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Palo Alto Networks (PANW) delivered a massive $3 billion in adjusted free cash flow (FCF) in the trailing 12 months ending Oct. 31. That represents a massive 41% of revenue. That high adjusted FCF margin implies that PANW stock could be worth up to 52% more or $378 per share.
The cybersecurity company said its revenue was up 20% YoY. In addition, its adjusted non-GAAP earnings per share (EPS) rose 66% from 88 cents in Q2 2022 to $1.38 in the latest quarter.
In addition, Palo Alto Networks showed on page 29 of its presentation that its adjusted FCF in the trailing 12 months (TTM) to Oct. 31 rose to $3 billion this quarter ($2.963b). That was 10.9% higher than its prior quarter TTM adj. FCF of $2.57 billion.
More importantly, its adj. FCF margins (i.e., FCF/revenue) rose from 38.8% to 41.1%. That can be seen in the chart below which the company provided in its presentation.
That means going forward the company will be able to convert over 40% of its revenue to free cash flow. That has huge implications for the underlying value of PANW stock.
PANW Stock Worth Significantly More Based on Its FCF Margins
For example, Palo Alto Networks forecast in its earnings release that it expects revenue to rise to between $8.15 billion and $8.2 billion. That works to an average of $8.175 billion. Analysts surveyed by Seeking Alpha project next year's revenue to rise to $9.69 billion. This means the next 12 months (NTM) revenue could be about $8.93 billion on average.
Therefore, if we apply a 40% adjusted FCF margin (to be conservative) going forward, adjusted free cash flow could rise to $3.572 billion (i.e., 0.40 x $8.93b). In other words, we can forecast a 20.5% gain in adj FCF in the NTM period.
That might imply at least a 20% gain in the stock price. However, the markets are likely to value PANW stock with a significantly better FCF valuation.
For example, using a 3.0% FCF yield (i.e., the same as multiplying it by 33.3x), the stock could be worth $119 billion. That is seen by dividing our $3.57 billion adj. FCF estimate by 3.0%, or multiplying it by 33.3x (i.e., $3.57b/.03 =$119b, and $3.57b x 33.333 = 119 b).
This $119 billion market cap estimate is over 52% higher than the stock's present market cap of $78 billion. In other words, compared to today's price of $248.91, PANW stock could be worth up to $378.34 sometime over the next year.
Analysts Estimates Are Too Low
Analysts have significantly lower estimates than my prediction. For example, Yahoo! Finance reports that the average price target of 41 analysts is just $281.80 per share. That is just 13% over today's price.
Moreover, AnaChart, a new sell-side analyst tracking service, shows that the average of 38 analysts is a 27.23% upside (up $26.56 to a price target of $275.47). However, based on AnaChart's performance scores of sell-side analysts, the best analyst on the stock took over 90 days for his price target to be reached. However, That analyst from Raymond James has just a $260 stock price target. (Note: the author has a consulting relationship with AnaChart).
The bottom line is that Palo Alto Networks is gushing huge amounts of free cash flow. Investors can expect that the stock is significantly undervalued using adj. FCF as a basis for a price target for PANW stock.
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.
