come during its fiscal Q1 period ending October 30. So, for example, this quarter the company generated $7.79 billion in TTM revenue, which was 13% higher than its prior-year TTM sales.
In addition, its TTM adj. FCF was over $3 billion for the first time ($3.023 billion). That was $255 million higher or +9.2% than the $2.768 billion in TTM adj. FCF it made last year. This has a huge smoothing effect on its adj. FCF margins.
For example, This quarter's adj. TTM FCF quarterly results represent an FCF margin of 24.9%. But over the past year its $3.02 billion in adj. FCF represented a higher margin of 38.8% of its $7.79 billion in sales. This bodes well for the upside in PANW stock.
Price Targets
For example, management said that its revenue would be in the range of $7.99 billion and $8.01 for the full fiscal year ending July 31. The press release also said Palo Alto Networks would likely produce adj. FCF margins for the full year ending July 31 of between 38.5% and 39%.
Based on this we can estimate that the company will generate $2.162 in sales in its next fiscal quarter as well as at least $465 million in FCF. That will bring its full fiscal year sales to $8 billion and adj. FCF to $3.1 billion.
Moreover, next year, analysts are forecasting that sales will rise 14.4% to $9.15 billion. Using the same FCF margin this implies that adj. FCF could rise to $3.546 billion. This allows us to set a price target.
For example, right now PANW stock is trading at a 3.0% FCF yield (i.e., $3.1b / $102.6 billion market cap today). The yield is even lower on a fully diluted basis, more like 2.84%.
So, if we divide next year's FCF estimate of $3.546 billion by 2.84% (which is the same as multiplying it by 35.2x), the projected market cap is $124.9 billion. That is 21.6% over today's market cap and implies that the price target is 21.6% higher or $385.57 per share.
Shorting OTM Puts
One way to play this, as I suggested in my last Barchart article, is to sell short out-of-the-money (OTM) puts - i.e., with strike prices below today's price. That way, in nearby expiry periods, you can set a good buy-in price, in case the stock falls, and get paid for this option.
For example, look at the June 14, 2024, put options expiration period, which is 24 days from now, a little over 3 weeks away. It shows that the $300 strike price, which is 5.15% below today's price of $317.71, trades for $3.60 on the bid side.
That means that the short seller of these puts makes an immediate yield of 1.20% (i.e., $3.60/$300.00). That is a very decent yield, especially for an existing investor in PANW stock, since the company still does not pay a dividend.
Here is how that works. The short-put investor secures $30,000 in cash and/or margin with their brokerage firm (i.e., 100x $300 strike price). This is because each short put contract represents a potential purchase of 100 shares should the stock fall to $300 on or before June 14.
Then, the investor enters an order to “Sell to Open” 1 put contract at $300 for expiration on June 14. The account will immediately receive $360. That represents a 1.20% return on investment. As long as the stock stays above the $300 strike price the investor will not have to buy 100 shares at $300.
Moreover, if the stock rises, any investor who is also long PANW shares (i.e., already owns shares) not only gets the upside capital gains, but also keeps the $360 in income. That is why this kind of play works best for investors who are already shareholders. Nevertheless, it also represents a good way to buy into the stock in case it falls.
In addition, the investor can repeat this trade every 3 or 4 weeks. For example, over 90 days, if done every three weeks, the expected return (ER) is 1.2% x 4 or 4.80%. That assumes that the investor can make the same put yield each time.
The bottom line is that PANW stock looks cheap after today's results. One way to play this is to short OTM put options in nearby expiry periods.
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.
