NSE4_FGT-7.0 Exam plan - Fortinet NSE 40 - FortiOS 7.0 Updated: 2023

Last month I recommended buying CrowdStrike (CRWD), highlighting how important cybersecurity had become in a world likely to be engulfed by AI (Artificial Intelligence) over the next decade. That, while AI would make businesses smarter and more productive, it would also become them more vulnerable to cybersecurity threats. Cybersecurity is a growing industry and I own several stocks in it with a keen eye to add more, making it my second largest investing sector after semiconductors. Fortinet (NASDAQ:FTNT) is a fairly mature player, founded in 2000 and is one of the largest with $5.5Bn in revenues, with closest competitor Palo Alto Networks (PANW) having $6.9Bn.

I've been accumulating Fortinet between $56 and $58 and plan to keep adding on declines, believing it to be the best bargain in cybersecurity. While it doesn't have the blistering growth of CrowdStrike or Zscaler (ZS), it is my best GARP, (Growth at a Reasonable Price) stock right now.

The Bull Case

GARP - Growth at a Reasonable Price

While Fortinet grew sales by 29% in 1H of 2023, management guided to weaker revenue growth in 2H of 2023, for full year sales between $5.35 to $5.45Bn.

The stock sank from $76 to $57 on August 4th 2023, after Q2-2023 earnings, a complete over reaction to a stellar company facing indigestion after three years of heady growth, creating an opportunity to buy at what I believe is a very reasonable price. Factoring in lower estimates of 18% and 17% revenue growth for Q3 and Q4, I expect Fortinet to grow 22% for the full year. Going forward, based on my estimates below, I expect a 3 year sales CAGR of 19% through 2026, still excellent growth by most standards, but a far cry from the 28% CAGR of the last three years.

Fortinet's excellent financials below indicate a fantastic bargain and the 25% drop from after weaker guidance has opened up a huge window of opportunity.

Fortinet is priced at 7X 2024 sales, which comes down to 5X by 2026. In the past three years with 28% revenue growth, earnings had grown faster at 33%. I expect operating leverage to continue and earnings should grow faster than revenues at 22% in the next three years. At 34X 2024 diluted earnings of $1.64, the PEG is very reasonable at 1.2, plummeting below 1 by 2026. Fortinet also has excellent GAAP gross margins of 75-76% and operating margins of 22%.

As we can see below, Fortinet had strong growth during and after the pandemic, with revenues growing from $2.6Bn in 2020 to an estimated $5.41Bn in 2023 - a CAGR of 28%! The margins too were impressive with a high gross margin of 78% in 2020, before dipping slightly to an estimated 76% in 2023. With strong margins, Fortinet grew earnings and operating profits even faster at 33% indicating excellent operating leverage. These are GAAP numbers, which make the showing even more impressive.

Forecasting the next three years, I do expect slower growth of 19% for the top line and 22% for earnings, earnings again growing faster. Management did provide conservative estimates through 2023, and I do believe that the next three years will be slower as growth starts resuming in Q1 to Q2 2024. But importantly, Fortinet at $57 is also 31% lower than its 52 week high of $81, which makes it an excellent bargain.

Strong service business with great margins

Fortinet's gross margin of 76% is excellent for a company with 38% of product sales. Services, which comprises 62% of revenues has a gross margin of 85% boosting overall margins. Services grew 30% in 1H of 2023, faster than 26% growth from products. Management expects this trend to continue with 28% service revenue growth in 2H2023.

Market Leadership

From CEO, Ken Xie on the Q2-2023 earnings call, emphasis mine.

According to IDC's latest quarterly security tracker, in addition to having the number one unit in firewall category for 10 consecutive years with over 50% market share, Fortinet is now the market share leader in both unit and revenue. Based on the latest Westland Advisory on Security and Cybersecurity report, Fortinet was named but only ITOT network protection platform leader. We are currently one of the top and the fastest growing OT security vendor in the market that Westland Advisor expect to grow to $33 billion by 2030.

Besides being the market leader in hardware as Ken Xie pointed out, Canalys had them at third overall with 6.7% market share in Q3-2022, with 30% growth, beaten only by Palo Alto at 8.4% and Cisco Networks (CSCO) at 6.9%. Fortinet, however grew faster at 30% than Palo Alto at 25% and Cisco at 17%.

