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Palo Alto Networks: Expect a Wild Ride in Fiscal Year 2020

Nicholas Rossolillo, The Motley Fool

A lot of upstarts have been gunning for Palo Alto Networks (NYSE: PANW). It's not that Palo Alto is a bad business, but the fast rise of first cloud and now edge computing has opened the door to disruption as security needs evolve and change the narrative around what is considered safe. The largest pure play on cybersecurity services has thus been losing steam and been forced to play catch-up by way of acquisition.

The stock has been all over the place this year as a result, and that was on glorious display during the company's fiscal 2019 fourth quarter. Light guidance was initially met with displeasure, and shares tanked double digits after hours, only to reverse all of those losses and end the day in the black. With Palo Alto's transition to the cloud still unfolding, more turbulence is my only forecast.

An illustrated shield displayed over numbers, illustrating data cybersecurity.

Image source: Getty Images.

2019 wasn't so shabby

Palo Alto topped its own guidance for the fourth quarter (the three months ended July 31, 2019). Revenue increased 22% year over year -- management had provided an outlook for 20% to 21% -- to $806 million, and billings during the quarter topped $1 billion for the first time. Adjusted earnings were $1.47 per share, also topping guidance for $1.41. So we're off to a good start.

However, just one quarter doesn't tell a story. The 22% growth in revenue is great, especially for a company the size of Palo Alto Networks, but it's a steep slowdown from the recent past. In fact, the full-year top-line growth figure ended up at 28%, so the fourth quarter was a drag on overall results. Plus, in light of industry change -- as well as Palo Alto's own aggressive acquisition spree in the last year -- earnings guidance for the new 2020 fiscal year was soft. Adjusted earnings are expected to be $5.00 to $5.10, down from the full-year total just posted.

Metric

12 Months Ended July 31, 2019

12 Months Ended July 31, 2018

Change

Revenue

$2.90 billion

$2.27 billion

28%

Gross profit margin

72.1%

71.6%

0.5 pp

Operating expenses

$2.15 billion

$1.73 billion

24%

Earnings (loss) per share

($0.87)

($1.33)

N/A

Adjusted earnings per share

$5.45

$4.20

30%

Data source: Palo Alto Networks, pp = percentage point.

CEO Nikesh Arora did say he thinks billings can average at least 20% growth over the next three years and revenue at least 20% for the next two. However, for full fiscal year 2020, guidance for billings called for an increase of 17% to 19% and for revenue to be up 19% to 20%. Clearly, Palo Alto Networks' next-gen cloud offerings are going to take some time to bear fruit, and another cool-off is expected in the short term. The good news, though, was that free cash flow (revenue less cash operating and capital expenses) margin should be about 30% in the year ahead. That's a lot of new cash headed for the balance sheet.

Another quarter, another acquisition, another slowdown

That cash will be an important factor in keeping Palo Alto Networks' smaller rivals at bay. Acquisitions were key in helping the company build out its cloud security platforms Prisma and Cortex, and adding other "bolt-on" services via purchase will continue to be the strategy.

The cloud is a complex thing. There's the data center -- or, for many companies, many data centers handling various tasks -- that must be secured. Then, there are all of the devices out there using the cloud, from computers at the office to employee devices like laptops and smartphones to IoT devices sending and receiving automated information. And finally, there's the space in between, when data is in transit from source to endpoint and back again, that needs protection. Sound like a mess? It is, and Palo Alto Networks believes there isn't a single offering out there that can cover all the bases.

That's why it has been making acquisitions, an attempt to be a type of one-stop shop for enterprises. In its current form, the cybersecurity industry has hundreds of vendors out there, and many large organizations patch together many of them to get the protection they need. To that end, another purchase was announced: Zingbox, an IoT security outfit, for $75 million. These small takeovers have become a nearly quarterly event, and it's likely to continue for a while.

Thus the forecasted slump in adjusted earnings in 2020. It's a slugfest in the crowded cybersecurity industry right now, and Palo Alto celebrated recently displacing Zscaler and Fortinet for a major European healthcare provider contract. No doubt some reshuffling has gone against Palo Alto as well. However, the company has ample resources to fund its own transformation and growth. Though the bottom line will be taking a hit in the short term, there's no reason to believe the long-term growth story is over yet for this stock.

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Nicholas Rossolillo owns shares of Fortinet, Palo Alto Networks, and Zscaler, Inc. The Motley Fool owns shares of and recommends Palo Alto Networks and Zscaler, Inc. The Motley Fool recommends Fortinet. The Motley Fool has a disclosure policy.

This article was originally published on Fool.com