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Fortinet Inc(FTNT-Q)
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Is It Too Late to Buy Fortinet Stock?

Motley Fool - Tue Nov 7, 2023

Fortinet's (NASDAQ: FTNT) stock dropped 12% on Nov. 3 after the cybersecurity specialist posted a mixed third-quarter report. Its revenue rose 16% year over year to $1.33 billion but missed analysts' estimates by $20 million. Its adjusted earnings grew 24% to $0.41 per share and cleared the consensus forecast by $0.05 per share.

Fortinet's headline numbers weren't terrible, but the company rattled shareholders with a big reduction in its full-year guidance. Does that warning indicate it's too late to buy Fortinet's stock?

A digital illustration of a padlock.

Image source: Getty Images.

Why did the bulls love Fortinet?

Fortinet's core product is a "security fabric" that weaves together end-to-end cybersecurity tools for on-premise, cloud-based, and Internet of Things (IoT) connections through a mix of appliances and cloud services. The company differentiates itself from its competitors by developing its own ASIC chips that are customized for its hardware and FortiOS operating system.

Fortinet claims those chips give it an edge against cybersecurity companies that use off-the-shelf chips. It also expects the gradual convergence of the cybersecurity, networking, and hybrid cloud markets to drive its long-term growth.

Fortinet seemed to be on track over the past decade. Between 2012 and 2022, revenue rose at a compound annual growth rate (CAGR) of 24% as billings increased at a CAGR of 25%. A $1,000 investment in Fortinet's stock at the start of 2012 would have grown to more than $11,000 by the end of 2022.

Why did Fortinet's growth cool?

But after its latest post-earnings plunge, Fortinet stock has only eked out a year-to-date gain of 3%. The reason for that lackluster growth is simple: It reduced its full-year revenue and billings guidance in both the second and third quarters of the year.

Metric

2022 (Actual)

2023 Outlook
(Q1 2023)

2023 Outlook
(Q2 2023)

2023 Outlook
(Q3 2023)

Revenue growth

32%

23%-24%

21%-23%

19%-21%

Billings growth

34%

21%-22%

16%-18%

9%-12%

Data source: Fortinet.

Fortinet blamed that slowdown on macro headwinds, which made it harder to gain new customers and secure longer contracts. However, many of Fortinet's peers -- including Palo Alto Networks(NASDAQ: PANW) and CrowdStrike(NASDAQ: CRWD) -- didn't repeatedly reduce their full-year guidance over the past few quarters.

Indeed, Palo Alto expects its revenue to rise 18% to 19% and for its billings to grow 19% to 20% in fiscal 2024 (which ends next July). CrowdStrike sees its revenue increasing 35% to 36% in fiscal 2024 (which ends next January).

Did it overestimate its growth potential?

Fortinet's sharper-than-expected slowdown suggests the company is underestimating its near-term challenges while overestimating its growth potential. This also indicates it's struggling to keep up with competitors.

In the second quarter, Fortinet doused hopes for a quick recovery by predicting billings growth would stay in the "high teens" through the end of 2024. In the third quarter, it lowered that forecast again to a "double digit" billings increase.

Fortinet also previously set a long-term goal of generating $8 billion in revenue and $10 billion in billings by 2025. To reach that target now, the company would need to grow revenue and billing at a CAGR of 22% and 21%, respectively, from 2022 to 2025. The company notably didn't reiterate those goals during its second- and third-quarter conference calls.

But its margins are stabilizing

Fortinet's top-line growth might remain sluggish in this challenging market, but it still raised its full-year forecasts for its adjusted gross margin, adjusted operating margin, and adjusted EPS growth for the second consecutive quarter.

Metric

2022 (Actual)

2023 Outlook (Q1 2023)

2023 Outlook (Q2 2023)

2023 Outlook (Q3 2023)

Adjusted gross margin

76.3%

75%-76%

75.25%-76.25%

76%-77%

Adjusted operating margin

27.3%

25%-26%

25.25%-26.25%

26.5%-27.5%

Adjusted EPS growth

49%

21%-24%

25%-29%

29%-31%

Data source: Fortinet.

The company attributed that expansion to a mix of higher-margin subscriptions and cost-cutting measures, which offset its higher cloud hosting costs. Fortinet expects gross margins to be compressed by elevated product inventories across its hardware business in 2024, but it plans to rein in its spending to offset some of that pressure. The company also reiterated its long-term outlook for maintaining adjusted operating margins of "25% or greater."

Is it too late to buy Fortinet stock?

Fortinet stock trades at 33 times forward earnings, but that multiple might decline if its higher-than-expected EPS guidance for 2023 drives analysts to raise their earnings estimates for 2024.

But even if that doesn't happen, Fortinet still looks cheap relative to its industry peers. Palo Alto and CrowdStrike trade at 47 and 51 times forward earnings, respectively.

Therefore, it still isn't too late to buy Fortinet as a long-term play on the cybersecurity market. That said, I wouldn't rush to buy Fortinet's stock right now as its top-line growth cools. I'd stick with Palo Alto and CrowdStrike as my preferred cybersecurity plays while keeping an eye out for Fortinet's eventual recovery.

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Leo Sun has positions in CrowdStrike and Palo Alto Networks. The Motley Fool has positions in and recommends CrowdStrike, Fortinet, and Palo Alto Networks. The Motley Fool has a disclosure policy.

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