What This Tech Company's Results Mean for its Sector
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Investors in the IT security sector had a right to approach the upcoming results of company Palo Alto Networks (NYSE: PANW) with a certain amount of trepidation. Competitors have been downgrading expectations and enterprise spending in technology has been weaker as the year has gone by. However, Palo Alto delivered a solid set of results and guidance, and despite the market response (which initially looks to be negative) this should not reflect on the operational performance of the company. Whether the stock is good value or not is another question.
Palo Alto Delivers Good Results
Palo Alto’s place within the security market is as a fast growing company that is accelerating sales growth primarily via displacing incumbent security providers. As such, we should expect it to have lower margins and cash flow conversion than the established players but much faster growth. The company makes a play over its quality differentiation allowing it to carry a pricing premium. This may well be true, but as it matures it may well find it harder to sell on this basis. Not all customers will be focused on quality, and its primary firewall competitors, like Check Point Software (NASDAQ: CHKP), Juniper Networks (NYSE: JNPR) and Cisco Systems (NASDAQ: CSCO), are highly cash generative and capable of upgrading their offerings in the future.
No matter, Palo Alto is firing on all cylinders at the moment and none can match its growth prospects. A brief summary of its results.
- Q1 Revenues of $85.9 million vs. estimates of $83.8 million
- Q1 EPS of 4c vs. estimates of 3c
- Q2 Revenue Guidance of $90-94 million vs. estimates of $90.8 million
- Q2 EPS Guidance of 4c vs. estimates of 4c
So it’s a ‘beat’ and the guidance looks pretty good relative to market estimates. This is a key point because its rivals have been downgrading expectations and new entrants like F5 Networks (NASDAQ: FFIV) have been aggressive about their prospects in data center security.
Moreover the commentary around the results was positive with management claiming that 50% of its new sales were for primary firewalls (this tends to increase the lifetime value of a client as it implies higher recurring revenues and retention ratios). In addition, they scored a host of major wins against Check Point (with a major telco), Juniper and Cisco (a leading European broadcaster) and a number of US data center security solutions from Cisco.
It wasn’t quite a Larry Ellison style alpha male conference call, but not far from it. Although he would, no doubt, be impressed by the hiring of F5 Networks' former global head of sales. He will no doubt bring a plethora of enterprise and data center contacts with him, and investors should take Palo Alto seriously when its management outlines that F5’s data center security solutions are not really competing with the larger part of Palo Alto’s business.
But what of the rest?
What is the Industry Saying?
Essentially Check Point had lowered guidance and analysts saw some weakness on account of its slowing product sales growth. In reality, this is partially due to its progress in bundling software sales within overall sales. Check Point’s overall revenue growth is in the high single digits but no matter, the market hates slowing product growth because it implies slowing future software sales.
Alongside this, Cisco had earlier seen its security revenues growing at a slower pace. In other words, the market was set up for a possible disappointment with Palo Alto. It didn’t come.
Palo Alto is a much younger company and there are no such growth problems here, although it did disclose some more aggressive pricing competition in the quarter. Management also claimed to have high win rates across all its major competitors (Juniper, Cisco and Check Point) without being drawn on any specific strength against any particular incumbent.
Furthermore, deferred revenues are growing faster than top line revenues (86% vs. 50% year on year), and free cash flow is now at over 20% of revenues.
Where Next for Palo Alto?
In conclusion, this is a pretty good set of results from Palo Alto. The market’s immediate reaction is probably more about investors who were lined up to try to take advantage of a market pop and then sell out. It’s the sort of thing that happens with highly rated stocks.
From my perspective as a growth at reasonable price (GARP) investor, I am not interested in Palo Alto; but I am interested in the IT security center and this reads like pretty good news to me. Palo Alto is affirming that conditions remain good, and I think the sector is well worth looking at now.
SaintGermain has positions in Check Point Software and Fortinet. The Motley Fool owns shares of Check Point Software Technologies and F5 Networks. Motley Fool newsletter services recommend Check Point Software Technologies and F5 Networks. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!