One of the leading cybersecurity pure-plays, Fortinet (FTNT 0.23%), just put some investor worry to rest. During the second half of 2023, Fortinet's firewall and security hardware business hit a wall after setting the world ablaze the last few years. Ample concern cropped up that this down cycle could be different from other cybersecurity hardware downturns of the past. Shares of Fortinet closed out last year with market-lagging returns (as measured against the Nasdaq Composite index).
Data by YCharts.
But Fortinet is off to a hot start in 2024 as management just gave investors a green light -- and foreshadowed that healthy cybersecurity stock returns could be in store once again this year.
Is Fortinet's downturn already coming to an end?
Fortinet's epic growth in the aftermath of the pandemic came to an end in the second half of last year. Driven by a massive migration to cloud computing and a need for more IT infrastructure to be installed, the company's hardware business (like firewalls, a device that monitors data traffic) soared. For Fortinet, these hardware installs tend to trickle down to "services" revenue in the years following.
But during the third-quarter 2023 earnings update, the pace of new hardware installs finally started to fade. Fortinet co-founder and CEO Ken Xie said that billings (invoices sent to customers that haven't been paid yet, a leading indicator of future revenue growth) would come in at $1.56 billion to $1.7 billion in the fourth quarter of the year. That represented a year-over-year decline from $1.72 billion in billings in Q4 2022. That's not a good look for a stock priced at a premium like Fortinet (currently trading for about 32 times trailing-12-month free cash flow).
Xie and the top team underpromised and over-delivered, though. Billings were actually up 8.5% year over year in Q4 2023 to $1.86 billion. The company is still in a slump, as billings guidance for Q1 2024 was for $1.39 billion to $1.45 billion, down slightly from the $1.5 billion reported a year ago.
Nevertheless, Fortinet is going to be just fine. While revenue will be mostly flat in the first half of 2024 (falling firewall and hardware sales, offset by higher services revenue), full-year 2024 revenue guidance for about 8% to 9% growth over 2023 implies the business is going to heat up during the second half of the year.
Good things to come for the cybersecurity market
Fortinet is a unique business among the largest cybersecurity pure-play stocks -- which include Palo Alto Networks (PANW 0.91%), CrowdStrike Holdings (CRWD 2.03%), and Zscaler (ZS 1.28%), to name just a few. Fortinet still earns about one-third of its sales from firewalls and network hardware (35% to be specific, for the full year 2023).
While this segment is in temporary decline for Fortinet, its "services" segment (the other 65% of revenue last year) remains in growth mode. Fortinet's service sales increased 25% year over year in the final months of 2023, and should remain in growth mode in 2024.
The other big cybersecurity platforms derive most (Palo Alto Networks) or all (CrowdStrike and Zscaler) of their revenue from subscriptions and services. If Fortinet's cybersecurity services remain healthy, it's a solid indicator of strength for the rest of the market that's more squarely positioned to benefit from cloud-based security services.
Of course, the market has caught wind of this, and cybersecurity stocks have been off to the races to kick off 2024. Investors should tread lightly, consider adding top cybersecurity stocks to their portfolio using a dollar-cost average plan, and keep some cash available on the sidelines to take advantage of any big pullbacks in share prices at some point this year.
Data by YCharts.
Nevertheless, the cybersecurity industry is part of a secular growth trend and should have years of high growth ahead of it. Fortinet just proved the resiliency of this top market.
