A lot has been said about the need for new cybersecurity services as cloud computing gobbles up more of global IT infrastructure. And it's true. The cloud -- data and apps housed in a remote data center accessed via the internet -- indeed necessitates a new way to play defense.
But that doesn't mean the cybersecurity incumbents are dead in the water. Case in point, "old" Fortinet (FTNT +0.01%) continues to exceed expectations, like "old" LeBron James making another title run at the ripe age of 38. Fortinet isn't struggling in this new era of the cloud. Far from it, this often overlooked cybersecurity name continues to execute on its growth goals and is generating tons of profit. Is the stock still a buy?
NASDAQ: FTNT
Key Data Points
Fortinet's measured bet on next-gen cybersecurity
Fortinet once again proved it isn't a former darling of some bygone era. It blew away its own financial expectations for the first quarter, with year-over-year revenue growth of 32% to $1.26 billion.
Earnings per share (EPS) surged 82% year-over-year (or up 79% on an adjusted basis), and free cash flow was $647 million (a 51% free cash flow profit margin!) as Fortinet laps 2022 -- a year of somewhat depressed profitability as it invested in inventory to meet soaring demand for its hardware.
The good times look like they'll keep rolling in Q2 as well. At the midpoint of guidance, management is forecasting revenue to be $1.3 billion (up 26% year-over-year) and adjusted EPS to be up 42%.
The company's full-year 2023 outlook was also upgraded and now implies revenue and adjusted EPS will each rise 23% over 2022.
All of this growth from a "legacy" cybersecurity company that has taken a measured approach to securing the cloud -- the fastest-growing segment of the cybersecurity space. Additionally, management authorized another $1 billion in share buybacks. Fortinet has seemingly perfected the delicate art of growing profitably, and in a way that rewards shareholders along the way. That stands in stark contrast to many of its newer and faster-growing (at least as measured by sales growth) cloud-native peers.
Cloud investors are missing a key point
Of course, the cloud market is expected to continue expanding at a rapid pace over the next decade, and proliferating cloud-based services will necessitate a lot more "cloud-native" security. However, many investors are missing the fact that Fortinet is enjoying this trend, too, even though its product-based business model -- it sells firewalls, which traditionally create a type of moat around a physical location like an office -- is seemingly aging. Why?
Fortinet cites tech researcher Gartner a lot when it talks about the "convergence of networking and security." Basically, behind every piece of cloud software, and every remote employee accessing that service or company data, there is a massive amount of network infrastructure that needs to be secured. The amount of digital data in motion at all times is staggering, and it requires new networking hardware and infrastructure with security services baked into it to keep the data from falling into the wrong hands.
In fact, even in this new cloud era, Fortinet's product sales have remained in high gear, notching a 35% year-over-year growth rate in Q1 2023 -- building on a 42% product sales growth rate in 2022, and a 37% growth rate in 2021.
And it's not as if Fortinet has completely written off recurring cloud services. On the contrary, product sales act as a type of funnel for recurring services. Fortinet's services grew 30% year-over-year in Q1 2023, the highest rate of growth since 2016. This acceleration in services is what gives Fortinet the confidence it will average over 20% per-year revenue growth and adjusted operating profit margin of at least 25% over the next three years.
Given the company's consistent performance and rosy outlook, this is no value stock at 55 times trailing-12-month EPS and nearly 30 times free cash flow. But a premium stock valuation has been the norm for this "old" cybersecurity player for a long time. Premium price or not, I still think this is a top security stock to own if you plan on holding for at least a few years.
