Investors Expect Palo Alto Networks Could Fly Higher Based on Higher FCF Margins

Palo Alto Networks (PANW), the cybersecurity company, will report its quarterly fiscal Q1 results in mid-November for the quarter ended Oct. 31. Investors expect its free cash flow (FCF) margins could push PANW stock a good deal higher.

• This is after the company generated $388 million in FCF in its last quarter on revenues of $1.95 billion. 
• That worked out to a 20% adj. FCF margin. This was significantly below the average for the full fiscal year that ended July 31 of 38.2%.

Investors don't believe this will continue. For one, the company has guided that it expects to see its full-year 2024 free cash flow margin from 37% to 39%. 

It also projected that revenues could rise over 18% from $6.89 billion last fiscal year ended July 31 to at least $8.15 billion.

That implies that its annualized FCF could be as high as $3.02 billion, or at least $754 million on average each quarter. In other words, last quarter's $388 million adj. FCF figure seems to have an anomaly.

That is why investors expect to see a significantly higher FCF number and FCF margin on Nov. 16 when the company reports its results for its fiscal Q1 2024.

PANW Stock Could Power Higher

Anticipation of this result is already starting to move PANW stock higher. Today it is at $240.63, up 14.7% from its recent low of $209.74 on Aug. 18.

However, going forward, it's possible to project an even higher price based on its expected high FCF margins. For example, assuming the company generates $3 billion in adj. FCF this year could mean its market cap could soar.

Here is how. If the market likes what it sees, it may reward PANW stock with a 3% FCF yield metric. That would give the stock a $100 billion market cap. This is seen by dividing the forecast $3 billion adj. FCF by 3%. That is also the same as multiplying it by 33.3x.

Given that Palo Alto Network's present market cap is about $74.2 billion, this implies the stock could rise by 34.8% (i.e., $100b/$74.2b-1). This means PANW stock could be worth $324.29 sometime during the coming 12 months.

Shorting OTM Puts for Income

That works out to be a good target price for investors who want to make additional income by shorting out-of-the-money (OTM) puts.

For example, for the Nov. 17 expiration period, which should be after it releases its fiscal Q1 results, the $227.50 put options trade at the bid price for $5.35 per put contract. That works out to an immediate yield of 2.35% (i.e., $5.35/$227.50) for the short seller of these puts.

PANW Puts expiring Nov. 17 - Barchart - As of Oct. 30, 2023

That is a very high put yield. One might argue that investors expect to see the stock fall significantly after the results, based on these high put yields. 

Even though this put strike is over 5% below today's price, a conservative investor might want to short an even lower strike price.

For example, the $220 strike price puts trade for $3.50 per contract. That still implies a high 1.59% yield (i.e., $3.50/$220), even though the strike price is over 8% below today's stock price. Nevertheless, these are very attractive yields. It might make sense to short a combination of both put strike prices.

The bottom line is that PANW could be worth substantially more than today's price. Investors can make additional income while holding the stock by selling short near-term expiration OTM puts for relatively high put option yields.

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.