Fortinet (FTNT 3.43%) stock is rocking and rolling again after its fourth-quarter 2022 earnings update. This top cybersecurity pure play not only put the icing on a great couple of years, it also added to shareholder optimism that it can achieve the lofty goals it set for itself at an investor event a few months ago. With shares quickly climbing back toward their all-time highs from nearly a year ago, is Fortinet still a buy?
Where high-performance networking and cybersecurity meet
Fortinet has been handily beating the overall market for years, and longtime shareholders know the secret sauce is the company's custom hardware. As the company pointed out during its investor presentation in December 2022, its proprietary chip technology (the security processing unit, or SPU) is best-in-breed. It's a big reason Fortinet wins business, as it helps its customers embed security solutions directly into their network infrastructure.
NASDAQ: FTNT
Key Data Points
This competitive strength was on financial display in Q4 2022. Management reported total revenue increased 33% year over year to $1.28 billion, including a 43% year-over-year increase in product sales (networking hardware featuring those Fortinet chips) to $540 million. It caps off an epic year of growth. Total 2022 revenue was up 32% to $4.42 billion (including $1.78 billion in product, a 42% increase). This builds on what was also a stellar 2021, when total revenue grew 29%.
Fortinet's profitability was even better in the Q4 report card. Its operating margin rallied in the final months of the year to 27.9%, under generally accepted accounting principles (GAAP), bringing the full-year total to 21.9% -- much of that due to the higher pace of hardware sales (more on that momentarily). Resulting free cash flow also rallied in Q4 to $497 million (a hefty margin of 39%), bringing the full-year free-cash-flow total to $1.45 billion.
Highly profitable services on the way
On to guidance. Fortinet said to expect first-quarter 2023 revenue to be in the range of $1.18 billion to $1.22 billion, a 26% year-over-year increase at the midpoint of the outlook. And for the full-year 2023 period, revenue is expected to be in the range of $5.37 billion to $5.43 billion, a 22% year-over-year increase. Of the total sales estimate, management said to expect services revenue to be around $3.35 billion, up 27% compared to 2022. This is important news, and a significant development that confirms what savvy investors have been expecting from Fortinet.
You see, the journey doesn't end after Fortinet sells its physical products that get embedded into a customer's network. Once up and running, that customer then turns on recurring software and services that are sold as a package with the security hardware. The result is an ongoing stream of service revenue for Fortinet that can generate highly profitable returns (typically far higher profit than the product sale) for the company for years to come.
It also makes for a very sticky relationship. Many cybersecurity upstart companies (most of which address problems with the modern cloud) are software only. There are often low switching costs associated with those types of services. But a company like Fortinet, with products embedded into the very fabric of a customer's IT infrastructure? That's significantly harder to uproot.
Additionally, Fortinet has done a great job over the years developing new cloud-based services as an add-on to (or integrated with) its hardware-based offerings. With a large installed base in existence, it gives the company the opportunity to go out and cross-sell more services as their customers need -- further enhancing Fortinet's chance to expand profitably.
With a big and expanding backlog of business, Fortinet's recent report was fantastic news for this cybersecurity leader. Shares now trade for 32 times 2022 free cash flow, a premium price tag. However, if Fortinet meets its goals for double-digit revenue growth, maintains its high profit margin, and continues to repurchase lots of stock (it repurchased $1.99 billion in 2022) over the next few years, it's certainly not an unreasonable price. I remain a buyer here.
