Name That Trade – $PANW: Firewall Flower

by Dan September 4, 2015 10:56 am • Commentary

In just the last few weeks it seems that the most important change in the U.S. equity markets has been investors willingness to think more critically about once untouchable stocks.  To me, this really started in late July with Apple’s (AAPL) inability to rally after a very solid quarter and guidance, and then confirmed by Disney’s one day post earnings decline of 9% from an all time high. On many occasions on the site throughout 2015 we have highlighted what we felt was narrowing breadth and weakening internals of the market, while also shining light on stocks that seem to have an unusual amount of positive sentiment associated with them regardless of valuation. One of those stocks is Palo Alto Networks (PANW), a $13.5 billion market cap cyber-security stock that has seemingly gone higher on every data breach headline. This seems stupid. We know hacks and data breaches happen. But trying to short into the stupid at anytime over the last couple years (prior to late July) has been a costly endeavor.

Despite the stock’s 20% decline from its all time high made in July, its remains (for now) up 30% on the year.  A quick gander at the ytd chart of PANW shows what could be a very critical technical level and a nasty Triangle of Death if it were to breakdown below the late May breakout level:

PANW ytd chart from Bloomberg
PANW ytd chart from Bloomberg

Oh baby, on a two year basis, $120 looks like a reasonable target on the slightest fundamental hiccup:

PANW 2yr chart from Bloomberg
PANW 2yr chart from Bloomberg


Event: When could that fundamental hiccup come?? Well, they are scheduled to report fiscal Q2 results on Wednesday Sept 9th after the close.  The options  market is implying about a 8.5% move between now and next Friday, most of that being the event move.  The average one day earnings move over the last 4 qtrs has been about 5.5%, while the 8 qtr average has been about 5.2%.  It’s important to note that the last 8 post earnings day moves have been higher.  

Volatility Snapshot:  Short dated options prices have seen a massive spike of late, but importantly still well below the levels from the spring of 2014, the last time the stock declined more than 20%:

[caption id="attachment_56648" align="aligncenter" width="600"]PANW 2yr chart of 30 day at the money Implied vol from Bloomberg PANW 2yr chart of 30 day at the money Implied vol from Bloomberg[/caption]

Our View: already down 20% in the last couple months, the stock still has little valuation support, trading at 100x fiscal 2016 expected earnings, and 11x expected sales, which are expected to grow 35% year over year.  The keyword is expected.  If forward guidance were to show a material deceleration in growth then the stock will definitely be re-rated in this environment.  A modest beat and raise is likely a sell the news event, while a meaningful beat and raise could cause a multi-day rally back to the recent $180 breakdown level.

So what’s so special about PANW??  To be fair, the company is a leading vendor in one of the largest secular movements in infrastructure software in decades.  The company’s brisk growth has been rewarded with an eye-popping valuation, and is often thrown around as a take-over candidate by the likes of CSCO, IBM, HPQ or ORCL.

Pressing the recent weakness could be dangerous into an event that has proven to be a positive catalyst for two years, but a negative reaction to just ok news on next week’s call could signal a sort of sea change for another segment of once loved stocks.

We will be sure to circle back with some trade ideas prior to Wednesday’s results.