Palo Alto Networks Earnings Preview: Can PANW Keep Riding the AI Security Boom Into September?

Palo Alto Networks proved its Q3 revenue of $3.00B was +31% YoY and beat consensus of $2.94B. However, the metrics that are truly important are ARR and RPO. Next Generation Security ARR reached $8.1B, and RPO increased to $18.4 billion. Approximately 1000 companies have reached out to Palo Alto for AI related security, thus a fundamental and structural shift in cyber security has begun.

There is a clear problem: generative AI and autonomous agents will ​create new attack surfaces faster than traditional security. Employees send data to AI apps. Developers connect LLMs to internal databases. Autonomous agents take unsupervised actions. 

Now organizations have to secure prompts, models, training data, and machine-to-machine permissions along with traditional concerns of securing users and endpoints. Prisma AIRS and the August product update, with the integration of Anthropic Inference Hooks for Claude governance, specifically target this problem.

A note on the headline NGS ARR growth rate of +60% includes the combined contribution of CyberArk and Chronosphere for $1.6B. Organic NGS ARR growth for the rest of the business was close to $6.5B for an increase of 28%. That organic growth at the Palo Alto scale of 28% is strong and demonstrates that the company can grow its core business without having to do M&A.

AI agents create a more significant derivative of risk where control and privileged access of environments and data will become increasingly important. CyberArk at $25B (February close) and Chronosphere at $2.6B add identity security and cloud native observability, respectively. The two combined $388M of Q3 revenue and $1.8B in RPO.

Even with considerable acquisition spending, Palo Alto achieved $910M adjusted FCF in Q3 (a $332M increase over the previous year), with the trailing-12-month adjusted FCF margin growing 430 basis points to 38.5%. The company's target is for 40% FCF margin by FY2028. This strong growth of cash coupled with the acquisitions they have completed allows for funding their acquisitions without impacting their balance sheet.

After Q3 reporting, Palo Alto increased their full-year 2022 guidance to $11.415-11.425B revenue growth (+24%) and $3.77-3.79 adjusted EPS (versus previous $11.28-11.31B and $3.65-3.70). This represents strong growth in revenue and EPS. Previously, the outlook for 2022 looked like growth in revenue would potentially be at the expense of profitability.

On August 6, the Chinese Cybersecurity Administration began a security review on Palo Alto Networks’ products. China isn’t a big reported revenue segment for PANW, but there was a similar review on Micron products that had the company’s products restricted from building critical national infrastructure in China. This should be monitored, especially as U.S.-China tensions continue to escalate.

PANW currently trades around $384.26 and has pulled back slightly from its resistance levels around $396.80. RSI is around 57 and has pulled back slightly from overbought levels, showing that some momentum is beginning to level off. $380.13-382.70 is the short term support level. 

Palo Alto Price Chart - Source: Tradingview

Keep an eye on $380 support, as if that holds then $396.80 is still in play. A break above that would set the price goal at around $406.63-$418.16-$427.14.

What Matters at September 1 Earnings

• Q4 Revenue:  $3.345-3.355B target
• NGS ARR:  $8.9-8.95B target
• RPO:  $20.9-21.0B target
• Organic Growth:  Evidence that core portfolio drives growth, not just M&A
• Free Cash Flow:  Sustaining ~40% adjusted FCF margin
• FY2027 Guidance:  Will likely matter more than Q4 beat/miss

Palo Alto has put together a strong Q3 with reported revenue growth of 31% and 60% NGS ARR growth and 36% growth in RPO, with organic ARR growth of 28%. Free cash flow is strong at 38.5% adjusted FCF margin. The company is also seeing good progress in integrating its product with CyberArk.

Risks: The China review will create some uncertainty, organic growth being lower than reported is always a concern, an elevated valuation, which assumes the company executes at a high level, and Jackson Hole will give the first indication of spending for the rest of the year in a few weeks.

Technically $384 for PANW in an ascending channel, $380 as critical support, $396.80 as the target for a breakout. September 1 earnings will show if AI security has warranted the premium, or if the integration has created a risk for investors to be cautious about. This is analysis; it is not an investment recommendation.