Despite fourth-quarter guidance that slightly disappointed, like many of its peers, Fortinet (NASDAQ: FTNT) shareholders have enjoyed a stellar 2017. However, unlike some cybersecurity providers, including Palo Alto Networks (NYSE: PANW), Fortinet's strong performance is warranted.
Palo Alto has talked about paring overhead, but it isn't delivering the goods. Sure, Palo Alto's 27% jump in revenue to $505.5 million last quarter dwarfed Fortinet's "mere" 18% increase to $374.2 million. But unlike Palo Alto, Fortinet founder and CEO Ken Xie's pledge to become a more efficiently run cybersecurity provider is showing where it counts: the bottom line.
Good and getting better
In addition to Fortinet's strong total revenue growth, its expense management efforts are driving outstanding operating margins and earnings-per-share (EPS) growth. Last quarter's $33.7 million in operating income obliterated 2016's $5.5 million, as did Fortinet's 9% operating margin compared to 2016's meager 2%.
Another reason Fortinet will be flying high in five years is its revenue growth and manageable overhead are being driven by service sales. It simply costs less to service existing customers than relying solely on generating new sales, and the benefits of that philosophy were plain to see last quarter.
Though product revenue grew just 7% to $137 million in the third quarter, Fortinet's all-important service sales soared 26% to $237.1 million. Considering deferred revenue climbed an impressive 30% to $1.22 billion last quarter, it's safe to say Fortinet's service revenue and total sales will continue to rise in the quarters and years ahead.
Though operating expenses did increase last quarter, Xie's cost-cutting efforts are making their mark. Overhead was up, but only 9% to $246.9 million, which is more than acceptable given Fortinet's top-line gains. The end result was nearly quadrupling EPS to $0.15 a share compared to just $0.04 a year ago.
For some perspective, Palo Alto's operating expenses jumped 21% last quarter to a mind-boggling $418.4 million. Toss in its 40% jump in cost of revenue, and Palo Alto's EPS actually sank 11% to a loss of $0.70 a share. Palo Alto may wow investors with its top-line gains, but Fortinet is becoming more profitable with each passing quarter.
The road ahead
Not only is Fortinet delivering on its objectives of growing a reliable foundation of service revenue while paring overhead, its new end-to-end Security Fabric solution will be a boon going forward. Xie cited Fortinet's "large installed base of network security customers" as a significant in-house collection of potential security fabric customers.
With the growth of the Internet of Things (IoT), cloud, and infrastructure markets continuing to skyrocket, Fortinet is in the right place at the right time. The recent security breaches affecting millions around the world have driven home the value of Fortinet's solutions as well. In fact, cybersecurity will generate more than $200 billion in revenue by 2021, according to one conservative estimate.
Another arrow in Fortinet's quiver is the fact that its cost-cutting initiative and focus on generating service revenue are still in the relatively early stages. But as Fortinet demonstrated last quarter, the efforts are already paying dividends, which bodes well for the next five years -- and beyond.
Will Fortinet stock continue its torrid growth of 46% in 2017? That's a lot to ask of any company, but the basis for steady revenue and EPS growth in the coming years is clear to see. Analysts certainly seem to believe Fortinet will continue growing.
Today, Fortinet is trading at a lofty 91.8 times trailing earnings, though that's still below its peer average of nearly 143 times. However, looking ahead, Fortinet stock is valued at just 37 times earnings, making it a good value in addition to its upside potential.
The groundwork has been laid to build sustainable, consistently growing top and bottom lines in an industry with nearly limitless opportunities. For those reasons, the next five years will be a boon for Fortinet shareholders.
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