Fortinet Inc. (FTNT, Financial) has delivered outstanding annual returns over the past decade. Its shareholders earned returns of 31.15% over the past three years, 40.69% over the past five years and 27.76% over the preceding 10 years.
But, with the end of 2022 just days away, the company is showing a year-to-date loss of 32.46%, and that’s just one year after delivering a 2021 return of 141.97%. Can Fortinet get back on track?
About Fortinet
Fortinet is a major cybersecurity player, and on its website, it describes itself as follows: “The Fortinet Security Fabric platform delivers broad, integrated, and automated protections across the entire digital attack surface, securing critical devices, data, applications, and connections from the data center to the cloud to the home office... Ranking #1 in the most security appliances shipped worldwide, more than 615,000 customers trust Fortinet to protect their businesses.”
On a trailing 12-month basis, it had revenue of $4.098 billion, which it forecasts will more than double to $10 billion in 2025. That’s within a total addressable market of $182 billion in 2025.
Competitors
Not only is there extreme competition among cybersecurity firms, but according to its 10-K for 2021, the space is characterized by rapid technological change.
Named competitors include Barracuda Networks (CUDA, Financial), Check Point Software (CHKP, Financial), Cisco Systems (CSCO, Financial), CrowdStrike Holdings (CRWD, Financial) and F5 Networks (FFIV, Financial).
This chart shows how Fortinet has outperformed Barracuda and Check Point on the capital gains front:
Financial strength
For the first time in its history, Fortinet took on long-term debt in 2021. In its 10-K for 2021, it explained, “During 2021, cash used in investing activities was primarily driven by $752.2 million spent for purchases of investments, net of maturities and sales of investments, $295.9 million of purchases of property and equipment, a large portion of which relates to our headquarters building construction, $160.0 million used for purchases of investment in a privately held company, and $74.9 million used for the acquisitions of Alaxala, ShieldX and other, net of cash and $42.5 million used for purchases of marketable equity securities.”
At the end of the third quarter of 2022, long-term debt totaled $990 million. While that’s a big jump into debt, it has not affected the viability of the company. It has an interest coverage ratio of 45.67 and an Altman Z-Score of 4.65. Both ratios indicate the company is financially healthy.
Profitability
One of the key reasons for Fortinet’s strong annual returns (before 2022, at least) is its margins. The operating and net margins drifted lower in the mid-2010s, then recovered later in the decade:
In addition, it has industry-leading returns on equity and assets, and has been profitable every year of the past decade.
Growth
Fortinet receives a 9 out of 10 GuruFocus growth rank, driven by its three- and five-year revenue growth rates and the predictability of the five-year Ebitda growth rate. This five-year chart shows revenue growing predictably and quickly (an average of just under 21% per year):
Ebitda has grown consistently and even faster than revenue, an average of 51.36% per year. So, Fortinet has earned that high ranking.
Growth of earnings per share without non-recurring items is faster again, with EPS without NRI growing from $0.04 per share to $0.73 in just five years:
More rapid growth shows up for free cash flow. Over the past five years, it grew by 32.03% per year and over the past 10 years, it increased by an average of 27.19% per year.
In its December 2022 Investor Presentation, the company forecasts more of the same:
What will drive this new growth? According to the company's investor presentation, the total addressable market will grow by an average of 10% per year, reaching $182 billion in 2025 (up from an estimated $138 billion for 2022).
Fortinet also points to heightened awareness of cybersecurity risks because of 1) ransomware and high-profile attacks, 2) the convergence of security and networking and 3) vendor/product consolidation. Regarding the latter, watch for the company to make new acquisitions in the coming years.
Dividends and share repurchases
Fortinet does not pay a dividend, but has bought back its own shares in three of the past five years:
Valuation
Despite the good news in the financial statements, the share price has withered over the past year:
Many, if not most, companies also saw their share prices slip even in the cases where their key metrics remained the same or even improved. Because of external economic and geopolitical issues, there has been a market-wide contraction of share prices.
Looking at other measures of valuation, the GF Value chart considers Fortinet to be modestly undervalued. It estimates the intrinsic value at $62.62, versus the Dec. 28, 2022 closing price of $47.86. That gives it a GF Value ranking of 9 out of 10.
Compared to the rest of the software industry, its price-earnings ratio is high at 52.83 versus the industry mean of 24.61.
Dividing the price-earnings ratio by the five-year Ebitda growth rate of 53.30%, we get a PEG ratio of 1.00, which indicates a fair price.
Gurus
Fortinet has a respectable number of gurus as investors. There are nine gurus holding shares of the company as of the latest round of 13F reports. Jim Simons (Trades, Portfolio) of Renaissance Technologies held 4,613,145 shares at the end of the third quarter after a reduction of 4.17%, which represented 0.59% of the company’s shares outstanding and 0.32% of Renaissance’s 13F holdings.
Jerome Dodson (Trades, Portfolio) of the Parnassus Fund owned 548,169 shares, while Louis Moore Bacon (Trades, Portfolio) of Moore Capital Management increased his holding by 40.67% to 210,999 shares.
Investors should be aware that 13F reports do not provide a complete picture of a guru’s holdings. They include only a snapshot of long equity positions in U.S.-listed stocks and American depository receipts as of the quarter’s end. They do not include short positions, non-ADR international holdings or other types of securities. However, even this limited filing can provide valuable information.
Institutional ownership comes in at 43.71% and insiders hold a sizable chunk of the equity at 12.02%. That’s due mainly to the holdings of Ken and Michael Xie, the founders and most senior executives. Together, they own 93,020,000 shares.
Conclusion
As a high-valuation tech stock, the price of Fortinet shares will likely continue to rise and fall depending on the many moods of the markets. But, I believe the company is likely to keep growing its top and bottom lines aggressively. With all key metrics pointed in the right direction, it seems able to continue to generate enough earnings and free cash flow to follow through on its growth plans through at least 2025.