Fast Growing SASE

Within Cybersecurity, SASE (Secure Access Service Edge) is a huge opportunity and fast-growing trend that Fortinet should easily capitalize on. Gartner believes that by 2025, single vendor SASE offerings from vendors such as such as Palo Alto Networks would dominate the security landscape. SASE solutions have the advantage of an integrated network and security architecture, linking wide area networks, web gateways, network firewalls and offering security as a service for Zero Trust Network Access (ZTNA). As we can see below, Palo Alto is the leader with Fortinet a challenger within this quadrant.

Fortinet is no slouch though and believes that their single vendor SASE solution will also make significant inroads into this market, piggybacking on their large installed base of WAN (Wide Area Network) customers.

Industry Growth

Statista has the cybersecurity industry growing at 10.5% for the next 5 years to $274Bn, while Cybersecurity Ventures predicts that total cybercrime costs will grow to a staggering $10.5 Tn by 2025. Clearly, there is tremendous growth in this industry and Fortinet should have at least a decade of it.

Downsides Risks, Challenges and Weaknesses

Slowing Sales

Selling cybersecurity services, hardware or platform licenses and subscriptions have always been time consuming and difficult, especially when you have contracts running into 7 figures covering hundreds of licenses. Fortinet ran into a wall of indigestion as pandemic induced over-buying finally caught up with them. This slide below captures the growth trend for Fortinet between 2020 to 2023. Pandemic reopening and tailwinds getting 29% and 32% revenue growth in 2021 and 2022, supply chain backlogs helping through 1H2023, before settling to baseline growth of 22% for the full year.

CFO, Keith Jensen had this to say about shorter duration contracts on the earnings call:

We saw shorter contract duration, with the average term decreasing by 1.5 months to 28 months, creating a 4 to 5 point billings headwind year-over-year. Normalizing billings growth with a change in contract duration, yields billings growth in the low - 20% range. Having some level of enterprise deals pushed to future quarters, it's not unusual.

Piper Sandler analyst James Fish believes that corporate budgets are not flush for 2024, and there could be disappointments in store.

Strong Competition

The cybersecurity industry is very competitive; 800 pound gorilla Microsoft (MSFT), is one of the most prominent competitors in every aspect of security, with its strong B2B customer base. For example, in End Point Security, IDC had Microsoft second with 16.4% market share. In SASE as we saw above, Palo Alto, Versa and Cato Networks were rated above Fortinet, with the $220Bn market cap giant Cisco Networks also jostling for space. In SSE (Security Service Edge) or Zero Trust Network, a space dominated by Palo Alto, Zscaler and Netskope, Fortinet is not even in the picture. Furthermore, there are segment overlaps with most vendors encroaching upon each other, all angling to add products and services.

Rerating of growth stocks

With 10-year treasuries yields close to 4.8% and rising, valuations of growth stocks tend to take a hit with P/E multiples contracting. Even as I believe that a P/S ratio of 7, a forward P/E of 34 with a PEG of 1.2 for a 20% grower like Fortinet is reasonable, the markets have decimated high growth stocks and ETF's; take the ARK Innovation ETF (ARKK) for example; at $39, it's 25% lower than its 52 week high, and a fraction of it's all time high of $150 from 2021. I would not be surprised to see Fortinet drop to a lower multiple if bond yields keep rising.

An Excellent Bargain

Fortinet has a very reasonable valuation; As we can see from the table above Fortinet's P/S ratio of 8.3 is much cheaper than closest competitor Palo Alto's 11.7; And its 3 years forward revenue growth of 19% is actually 1% higher than Palo Alto's 18%. In 2023, even with the weaker second half forecast it's still growing faster at 22% than Palo Alto's 19%. Of course, CrowdStrike and Zscaler are much smaller and growing faster as pure plays in Endpoint and ZTNA, respectively.

Fortinet's operating margin of 22% is way higher than the rest. On a GAAP basis only Palo Alto is profitable but at a meager 6% compared to Fortinet's 22%.

Fortinet's forward P/E is 34x estimated 2024 earnings, with a PEG of only 1.2, which is outstanding for a company slated to grow at 22%. In 2026, with an estimated EPS of $2.45, the P/E drops to 23 and the PEG goes below 1. This is a lot below its high P/E ratio of over 50 and below its average of the last few years.

Fortinet has no dilution compared to other fast growers; shares outstanding have dropped from 838Mn in 2020 to 805Mn last year with buybacks.

