Palo Alto Networks (PANW 0.91%) and Fortinet (FTNT 0.23%) are both bellwethers of the cybersecurity sector. Both companies are known for consistently growing their billings and revenue by double-digit percentages while generating stable profits.
But over the past 12 months, Palo Alto's stock price is up about 22% while Fortinet's stock only advanced 11%. Let's see why the former outperformed the latter, and if it will remain the stronger cybersecurity stock over the next 12 months.
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The key differences between Palo Alto and Fortinet
Palo Alto and Fortinet both sell next-gen firewall (NGFW) appliances, which add advanced network filtering tools to traditional firewalls. Yet the two companies expanded their ecosystems beyond NGFW appliances with different strategies.
Palo Alto's next-gen firewalls became the bedrock of its network security platform Strata. It subsequently launched Prisma, its cloud-based security platform, and Cortex, which provides AI-powered threat detection tools. Most of its growth is now driven by Prisma and Cortex, which it collectively refers to as its "next-gen security" (NGS) services.
Fortinet's FortiGate next-gen firewalls became the heart of its "Security Fabric," which provides end-to-end security services for on-premise, cloud-based, and Internet of Things (IoT) devices via appliances, on-site software, and cloud-based services. It produces its own ASIC chips, which are customized for its own hardware and FortiOS operating system. It claims these proprietary chips give it an edge against companies that use off-the-shelf chips.
Palo Alto serves more than 80,000 enterprise customers worldwide, while Fortinet serves over 680,000 customers. However, Palo Alto generates higher annual revenue than Fortinet because it mainly serves larger customers.
Palo Alto faces a milder near-term slowdown than Fortinet
Palo Alto and Fortinet grew at similar rates over the past five years. From fiscal 2018 to fiscal 2023 (which ended this July), Palo Alto's revenue rose at a compound annual growth rate (CAGR) of 25% as its billings grew at a CAGR of 26%. From 2017 and 2022, Fortinet's revenue grew at a CAGR of 24% as its billings rose at a CAGR of 25%.
Over the past year, both companies faced macroeconomic challenges as inflation and higher interest rates drove businesses to rein in their software spending. However, Palo Alto faces a milder slowdown than Fortinet.
Palo Alto's revenue and billings grew 25% and 23%, respectively, in fiscal 2023. But for fiscal 2024, it expects its revenue to rise 18%-19% as its billings grow 19%-20%. Fortinet's revenue and billings rose 32% and 34%, respectively, in 2022. But for 2023, it expects its revenue to rise 21%-23% as its billings grow 16%-18%.
Fortinet is still growing at a comparable rate as Palo Alto, but its year-over-year slowdown was more jarring. Fortinet's slowdown also raises some concerns about its long-term goal of hitting $10 billion in annual billings by 2025. To reach that target, it would need to grow its billings at a CAGR of 21% from 2022 to 2025. Palo Alto hasn't set any comparable goals yet.
Palo Alto's margins are expanding more quickly
Palo Alto's adjusted operating margin jumped from 19% in fiscal 2022 to 24% in fiscal 2023 as it reduced its supply chain costs, slowed down its hiring, and generated more revenue from its higher-margin software and services. It expects that expansion to continue with an adjusted operating margin of at least 25% in fiscal 2024.
Fortinet's adjusted operating margin rose from 26% in 2022 to 27% in 2023 as it benefited from price hikes and lower product costs. But for 2024, it expects that figure to dip to 25%-26% as its growth cools off and its costs continue to climb.
Palo Alto and Fortinet are both profitable by generally accepted accounting principles (GAAP) terms, but they provide forecasts in non-GAAP (adjusted) terms. Palo Alto expects its adjusted EPS to grow 19%-22% in fiscal 2024, compared to its 76% growth in fiscal 2023. Fortinet expects its adjusted EPS to rise 25%-29% in 2023, compared to its 49% growth in 2022.
The valuations and verdict
Palo Alto Networks trades at 43 times forward earnings, while Fortinet has a slightly lower forward multiple of 38. Fortinet might seem like the better bargain, but I believe Palo Alto will continue to generate bigger gains for three simple reasons: Its business is better diversified, its sales growth is more consistent, and its operating margins are still expanding.
