This Cybersecurity Stock Is an Easy Pick for Investors in Tumultuous 2022
As I reside in Eastern Europe, most conversations I have inevitably turn to concerns over protecting the region. A strange time to be an American abroad, indeed. But front of mind for U.S. investors right now is cybersecurity. Even the White House has spoke of the potential threat to U.S. businesses.
"The magnitude of Russia's cyber capacity is fairly consequential," President Biden warned in an address to a business roundtable in late March. "It's coming."
An FBI bulletin also alerted that Russian intelligence services are "scanning networks for vulnerabilities for use in potential future intrusions." Needless to say, businesses need to increase spending on cyber defenses both to protect national security and decrease the risk of getting major black eyes akin to the Colonial Pipeline breach or Solarwinds (SWI) hack.
Among services available are cloud-focused options like Crowdstrike (CRWD) , ZScaler (ZS) , and Okta (OKTA) as well as consumer-focused options like NortonLifelock (NLOK) and Fortinet (FTNT) . Further, major conglomerates like Amazon (AMZN) , Microsoft (MSFT) , and Cisco (CSCO) have their own subsidiaries focused on securing networks from the likely increase in intrusions.
We believe the cyber security industry led by key names such as Palo Alto, Zscaler, Crowdstrike, Sentinel One, Check Point, Palantir, CyberArk, Tenable has been on the front lines proactively guarding from Russian cyber attacks and has been very successful; bullish for sector
— Dan Ives (@DivesTech) March 18, 2022
But my top pick for the rest of 2022 -- as the year has been upended by the Russian invasion of Ukraine -- is a tried-and-true option: Palo Alto Networks (PANW) . This is a stock that combines a strong balance sheet, evident growth, and a firm focus squarely on the cybersecurity domain that has all of the hallmarks of a secular growth story.
Stay at Home Security
One of the main stories of the modern economy post-Covid is the transition to a work-at-home lifestyle. Per Pew Research, more than two thirds of American workers moved to a work from home status during the pandemic with more than half of employees indicating they wish to remain in this environment.
While this provides a focus on convenience for workers, it creates a headache for security administrators.
"Businesses' needs for comprehensive cybersecurity have significantly increased within the last year," U.K.-based IT consultancy Flint wrote in a recent report. "As confidential discussions shift from the boardroom to the kitchen, the security level of the (unified communication) solution has been exposed, with a number of IT departments suddenly realizing that they never actually managed to get around to introducing a robust security policy."
Now, the focus must turn toward companies providing enterprise services more so than those providing consumer-focused options. Further, some consumer-focused leaders are encountering headaches of their own, such as Norton's issues in advancing its blockbuster acquisition of Czech cybersecurity leader Avast (AVASF) .
"We think strong security demand should remain durable through '22 and, as a result, security stocks provide better opportunities for relative outperformance vs. broader software." Morgan Stanley analyst Hamza Fodderwala wrote in a recent note summing up the industry action.
He added that current advisories and issues in protecting key information are likely to keep corporate budgets aimed in this direction robust relative to overall software spending.
Picking Palo Alto
Given the many options in the sector, there are choices to make for investors.
Crowdstrike, Zscaler, and Okta are not investments to eschew. No doubt, they will each benefit from these broader trends. But there is an issue in terms of valuing these options, as each has pushed toward the high-end of expected earnings growth.
"I view (Palo Alto) as a table pounder," Wedbush analyst Dan Ives said in a recent interview with CNBC. "I look at Palo as being front and center ... it is one that, based upon their cash flow, growth, and installed base, checks every box."
Looking into the numbers, Ives' enthusiastic review is understandable. The company reported that operating income grew 20% and adjusted free cash flow grew 33% in the last quarter. Further, free cash flow grew to $441 million on a margin of 33.5%. Clearly, there is a disciple in pushing profitability that the rest of the industry has historically struggled with.
"We believe it is important to hold ourselves to this discipline even when growth is robust in order to drive a best-in-class financial model as we scale into a larger company," CEO Nikesh Arora told analysts in the most recent earnings call, underlining this company focus.
Many analysts, including RBC Capital analyst Matthew Hedberg, raised price targets following Arora's presentation.
"Palo Alto delivered another strong quarter with broad-based outperformance highlighted by 70% next-gen [annual recurring revenue] growth and hardware sales that continue to elude supply-chain challenges as the company takes share on accelerating demand trends," Hedberg noted.
Recent reports by both Zscaler and Crowdstrike also appear strong, with each passing Real Money's own Stephen "Sarge" Guilfoyle's standards in terms of balance sheets and earnings of late. However, I doubt Sarge would argue that Palo Alto is the sturdiest of the group.
Even at a currently lofty valuation, the stock appears reasonable in light of the current secular trends and appears likely to maintain its attractive profitability metrics. For a defensive-minded name in security that likewise offers an investor significant upside, Palo Alto appears an easy top pick even at all-time highs.
Gloss