This is a fast growing sector with a lot of tailwinds like AI and regulations such as EU Cyber Resilience Act and from the SEC, ensuring that this market will continue to grow.

Besides the excellent financials and bargain price, Fortinet has several other competitive advantages such as:

• Strong customer switching costs, which reduces churn.
• Network effect of several offerings added to its base firewall solutions, making it easier and cheaper to add customers and expand revenues per customer.
• A platform based SASE solution integrating all of customers' cybersecurity needs.

A market leader at 34x forward earnings with a PEG of only 1.2 in a secular growth industry - Fortinet is a terrific bargain. I'm buying on declines expecting the stock to double in 3 years and return 24% per year.

Shares of Fortinet (FTNT) dropped Friday afternoon after cutting its annual guidance for the second time this year, decreasing its revenue forecast for 2023 to $5.33 billion. The cut stems from lower sales estimates for the fourth quarter, with new estimates between $1.38 billion and $1.44 billion, below previous estimates of $1.50 billion, according to data from the London Stock Exchange Group.

Yahoo Finance Anchors Josh Lipton and Diane King Hall break down the latest information from the cybersecurity company.

For more expert insight and the latest market action, click here to watch this full episode of Yahoo Finance Live.

Video Transcript

JOSH LIPTON: Cybersecurity company Fortinet, sliding after it cut annual guidance a second time now, sees 2023 revenue of 5.33 billion. That's down from a previous guidance of 5.45 billion. So this one-- not good news from the company. You can see the reaction, and we're down about 13% in today's trade. Cut the guidance-- now sees fiscal 23 revenue as you said as much as five-- five-- 5.33 billion.

Remember, this company also-- what they do-- they sell antivirus products. They sell firewalls. This is the second [INAUDIBLE] quarter though where they cut guidance. And by the way though, it's a tough time for this company.

Worth pointing out-- different story at Cloudflare, which is another cybersecurity name. They reported beat, raised guidance, and that stock's moving higher in today's [INAUDIBLE].

DIANE KING HALL: Yeah, exactly. You have convergence happening there. I noticed that with Cloudflare. And originally, Fortinet-- Fortinet had put some pressure on that sector. TD Cowen-- out with a note about Fortinet saying that this is going to be a year of transition for this company, pointing out, obviously, [? the miss. ?]

This was on lackluster demand for its products, billings et cetera. You know, the outlook-- it needs to turn around. You had Guggenheim also out with a note on Fortinet, saying that this is due to the cyclical downturn that we're seeing. It just led to another poor quarter to your point.

Story continues

Guggenheim pointing out that, and this is led by Raymond McDonnell, that it's going to get worse before it's better for this company clearly. And it is getting punished in terms of the action today.

And when you think about the kind of day it is, it's a risk-on day that we're seeing on Wall Street. There's no grace being shown to this stock at all right now in terms of its performance.

JOSH LIPTON: No mercy into the weekend-- no.

DIANE KING HALL: No.

Fortinet Inc. whiffed badly with its guidance three months ago, and the company’s third-quarter report Thursday brought another disappointment.

The cybersecurity company came up short with its fourth-quarter revenue forecast, which calls for $1.38 billion to $1.44 billion. Analysts were looking for $1.50 billion. Fortinet’s FTNT, -1.25% management also projects $1.56 billion to $1.70 billion in billings, which is defined as GAAP revenue plus the change in deferred revenue from the beginning to the end of the period, minus any deferred revenue balances.

November 08, 2023, 10:46 AM EST

After several days of losses following its latest financial report, the network security vendor is seeing renewed interest from investors.

Shares in Fortinet are on the rise Wednesday, following several days of stock price losses after its latest quarterly financial report disappointed investors and analysts.

Fortinet’s stock price (ticker: FTNT) is up 2.7 percent to $50.85 as of this writing Wednesday morning.

[Related: Okta, Fortinet See Further Stock Price Declines]

Prior to the reversal, the network security vendor has seen declines in share value each day since last Thursday, when the company released a weaker-than-expected financial report.

At the current Fortinet stock price as of this writing, the company’s shares are 11.7 percent below its closing price of $57.59 Thursday.

It wasn’t immediately clear what may have prompted the rise in Fortinet’s stock price, though investors were also sending shares in other major cybersecurity industry players upward Wednesday morning. Zscaler’s stock price was up 1.6 percent to $174.11 a share, while Palo Alto Networks — a top Fortinet rival that took a hit to its stock price after the vendor’s report last week — was up 0.6 percent to $243.55 as of this writing.

