Fortinet: Strong Profitability Is Driving Strong Returns

Fortinet, Inc (FTNT) is a provider of broad, integrated, and automated cybersecurity solutions in the United States and worldwide. The company receives the majority of its revenue from overseas. In Q3 of Fiscal 2021, 40% of revenues were received from the Americas, while 37% were earned in Europe, the Middle East, and Africa (EMEA). The remaining 23% were earned in the Asia Pacific (APAC) region.

I am neutral on FTNT stock. (See Analysts’ Top Stocks on TipRanks)

A Profitable Company in a Growing Industry

Fortinet’s cybersecurity products are in high demand, and demand is likely to increase in the long term along with security threats. The company’s products and services include firewalls, malware protection, virtual private networks (VPNs), spam filtering, and endpoint protection. Fortinet continues to offer solutions like hardware and software.

The stock currently trades around $320 per share. This is an increase of about 150% over the past year. Year-to-date, the stock has gained 115%. However, it has not been immune from the recent pullback in growth and tech. Still, the stock price trades 10% off its 52-week high as of this writing.

Should growth stocks continue to decline, Fortinet should weather the storm better than most for one major reason; the company is highly profitable. Many names, including many in cybersecurity, experiencing large selloffs are not yet profitable, and investors seem to be thinking twice about valuations.

Q3 Earnings Were Impressive

Fortinet released earnings for Q3 2021 in early November. Many were not impressed as the stock fell over 8% soon after the release. However, revenue growth actually accelerated over the prior several quarters. Q3 2021 revenue was up 33% year-over-year. In the three prior quarters, revenues were up 22%, 23%, and 30% over the same periods last year. The accelerating growth trend is highly encouraging.

Along with the impressive growth, Fortinet posted $165 million in operating income for the quarter and $163 million in net income. Net income was up 32% over Q3 2020. Net margin was also impressive at 19%, up from 17% in the prior quarter. What does all of this mean? It separates Fortinet from many fledgling cybersecurity players who are not close to GAAP profitability.

Fortinet also has a strong balance sheet. As of the last report, the company has $3.1 billion in cash and short-term investments on hand against just $988 million in long-term debt. The balance sheet is strong due to the impressive amounts of cash flow from operations that the company continues to post. Over the past 12 months, Fortinet has cleared $1.4 billion in cash from operations on $555 million in net income.

Fortinet Could Get Caught in a Market Downswing

Despite the positive metrics mentioned above, Fortinet may face some turbulence based on market sentiment. The price-to-sales ratio is high at nearly 17x. It is not in the same realm as some other names, such as CrowdStrike which trades at over 34x sales; however, it is still elevated historically. In addition, the forward P/E ratio stands at around 71x. As the market revalues growth stocks, Fortinet’s share price may also be punished.

Growth stocks often perform poorly as interest rates rise. The Federal Reserve has signaled that interest rates may rise sooner and faster than expected due to high inflation. In addition, the Federal Reserve is tapering its open market asset purchases which could pressure the markets. All of this adds up to a cautious outlook for now.

Wall Street’s Take

Turning to Wall Street, analysts have a Moderate Buy consensus rating on FTNT stock. This is based on 12 Buys, seven Holds, and one lone Sell rating.

The average Fortinet price target of $370.85 implies 16% upside potential.

Summary on Fortinet

Fortinet is a strong cybersecurity company that is posting impressive results. Revenue growth is accelerating, and margins are expanding. This is due to the recent focus on software sales instead of legacy hardware. This trend is likely to continue.

The balance sheet is also strong. Unfortunately, the macroeconomic climate is difficult. Federal Reserve tapering, interest rate risks, and general shakiness in investor sentiment represent clear short-term risks. For these reasons, Fortinet currently warrants a Hold rating.

Disclosure: At the time of publication, Bradley Guichard had a position in securities mentioned in this article.