Zscaler's (ZS 3.48%) stock price jumped 13% on Friday, May 27, after the cybersecurity company posted its third-quarter earnings report. Its revenue rose 63% year over year to $286.8 million, which beat analysts' expectations by $15.3 million. Its adjusted net income increased 15% to $24.7 million, or $0.17 per share, which also topped estimates by six cents.
Those growth rates were impressive, but will Zscaler's stock stabilize after being cut in half over the past six months? Let's review four reasons to buy Zscaler and one reason to sell it to find out.
Image source: Getty Images.
1. A disruptive approach to a niche market
Zscaler specializes in "zero trust" security solutions, which treat everyone, including an organization's most trusted employees, as potential threats. As a cloud-based service, Zscaler doesn't require any on-site appliances, which can be more difficult to maintain and scale as an organization expands.
That flexible business model makes it comparable to CrowdStrike (CRWD 3.63%), which provides endpoint security services with a cloud-native platform called Falcon. However, Zscaler focuses on the narrower niche of zero-trust security services -- a market that could still grow at a compound annual growth rate (CAGR) of 18% from 2021 to 2026, according to Mordor Intelligence.
Other diversified cybersecurity companies like CrowdStrike and Palo Alto Networks (PANW 4.19%) have also been rolling out zero trust services, but Zscaler still enjoys an early mover's advantage.
2. It's growing like a weed
Zscaler's revenue growth accelerated significantly in both fiscal 2021, which ended last July, and the first nine months of fiscal 2022.
|
Period |
FY 2020 |
FY 2021 |
9M 2022 |
|---|---|---|---|
|
Revenue |
$431.3 million |
$673.1 million |
$772.9 million |
|
Growth (YOY) |
42% |
56% |
62% |
Data source: Zscaler. YOY = Year over year.
In its third-quarter report, it raised its full-year revenue guidance from 55%-56% growth to 60% growth. Analysts had expected its revenue to rise 56% for the full year and 36% in fiscal 2023.
3. Robust growth in large customers
Zscaler also continues to lock in large customers that generate more than $1 million in annual recurring revenue (ARR). Its number of customers that fit that profile rose 77% year over year to 288 in the third quarter. It also gained 140 new customers that generated over $100,000 in ARR, which expanded that higher-value group to 1,891 customers.
4. Stable gross and operating margins
Zscaler's gross and operating margins also remain stable on a non-generally accepted accounting principles (non-GAAP) basis, and its free cash flow (FCF) margins continue to improve.
|
Period |
FY 2020 |
FY 2021 |
9M 2022 |
|---|---|---|---|
|
Gross Margin |
80% |
81% |
81% |
|
Operating Margin |
7% |
12% |
10% |
|
FCF Margin |
6% |
21% |
20% |
Data source: Zscaler. Non-GAAP.
It's generating those stable margins even as it expands its lower-margin "emerging" products like ZDX (digital experience monitoring), CSPM (cloud configuration security), and workload segmentation services to grow its ecosystem and lock in its customers.
Zscaler also raised its full-year non-GAAP earnings per share (EPS) guidance from 4%-8% to 23%-25%. Analysts had expected its non-GAAP EPS to grow 8% this year and 70% in fiscal 2023.
The one reason to sell Zscaler: its valuation
Zscaler is still growing like a weed, but its GAAP net losses are still widening. Therefore, most investors will still value it by its price-to-sales ratio. Zscaler currently trades at 21 times its own sales estimate for fiscal 2022, which is still a premium valuation in this challenging market.
For reference, CrowdStrike trades at 17 times this year's sales, while Palo Alto -- which is growing slower -- trades at nine times this year's sales. Therefore, Zscaler's valuation could limit its upside potential, even if its higher guidance prompts analysts to raise their estimates for fiscal 2023.
Its strengths outweigh its weaknesses
Zscaler's stock got overheated during the growth and meme stock rally last year. But today it looks a lot more attractive, even if its valuations are still a bit frothy for a market that seems allergic to growth stocks. I believe it's safe to nibble on Zscaler at these levels, but investors should brace for a lot of near-term volatility as macroeconomic headwinds continue to rattle the markets.
