What happened
Shares of cybersecurity disruptor Zscaler (ZS -2.34%) rocketed 50.4% higher in May, according to data from S&P Global Market Intelligence.
Zscaler had fallen far off its all-time highs coming into the month, as the bubble-like valuations of the pandemic period ran into rapid interest rate increases, fears over recession, and a slowdown in software purchasing on the part of large enterprises over the past year.
However, Zscaler seemed to prove its unique advantages in May, as it preannounced third-quarter revenue and earnings far above its initial guidance given in early March. That bucked the slowing trend other software firms have recently experienced, showing Zscaler to be a standout all-star stock in the cybersecurity realm.
So what
On May 8, Zscaler issued a press release preannouncing its fiscal third-quarter results, which came in significantly ahead of expectations. The new revenue guide topped its initial outlook by about 5%, which is a significant positive change in a rather short amount of time.
In the pre-announcement, CEO Jay Chaudhry noted: "We had a strong finish to the quarter as the high ROI of adopting the Zscaler Zero Trust Exchange platform continues to resonate with customers and prospects in this challenging macro environment... Our customer engagements are strong, and our platform continues to expand with innovations that solve our customers' real-time IT challenges."
When Zscaler wound up reporting those earnings results on June 1, results were even slightly better than that initial preannouncement, as seen in the chart:
|
Metric |
Initial Q3 Guidance |
Q3 Actual Results |
|---|---|---|
|
Revenue |
$396 million-$398 million |
$419 million |
|
Adjusted (non-GAAP) operating income |
$55 million-$56 million |
$63.9 million |
|
Adjusted EPS |
$0.39 |
$0.48 |
Data source: Zscaler Q3 2023 earnings presentation.
How is Zscaler defying the broader slowdown? Well, one of Zscaler's advantages is that the adoption of its Zero Trust software platform can displace a lot of legacy technologies, such as network firewalls and virtual private networks (VPNs). So there is not only a protection and performance angle, but also a financial rationale for upgrading to Zscaler, which the company is taking advantage of now.
On that note, Zscaler recorded a net retention rate above 125% and a net promoter score over 70, along with a number of high-profile customer wins with customers needing top-notch security, such as government agencies and global financial institutions.
ZS PS Ratio data by YCharts
Now what
While C-suites are definitely scrutinizing software spend more closely than they were during the pandemic, this pattern could actually lead to a handful of winners, as these executives look to consolidate multiple vendors into fewer winners to simplify operations and limit costs. So, while many software companies are "losing" in this transition, a handful of cybersecurity and enterprise software companies may actually come out winners from this downturn.
It appears that Zscaler is one of those winners. However, its valuation is also quite high, at 13.9 times this fiscal year's revenue forecast.
That being said, with revenue projected to grow 46% this year, it's perhaps not unreasonable. Management believes it's attacking a $72 billion addressable market, so Zscaler's current revenue around $1.6 billion still leaves room for ample growth. For younger growth stock investors with a long time horizon, it's a name to watch and potentially buy on any dips.
