Palo Alto Networks Stock Fair Value at $375: Morningstar Research

Jimmy Peterson 21 November 2024

Morningstar has updated its valuation of Palo Alto Networks Incorporated, a leader in the cybersecurity sector, setting a fair value estimate of $375 per share, slightly below the current market price of $392.89. This reflects the company’s robust performance, driven by platform-based solutions and strong recurring revenues, but acknowledges high valuation concerns. Morningstar assigns a "Hold" rating, suggesting limited upside at current levels, with a focus on Palo Alto's exemplary capital allocation and wide economic moat.

Summary

Palo Alto Networks has demonstrated impressive growth, with its first-quarter FY2025 revenue rising by 14% year-over-year to $2.14 billion. The company continues to leverage its platformization strategy, recording a 40% increase in annual recurring revenue (ARR) from next-generation security solutions. Despite strong operational metrics, the stock trades at a 5% premium to its fair value. Morningstar underscores the firm's strategic investments, high-margin opportunities, and industry leadership while maintaining caution over valuation concerns. A two-for-one stock split scheduled for December 2024 adds further intrigue for investors.

Key Financial Highlights

Revenue Growth:

Total revenue grew 14% YoY, reaching $2.14 billion in Q1FY25.
ARR from next-generation security platforms increased 40% to $4.52 billion, with over 53% of the firm's ARR driven by high-value platformization customers.
Margin Expansion:

Adjusted operating margins improved by 60 basis points to 28.8%.
The firm has achieved significant operating leverage, with larger clients contributing to higher average customer spending.
Profitability:

Net income continues to improve, driven by reduced vendor sprawl and increased demand for holistic security platforms.

Platformization Strategy: Driving Growth and Stickiness

Palo Alto Networks has successfully executed its platformization strategy, which focuses on consolidating security needs into a unified solution. Notable achievements include:

A 48% YoY growth in ARR from customers spending over $1 million annually on a single platform.
Completion of 1,100 platforms in total, with 70 added in Q1FY25.
A significant increase in $5 million accounts (+30% YoY), signaling strong client retention and high-value relationships.
This approach reduces vendor sprawl, enhances customer loyalty, and positions Palo Alto as a one-stop solution provider in the cybersecurity space.

Economic Moat: Wide and Growing

Morningstar attributes a wide economic moat to Palo Alto, driven by:

High Switching Costs: Clients face significant barriers to switching vendors due to integration complexities and retraining requirements.
Network Effects: Increased data flow enhances the firm's AI-driven threat detection, making its solutions indispensable for enterprises.
Market Leadership: Over 75% of Global 2000 companies use Palo Alto's platforms.
The firm's three key platforms—Strata (network security), Prisma (cloud security), and Cortex (security operations)—cater to evolving enterprise needs, ensuring its dominance in the industry.

Valuation and Investor Outlook

Morningstar's fair value estimate of $375 reflects:

A 2025 EV/sales multiple of 14x.
Projected revenue CAGR of 18% over the next five years.
Gross margin expansion to the low-80% range due to higher software contributions.
At a Price/Fair Value (P/FVE) ratio of 1.05, the stock is deemed slightly overvalued. The company’s strong fundamentals, however, suggest sustained long-term returns.