This Cybersecurity Stock Has Everything

In Monday’s Spill, we explained how to use the price-to-sales (P/S) ratio to value different high-growth stocks.

Among them was Fortinet (FTNT).

While this company wasn’t our primary focus initially, the various valuation metrics and growth outlook intrigued us.

Plus it was the 4th most searched cybersecurity stock by financial pros last month.

Although Fortinet’s forward revenue growth is about half that of companies like Zscaler (ZS) and Crowdstrike (CRWD), we like the fundamentals behind the company much more.

Plus, analysts are likely underestimating their growth.

Fortinet’s Business

In the last year we saw hacks cripple a major natural gas pipeline and meat packer.

It’s estimated that cybercrimes cost $6 trillion in 2021. And that number is only going to grow.

Fortinet provides network security appliances and Unified Threat Management (UTM) network security solutions to enterprises, service providers, and government entities worldwide.

The company’s solutions integrate multiple levels of security protection including firewall, virtual private networking (VPN), antivirus, intrusion prevention (IP), web filtering, anti-spam and wide area network (WAN) acceleration.

Fortinet’s products and subscription services provide dynamic security protection while simplifying the IT security structure.

Its solutions incorporate application-specific integrated circuits, hardware architecture, operating system, and associated security and networking functions.

To give you an idea, retail users can select for SaaS services that secure content and devices while enterprises can opt for more comprehensive packages.

Fortinet sells its products and services through a network of more than 20,000 channel partners, distributors, resellers, etc. to more than 450,000 customers worldwide.

One key point to note – while many of Fortinet’s peers are focused mainly on cloud security, Fortinet is heavily invested in network security.

This is a much larger addressable market, which will be key to their total growth.

Now, a significant portion of total sales comes from the 10 biggest distributors of which the top 10 accounted for 31% of total revenues in 2019.

Fortinet’s revenues break down into products and subscriptions.

Subscriptions are the company’s bread and butter. However, their margins on products aren’t too shabby. Most competitors typically struggle to achieve gross margins north of 40%.

Financials

Fortinet has delivered remarkable growth over the last decade with a 10-year average revenue growth rate of 23.10% in 2020.

Over that same period, gross and operating margins improved as the company lapped capital investments and tightened SG&A spending.

That’s led to a consistent growth in operating and free cash flow which now exceeds $1.2 billion annually.

This is a key point because the company hardly carries any debt, only about $1 billion.

Yet, they also have $3.1 billion in cash on the balance sheet.

In fact, total current assets come out to $3.964 billion compared to total liabilities (not just current) of $4.853 billion.

That is a solid balance sheet management can leverage to invest in everything from research and development to acquisitions as needed.

Valuation

We want to go back to a valuation comparison we did the other day on Fortinet and several of its competitors.

Clearly, Fortinet’s P/E ratio isn’t something to write home about. And you might think that the price to cash flow ratio of 41.11x is a bit steep.

But, consider that Fortinet generated $1,252.5 million in free cash flow (operating cash less capex) on $3,126.6 million in revenues.

That means they generated 40c of cash for every dollar in sales.

That’s insane!

And it’s exactly why price-to-sales is a very relevant metric for Fortinet.

Because when we look at a forward P/S of ~14x, we know that our forward price to free cash flow comes in around 35x.

And with a market CAGR of +10% and market share growth, it’s easy to see why shares could go even higher.

Our Opinion – 8/10

We like FTNT right around $300 per share.

Management is generous with share buybacks, and has a huge amount of cash at their disposal.

Yes, this company looks expensive when you use traditional P/E metrics. However, we like to look at the P/S ratio in place of P/E because so much of sales drops to the bottom line.