Thesis

Fortinet (NASDAQ:FTNT) has several catalysts in place for continued market share gains, including the company’s move into enterprise would continue to support share gains. Secondly, the company’s projected 20% billings growth in the fiscal year 2023 provides greater confidence in achieving its fiscal year 2025 goals of $10 billion in billings, $8 billion in revenue, and mid-to-high 30s free cash flow margins. The company’s portfolio is diversified across various geographies, customer types, and verticals. Moreover, a shift in its mix towards faster-growing non-FortiGate products, and the normalization of its backlog will continue to support growth, in my view. I maintain a Buy rating on the stock and currently maintain an end-of-2023 price target of $78 based on 30x EV/CY23 FCF.

Post Q4 Earnings Outlook:

FTNT’s 4Q results were solid and exceeded expectations in various metrics, such as billings, operating income, and free cash flow. The results were bolstered by better-than-expected growth in the mid-enterprise and SMB sectors in Europe and the US Despite revenue falling short of consensus, the stock is up 13% since the result announcement as the market remains optimistic on the company’s health execution. I was pleasantly surprised by the company’s FY23 billings growth guidance of approximately 20% at the midpoint, given concerns around macroeconomic uncertainty. Management noted incremental platform consolidation traction as CISOs place greater focus on making sure technology works together, with ROI and cost optimization top of mind.

Fortinet has more control over one-third of the backlog that is related to firewall products compared to the remaining two-thirds, which is primarily composed of routers and switches. FTNT noted that one-third of the ending Q322 backlog was from FortiGate, implying the remainder is mostly non-firewall, primarily routers/switches. This is important because the company has a wider range of SKUs and suppliers for firewall products, which gives them more control over their supply chain; hence the company is likely to have better control over the one-third of the backlog that is related to firewall products. While there will probably be some component of the backlog that drains in FY23, it may not be 100% due to the supply chain challenges in the networking space that are difficult to control.

Financial Outlook

The company is expected to see margin expansion in the coming quarters, supported by price increases and an improvement in supply chain costs. The company’s improved gross margins suggest that the FTNT has been successful in implementing price increases. Moreover, the company achieved its highest annual product revenue growth rate in over 10 years in FY22, and while deceleration is expected in FY23, the company’s low-cost relative to performance, best-of-breed SD-WAN, and unified management are helping to consolidate its market share. FTNT is also expected to benefit from new ASIC product cycles and expanding firewall use cases. While cancellation rates are currently low, further worsening in the macro environment may result in higher cancellation rates. However, cancellations would need to be widespread among customers to have a meaningful impact due to the large volume of deals Fortinet has. The management has factored in elevated levels of cancellation in their outlook for 2023.

Valuation

FTNT trades at a significantly higher multiple compared with some of its peers, which is not surprising given the company’s high EPS growth over the previous few quarters and continued expectations of growth in the future. I believe the company will continue to trade at a high multiple in the future given strong demand for its core firewall, segmentation, SD-WAN, and OT security support products, along with the acceleration of subscription growth and gross margin expansion. Hence, I maintain a Buy rating on the stock with an end-of-FY2023 price target of $78 on a 30x EV/CY23 FCF, which is in-line with the company’s historical multiple.

Final Thoughts

I believe that FTNT will continue to see robust demand for its products related to core firewall, segmentation, SDWAN, and OT security, which will lead to significant revenue growth in the future. The company is also likely to benefit from a rise in subscriptions and an expansion in gross margins, which will contribute to its overall strength. I remain positive on the stock and currently maintain an end-of-2023 price target of $78 based on 30x EV/CY23 FCF.