The release Thursday of Fortinet’s results for the third quarter ended Sept. 30 showed a 16 percent gain in overall revenue from a year earlier. However, Fortinet also saw a drop in firewall sales, which led the company’s third-quarter revenue to fall short of the analyst consensus estimate.

Fortinet’s product revenue for Q3 declined 0.6 percent year over year to $465.9 million—marking the company’s first year-over-year decline in firewall sales since it went public in 2009. The company is encountering a “slowdown in secure networking market growth,” said Ken Xie, Fortinet’s co-founder, chairman and CEO, during the company’s quarterly call with analysts Thursday.

The company’s revenue outlook for the fourth quarter also came in below Wall Street expectations.

Amid the report Thursday, Fortinet said it will be shifting more of its focus to faster-growing areas, such as SASE (secure access service edge) and security operations tools. SASE now represents 20 percent of Fortinet’s business while SecOps tools now make up 10 percent.

“In response to the slowdown in [the] secure networking market, we are shifting our marketing and sales team’s focus towards the faster-growing security operations and SASE market over the next few quarters,” Xie said during the call with analysts.

Within the SASE market, “our industry leadership in both firewall and SD-WAN — the two largest components of SASE — provide us with a significant competitive advantage,” he said.

In Fortinet’s third-quarter results, service revenue grew nearly 28 percent year over year to reach $868.7 million, the company reported.

Shares of Fortinet Inc (NASDAQ:FTNT) tanked in early trading on Friday, after the company reported mixed quarterly results.

The results came amid an exciting earnings season. Here are some key analyst takeaways from the earnings release.

• Truist Securities analyst Junaid Siddiqui maintained a Buy rating, while slashing the price target from $82 to $60.
• Guggenheim Securities analyst Raymond McDonough reiterated a Buy rating, which reducing the price target from $70 to $62.
• Needham analyst Matt Dezort reaffirmed a Hold rating on the stock.
• Oppenheimer analyst Ittai Kidron maintained a Perform rating on the stock.
• KeyBanc analyst Eric Heath reiterated a Sector Weight rating on the stock.

Check out other analyst stock ratings.

Truist Securities: Fortinet reported its third-quarter results below expectations, “amidst an increasingly challenging macro driven by continued weakness in its product revenue segment,” Siddiqui said in a note.

Management reset their full-year guidance, indicating a slowdown in the company’s core secure networking market and “elongated sales cycles amidst increased deal scrutiny,” the analyst added. “Even though we are disappointed with the weak Q3 results, we still continue to favor FTNT's balanced approach to growth and profitability making FTNT a defensible name long-term, in our view."

Guggenheim Securities: Fortinet reported weak quarterly results, with the cyclical downturn in hardware leading to “another product and billings miss,” McDonough said.

“In our view, the current cyclical downturn is likely to be steeper and shorter than the last, which lasted about eight quarters,” the analyst wrote. “This quarter and subsequent guides suggest a steeper decline, but we do believe we are more than halfway through this ‘period of digestion’."

Needam: “Fortinet corrected sharply after Q3 Billings and Product Revenue missed on a sharper than expected slowdown in secure networking appliance sales,” Dezort wrote in a note.

“The outlook also disappointed with Billings growth now expected to recover into the double-digits in 2H24, down from prior messaging for mid-teens,” the analyst stated. “Fortinet is shifting focus and reorienting their sales force toward a SASE and SecOps first motion, which is likely to take a few quarters to digest adding to the headwinds near-term."

Oppenheimer: Although Fortinet delivered an earnings beat in the third quarter, its billings and revenues were disappointing and the company lowered its full-year guidance for the second consecutive quarter, Kidron said.

“In our opinion, Fortinet must now face the reality of constrained demand in its core firewall market, which will pressure its growth moving forward,” the analyst wrote. “And while the company is shifting its focus to SASE and SecOps, these are highly competitive markets that Fortinet was late to invest in,” he added.

KeyBanc: Fortinet delivered “a large 3Q miss and guide lower on billings, revenue and product revenue as the firewall digestion period is more extensive than expected and execution remains challenging,” Heath said.

“Weakness was more pronounced in Europe, U.S., large enterprise, as well as in the service provider and retail verticals,” the analyst added.

FTNT Price Action: Shares of Fortinet had declined by 15.58% to $48.62 at the time of publication Friday.