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Palo Alto Networks (PANW) delivered adj. free cash flow results yesterday for its fiscal year ending July 31, 2024. It produced $3.12 billion in adj. free cash flow (FCF), which represents a very high 38.9% FCF margin (i.e., FCF/revenue). That bodes very well for PANW stock going forward, despite the recent rise in its shares
PANW is up over 8.6% today at $373 per share. Based on analysts' revenue forecasts for the next two years and Palo Alto's own FCF margin projection, PANW stock could be worth 20% more at over $448 per share.
I wrote in a June 24 Barchart article that it would be worth $365.80 per share: “Palo Alto Networks Stock Still Looks Cheap to Analysts - Shorting OTM Puts Makes Sense Here.” I am now raising the price target based on its strong fiscal Q4 results and management guidance.
High FCF Margins and Strong Guidance
This cybersecurity technology company reported that its revenue rose 12% YoY and, more importantly, its adjusted FCF hit $3.12 billion. That can be seen on page 5 of its quarterly presentation. That represents a very high 17% growth in the past year in its adj. FCF and the FCF margin rose as well by 10 basis points to 38.9%.
This was directly in line with the company's prior guidance that it would generate between 38.5% and 39% FCF margins in its prior Q3 quarterly earnings release. In other words, management has a lot of credibility here and we can expect their guidance going forward will be honest.
For example, management said it expects for the next year that its revenue should rise between 13% and 14%, from $8.028 billion this year to between $9.1 billion and $9.15 billion. Moreover, the company said its adj. FCF margin will stay strong at between 37% and 38%.
In other words, management is forecasting adj. FCF of about $3.42 billion using the midpoints (i.e., 37.5% x $9.125 b). That would be 9.6% higher than this past fiscal year ($3.12 billion). But using sell-side analysts' projections, we can expect even higher FCF. That could lead to further upside in PANW stock in the long term.
Setting a Target Price
For example, Seeking Alpha reports that 44 analysts project $9.14 billion in sales this coming fiscal year ending July 2025 and $10.58 billion for the next year. That means that sometime in the next 12 months (NTM) Palo Alto Networks will be on a run rate to produce an average of $9.86 billion in sales - almost $10 billion, or 20% more than last year.
Moreover, using the company's own 38% adj. FCF margin estimate, which could mean it will generate $3.75 billion in adj. free cash flow (i.e., 0.38 x $9.86b). That is also 20% more than its present $3.12 billion in trailing 12-month (TTM) FCF.
The point is that the market may have to adjust its valuation some time in the next 12 months (NTM) as it realizes that these high FCF estimates are expected to occur.
For example, right now the stock is trading on an FCF yield of 2.6% (i.e., $3.12 billion/$120.25 billion market capitalization). If this improves to 2.5% (especially given the company's higher buybacks also announced yesterday), that could result in a market value of $150 billion (i.e., $3.75 billion in NTM forecasts adj. FCF / 0.25 = $150b).
This is over 24.7% higher than today's stock market value of $120.25 billion. But just to keep it conservative, let's use a 2.6% FCF yield estimate. So, dividing $3.75 billion by 2.6% results in a market cap of $144 billion, or 19.94% higher (i.e., +20%).
That is how I reached the price target of $448 per share (i.e., 1.20 x $373 = 447.60. Keep in mind this is a projection for the next 12 months (NTM). It could very well dip between now and when that price target is hit.
How to Play This
So, play this conservatively. One way to do this is to sell short out-of-the-money (OTM) put options in nearby expiry periods. I have discussed this kind of play in numerous other articles.
For example, the $340 strike price put options for the Sept. 20 expiry period trades for $2.28 per contract on the bid side. That represents an immediate yield of 0.67% for the short seller over the next 31 days.
This strike price is well below today's spot price, i.e., over 8% out-of-the-money. That means that there is good downside protection for the short seller. The worst that can happen to them is that they have to buy 100 shares per contract shorted at the strike price - assuming PANW stock falls to $340 on or before Sept. 20.
That might now be such a bad thing if the investor expects to see a price target of $448 per share over the next 12 months (NTM). Moreover, for existing investors who already own PANW shares, it is a way to generate extra income. They will have to secure additional capital with their brokerage firm to do this play, however.
Nevertheless, Palo Alto Networks stock looks like a good bet here for the NTM period based on analysts' forecasts and management guidance.
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.
