Fortinet's Underappreciated Growth Story

Fortinet Inc FTNT is an underappreciated subscription growth story, Deutsche Bank said in a Tuesday note. 

The firm upgraded Fortinet from Hold to Buy and raised the price target for shares of the company from $36 to $48. 

In afternoon trading Wednesday, shares of Fortinet were rallying by about 2.25 percent to $40.13. 

Fortinet will continue to gain market share in the network security space, with shares expected to increase to about 20 percent of the network security market's absolute dollar growth in 2017 from just over 10 percent today, said analyst Gray Powell.

The Street is underestimating the benefits of the company's mix to subscription, Powell said. (See Powell's track record here.) The shift to subscription services creates a potential for margin improvement, with about 90 percent of growth expected to be driven by higher margin subscription services, the analyst said. 

Over the next three years, Powell projects an improvement in gross margins of 250 basis points due to the change in mix in favor of subscriptions, which carry an 85 percent gross margin compared to 60 percent for products.

Fortinet is likely to meet or exceed Street revenue estimates over the next three years, even with conservative product assumptions, according to Deutsche Bank. The firm is of the view that Fortinet can grow total revenues at a CAGR of 14 percent from 2017 through 2020.

"We view FTNT as a company with mid-teens revenue and high teens normalized free cash flow growth over the next three years — which we think creates a compelling risk reward at current valuation levels," Gray said. 

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