Event: Palo Alto Networks (PANW) reports fiscal Q3 results tonight after the close. The options market is implying about a 5% one day move vs the 4 qtr average of about 6%. Last quarter reported in early March, the implied move was about 7% and the stock only rallied 2%, closing at a then new all time high.
Sentiment: Wall Street analysts are overwhelmingly bullish with 28 Buy ratings, 7 Holds and only 1 Sell with an average 12 month price target of $166. And with only 6% short interest, it seems that shorts have also given in to common sense.
Price Action / Technicals: Since early March PANW has made two new all time highs, and is now up 32% in 2015!
The two year chart below shows the steepness of the stock’s rise, with the stock breaking below the trend channel just once, and now up 180% from the 2014 lows made in March:
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PANW 2yr chart from Bloomberg[/caption]
Valuation: The stock trades at 207x expected 2015 earnings, and 15x expected sales of $880 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.
Implied Vol Snap Shot: While short dated options prices are elevated into tonight’s print, they are well below the levels prior to the last few earnings reports (green):
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PANW 1yr chart of 30 day at the money IV from Bloomberg[/caption]
The 5% implied move, below last quarter’s 7% implied move shows a greater level of complacency, despite the stock gaining more than 10% since the Q2 print. The 2% one day move last quarter has caused options traders to remain a bit more vigilant than in quarters past.
My View: The company is at the forefront of a massive secular trend in network security and the sector could be one of the most talked above targets in what is heating up to be an active tech m&a environment. PANW is best of breed and likely tops on many potential acquirers lists, if it weren’t for the company’s ever increasing market cap, now north of $13 billion.
Investors have entirely disregarded common sense investing for the trend/ mania in the case of cyber-security stocks. I am hard-pressed to consider who could buy this company at premium of its current market valuation. Will Cisco’s (CSCO) new CEO make such a bold move right out of the gate?? I think not, despite what has been some hints to their interest to make a larger push in the space.
SO WHAT TO DO? Good luck shorting high growth / high valuation stocks that seem to be well placed in massive secular shifts), 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.
If the stock does get hit it’s likely that it returns to its 50 day moving average (see 1yr chart below) which currently stands at about $149. To play for that move (and perhaps works as a hedge against long stock) is to buy a put spread targeting that potential move. The May29th weekly 160/149 put spread can be had for around $3 and could provide some peace of mind for those long stock into the event. As an outright bearish bet the May29th weekly 160/149/138 put fly for around 2.60 could make sense. The only risk of that is a large move lower which would be annoying so perhaps the put spread is better on that.
Stock alternatives/replacements could be the way to go to define the risk on a longer term bullish view. The July 160/180/200 call fly is about 5.70 and is almost 2 dollars in the money. With that strategy you are defining your risk to 5.70 but can participate like stock between 165.70 up to 180. Profits would trail off above but a gap on earnings through that level seems unlikely.
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PANW 1yr chart from Bloomber[/caption]