Palo Alto Earnings: We See Continued Traction on Platformization

Key Morningstar Metrics for Palo Alto Networks

• Fair Value Estimate: $225.00
• Morningstar Rating: ★★★★
• Morningstar Economic Moat Rating: Wide
• Morningstar Uncertainty Rating: High

What We Thought of Palo Alto Networks’ Earnings

Palo Alto Networks PANW reported strong second-quarter results, with sales growing 15% year over year to $2.6 billion and adjusted operating margins expanding 190 basis points to at 30%. The firm’s next-generation annual recurring revenue grew 33%, with 4 points of inorganic growth.

Why it matters: Palo Alto’s consolidation efforts within cybersecurity are clearly gaining traction. The firm’s multi-platform product lineup spans network, cloud, security operations, identity, artificial intelligence, and observability, and aligns well with customers seeking to consolidate spending with fewer vendors.

• We saw further proof points in the quarter that Palo Alto’s platformization strategy is working. The firm did 110 net new platformizations this quarter, up from 60 last quarter and 75 a year ago. Further, the net retention for platformized customers was an impressive 119%.
• On AI, we are also seeing strong adoption of the firm’s AI-adjacent solutions, with the customer count for XSIAM, the firm’s automated security operations solution, up more than 200% year over year, and the number of runtime security customers up more than 200% sequentially.

The bottom line: We maintain our $225 fair value estimate for wide-moat Palo Alto and continue to view the shares as materially undervalued. We see the recent selloff in Palo Alto shares as unwarranted and continue to view the firm and its security broadly as clear beneficiaries of AI.

• Our view on AI is informed by the new threat vectors unlocked by AI that map onto new product categories for platforms such as Palo Alto. We believe the only way to secure against malicious AI-enabled actors is to leverage AI-enabled security tools, further driving demand for security.
• We think the market is inaccurately extending the competitive threat faced by SaaS companies in the application layer to security firms, which have higher switching costs, proprietary telemetry data, and a risk-reward profile skewed in a way to minimize churn.