Name That Trade – $PANW – Cyber Chase

by Dan March 2, 2015 11:15 am • Commentary

Event: Palo Alto Networks (PANW) reports fiscal Q2 results after the close tonight, the options market is implying about a 7% one day move*, vs the 4 & 8 qtr average of about 6.5%.

*The March 6th weekly straddle (long the call and the put) is offered at $11.50 with stock at $143, if you bought that you would need a move above $154.50 or below $131.50 by Friday’s close to break even

Price Action / Technicals:  The stock has been one of the few network security stocks that has shown massive relative strength to other high valuation stocks in tech, up 17% in 2015, and up 150% from the 52 week lows made last May.

The uptrend since last May has been a work of art, despite the very quick mid October sell off of 17% that resulted in new 52 week highs in less than 2 weeks:

PANW 1yr chart from Bloomberg
PANW 1yr chart from Bloomberg

The recent breakout, placing the stock 43% above its 200 moving average (yellow line), may suggest the stock is just a tad overbought in the near term.  

Valuation:  The stock trades at 200x expected 2015 earnings, and 13.5x expected sales of $850 million.  There is little to say after those eye-popping multiples, aside from the fact that with the stock at all time highs, investors obviously don’t care.

Sentiment:  You know who else doesn’t care about valuation? Wall Street analysts They have 25 Buy ratings, 6 Holds and 1 Sell with an average 12 month price target of $144.  And with only 5% short interest, it seems that shorts have also given in to common sense.

Implied Vol Snap Shot: While short dated options prices are elevated into tonight’s print, I think it is safe to say that short dated vols look fair to almost cheap, well below the levels prior to the last few earnings reports:

[caption id="attachment_51499" align="aligncenter" width="600"]PANW 1yr chart of 30 day at the money IV from Bloomberg PANW 1yr chart of 30 day at the money IV from Bloomberg[/caption]

Options Open Interest: traders are not particularly active in the options of this stock. Despite having a $11.5 billion market cap, there is only 57,00 total open interest, with 26,000 puts and 31,000 calls.  The single largest strike of open interest is 3500 of the April 145 calls and 1100 of the March 145 calls.

My View: The company is at the forefront of a massive secular trend in network security and as my friend Guy Adami likes to say, “every bad hack headline is good for these guys”. And it’s true, until it’s not. It’s obviously a sentiment thing where investors have entirely disregarded common sense investing for the trend/ mania.  This is not my cup of tea, I am hard-pressed to consider who could buy these guys at premium of its current market valuation.

Just to put things in perspective, HPQ this morning paid $2.7 billion for Aruba Networks (ARUN). This is a totally different business with lower growth rates but ARUN is expected to have the same amount of sales in 2015 as PANW.  But ARUN is worth $2.7 billion on their $850 million in sales growing 18% year over year, and PANW has a $11.5 billion market value with same expected sales?  C’mon. Something has to give here especially when you consider that it’s likely that PANW sees some moderation in their sales growth.

SO WHAT TO DO?  Good luck shorting high growth / high valuation stocks that seem to be well placed in massive secular shifts (see CRM last week), but I certainly wouldn’t recommend committing new capital here.

Could the stock be up 10% on a beat and raise, sure. Is the path of least resistance up in a Nasdaq that is about to make new 15 year highs? Sure.  But trees don’t grow to the sky, and stocks that are priced to perfection have little room for error.

So for those inclined to express a bearish view into the event, we think the weeklies are the best way to go. The March 3rd 139/129 put spread at around $2.50 seems reasonable dollar wise with a 3 to 1 potential payout on the event. Of course, it’s totally binary and that 2.50 could be gone overnight, so not really a high probability outcome if you don’t get the direction correct.

Its hard for us to even consider bullish trades into the event, but we do think stock replacement / alternatives make a ton of sense here. For those that have been riding this higher it may be time to define your risk instead of hoping you’re not that last one holding the bag.

The April 150/175 call spread for $4.50 and is probably a lot better than owning the stock here and keeps a bullish stance while defining the overall risk down to just $4.50. Flies would normally be interesting but there just doesn’t seem to be great levels to the upside (or the downside for that matter) to target so out-of-the-money verticals is probably the best way to go in a stock like this with such potential to rip higher or get crushed lower.