Palo Alto Networks (NASDAQ:PANW), a prominent cybersecurity solutions provider, revealed remarkable financial results for its fiscal Q4 on Friday, August 18th. The company’s substantial surge in free cash flow (FCF) and impressive FCF margins garnered considerable attention from the financial markets. As a direct consequence, the value of PANW stock experienced a notable upswing, soaring by nearly 15% during the early trading session on Monday, August 21st, reaching $241.00.

Yet, the potential for further stock price escalation appears promising. This optimistic outlook is rooted not only in the remarkable 38% growth observed in fiscal Q4 (which concluded on July 31st), as characterized by its robust adjusted FCF figures but also in the company’s remarkably high FCF margins, calculated as FCF divided by revenue.

Rapid Expansion of FCF and Margin Figures

A prime illustration lies in the fiscal year that concluded in July, during which FCF margins impressively escalated to 39%, coinciding with a 25.2% YoY increase in revenue, totaling $6.89 billion. This FCF margin significantly outperformed the 33% adjusted FCF margin registered the previous year. This information can be verified on page 18 of the fiscal 2023 slide presentation.

Additionally, the company’s guidance to analysts indicates an anticipation of maintaining margins within the range of 37% to 38% for the upcoming year. Coupled with the heightened revenue forecasts provided by analysts, this projection signals the likelihood of sustained FCF expansion.

For instance, a survey conducted by Seeking Alpha, involving 28 analysts, predicts revenue of $8.18 billion for the fiscal year ending on July 31, 2024. This projection reflects an 18.7% increase in comparison to the $6.89 billion revenue recorded in fiscal 2023. Calculations based on a 38% FCF margin suggest that the adjusted free cash flow for the following year could potentially reach $3.1 billion, signifying a substantial 16.4% rise compared to the $2.67 billion adjusted FCF achieved during fiscal 2023.

Utilizing these figures to set a price target for PANW stock, even considering its recent upsurge, becomes feasible. The methodology is detailed below.

Setting a Target for PANW Stock Price

Employing a 3% FCF yield metric yields an insightful perspective: Palo Alto Networks possesses the potential for a market capitalization exceeding $100 billion. By dividing the estimated $3.1 billion in adjusted FCF by 3.0%, an estimated target market capitalization of $103.3 billion is derived.

This calculation corresponds to a multiple of 33x the adjusted FCF (since the reciprocal of 3% is 33x, as 1/.03 ≈ 33.3). Consequently, 33.3 multiplied by $3.1 billion equates to $103.3 billion.

Comparing this target market cap to the current market capitalization of $80.8 billion (based on 335 million shares outstanding) yields a notable increase of 27.8%. In practical terms, this implies that PANW stock has the potential to climb to $308 per share, a considerable 27.8% higher than the present value of $241.00.

A Strategy Involving Shorting OTM Put Options

For those inclined towards a conservative investment approach, an option is to engage in shorting OTM put options. This strategy enables investors to secure added income while potentially mitigating their entry costs.

For instance, considering the period until September 8th, PANW puts with a strike price of $240 (5% below the current price) are trading at $2.82 per put contract. These elevated put option premiums present an attractive shorting opportunity.

Taking this scenario into account, the short-sale maneuver offers an immediate yield of 1.23% for those shorting PANW puts at the specified strike price.

Here’s a practical illustration: An investor who allocates $23,000 through their brokerage firm can proceed to “Sell to Open” 1 put contract with the $230 strike price, set to expire on September 8th. As a result, the account promptly receives $280, which corresponds to a yield of 1.23% based on the initial $23,000 investment.

From this juncture, the short-put trader must monitor the performance of PANW stock to ensure that it remains above $230.00 per share until September 8th, a span of 18 days. Furthermore, even in the event of a stock decline, the investor maintains a breakeven price of $227.20 ($230 strike price – $2.80 premium received).

This essentially implies that the breakeven point is positioned 5.72% below the present price. This advantageous scenario emerges because the investor retains the $2.80 premium even if the stock dips to $230.00.

In the event that the stock does descend to $230.00, exercising the puts confers the opportunity to procure 100 shares of PANW stock at a lower cost compared to the present value. Subsequently, the investor can engage in the sale of out-of-the-money calls utilizing these shares, a strategy known as a covered call sale.

This analysis underscores the potential for significant upward movement in PANW stock. One prudent strategy to navigate this opportunity is by selling short out-of-the-money puts.

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