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April 15, 2024
Palo Alto Networks, Inc. (NASDAQ:PANW) Shares Could Be 23% Below Their Intrinsic Value Estimate
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Palo Alto Networks, Inc. (NASDAQ:PANW) Shares Could Be 23% Below Their Intrinsic Value Estimate

Mar 20, 2024


Key Insights

  • Palo Alto Networks’ estimated fair value is US$395 based on 2 Stage Free Cash Flow to Equity

  • Palo Alto Networks’ US$303 share price signals that it might be 23% undervalued

  • Our fair value estimate is 18% higher than Palo Alto Networks’ analyst price target of US$334

Does the February share price for Palo Alto Networks, Inc. (NASDAQ:PANW) reflect what it’s really worth? Today, we will estimate the stock’s intrinsic value by projecting its future cash flows and then discounting them to today’s value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. Don’t get put off by the jargon, the math behind it is actually quite straightforward.

We generally believe that a company’s value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

Check out our latest analysis for Palo Alto Networks

What’s The Estimated Valuation?

We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company’s cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. To start off with, we need to estimate the next ten years of cash flows. Where possible we use analyst estimates, but when these aren’t available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, so we need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) forecast

2024

2025

2026

2027

2028

2029

2030

2031

2032

2033

Levered FCF ($, Millions)

US$3.07b

US$3.51b

US$4.12b

US$4.80b

US$5.64b

US$6.27b

US$6.80b

US$7.25b

US$7.63b

US$7.97b

Growth Rate Estimate Source

Analyst x27

Analyst x26

Analyst x19

Analyst x1

Analyst x1

Est @ 11.09%

Est @ 8.45%

Est @ 6.60%

Est @ 5.31%

Est @ 4.40%

Present Value ($, Millions) Discounted @ 6.9%

US$2.9k

US$3.1k

US$3.4k

US$3.7k

US$4.0k

US$4.2k

US$4.3k

US$4.2k

US$4.2k

US$4.1k

(“Est” = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$38b

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 2.3%. We discount the terminal cash flows to today’s value at a cost of equity of 6.9%.

Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = US$8.0b× (1 + 2.3%) ÷ (6.9%– 2.3%) = US$175b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$175b÷ ( 1 + 6.9%)10= US$90b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is US$128b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of US$303, the company appears a touch undervalued at a 23% discount to where the stock price trades currently. Valuations are imprecise instruments though, rather like a telescope – move a few degrees and end up in a different galaxy. Do keep this in mind.

dcf

dcf

Important Assumptions

We would point out that the most important inputs to a discounted cash flow are the discount rate and of course the actual cash flows. If you don’t agree with these result, have a go at the calculation yourself and play with the assumptions. The DCF also does not consider the possible cyclicality of an industry, or a company’s future capital requirements, so it does not give a full picture of a company’s potential performance. Given that we are looking at Palo Alto Networks as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighted average cost of capital, WACC) which accounts for debt. In this calculation we’ve used 6.9%, which is based on a levered beta of 1.011. Beta is a measure of a stock’s volatility, compared to the market as a whole. We get our beta from the industry average beta of globally comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.

SWOT Analysis for Palo Alto Networks

Strength

Weakness

Opportunity

Threat

Moving On:

Although the valuation of a company is important, it is only one of many factors that you need to assess for a company. The DCF model is not a perfect stock valuation tool. Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. Can we work out why the company is trading at a discount to intrinsic value? For Palo Alto Networks, there are three additional elements you should further examine:

  1. Risks: Consider for instance, the ever-present spectre of investment risk. We’ve identified 2 warning signs with Palo Alto Networks (at least 1 which is significant) , and understanding them should be part of your investment process.

  2. Management:Have insiders been ramping up their shares to take advantage of the market’s sentiment for PANW’s future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.

  3. Other High Quality Alternatives: Do you like a good all-rounder? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!

PS. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the NASDAQGS every day. If you want to find the calculation for other stocks just search here.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.



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