A huge addressable market could eventually help cybersecurity company Zscaler get back in the good books of investors.
This has been a forgettable year for Zscaler (ZS 2.01%) investors so far: Shares of the cybersecurity specialist have lost 30% of their value year to date, and things went from bad to worse for the company following the release of its fiscal 2024 fourth-quarter results on Sept. 3.
Though it delivered better-than-expected numbers, Zscaler’s stock plunged by 17% the day after that quarterly report as management’s guidance for the current quarter and the new fiscal year were well below expectations. Let’s look at the reasons why Zscaler’s guidance wasn’t up to the mark and consider whether this drop in this stock’s price should be viewed as a buying opportunity.
Zscaler’s guidance points toward a significant slowdown
In its fiscal Q4, which ended July 31, Zscaler’s revenue increased 30% year over year to $593 million, which was well ahead of Wall Street’s consensus estimate of $568 million. The cybersecurity company’s adjusted earnings increased 37% to $0.88 per share, crushing the consensus estimate of $0.69 per share.
That impressive growth was a result of the company’s expanding customer base, as well as an improvement in customer spending. For instance, the number of large customers that have generated more than $1 million in annual recurring revenue (ARR) for Zscaler increased 26% year over year to 567. Meanwhile, the number of customers with more than $100,000 in ARR jumped by 19%.
On the latest earnings conference call, Zscaler CEO Jay Chaudhry remarked that the demand for Zscaler’s zero trust security solutions remains solid, while the emergence of generative artificial intelligence (AI) is “creating new avenues of growth for us.” However, it looks like Zscaler’s catalysts are going to take a backseat in the first half of the new fiscal year.
The company is forecasting $605 million in revenue in the first quarter of fiscal 2025, which would be a 22% increase from the same quarter last year. It expects non-GAAP net income to land at $0.625 per share, a decline from the prior-year period’s reading of $0.67 per share. In short, Zscaler’s top-line growth is set to slow down considerably in the current quarter, with management pointing out that “the macro remains challenging” and noting that customers are still scrutinizing large deals.
In simpler words, Zscaler management says that the company is currently witnessing a challenging spending environment. That could be attributed to a slowdown in enterprise spending on account of higher interest rates and a tepid economic situation. At the same time, the lower margin profile of Zscaler’s emerging products and the company’s investments in cloud and AI infrastructure explain why its earnings are set to shrink in the current quarter. Before the latest report, consensus estimates had been forecasting $0.73 per share in earnings for fiscal Q1.
The guidance for the full year isn’t very promising either as Zscaler expects its top line to land at $2.61 billion. That would be a 20% increase from fiscal 2024 levels when the company’s top line increased by a healthy 34%. Also, the full-year earnings guidance of $2.84 per share is way lower than the $3.33 per share consensus estimate and would be a contraction from the $3.19 per share it earned in fiscal 2024.
In all, it is not surprising to see why investors pressed the panic button following Zscaler’s latest report. However, there are a few details that suggest that this company could stage a turnaround.
Looking past the company’s cautious guidance
There is no denying that Zscaler’s sell-off following its latest quarterly report seems justified. But at the same time, investors shouldn’t miss the fact that the company is building a robust long-term revenue pipeline that could help it regain its mojo.
More specifically, Zscaler’s remaining performance obligation (RPO) stood at $4.4 billion last quarter, an improvement of 26% from the same quarter a year earlier. Additionally, its dollar-based net retention rate of 115% indicates that its existing customers continue to spend more money each year on its offerings. (This metric compares the spending by a company’s established customers in a quarter to the spending by those same customers in the same quarter last year, so a reading of more than 100% means that the adoption of Zscaler’s cybersecurity services is improving.)
Moreover, Zscaler asserts that it has a total addressable market (TAM) worth $96 billion, which leaves it plenty of opportunities for growth. So the troubles that Zscaler is facing right now could eventually pave the way for stronger growth in the future. That’s the reason why it could turn out to be a smart buy for opportunistic investors looking to add a potential growth stock to their portfolios.
After the recent pullback, Zscaler stock is trading at 10 times sales, significantly lower than its five-year average sales multiple of 22. Of course, that lower sales multiple can be attributed to its forecast for a near-term slowdown in its growth, but if its fortunes rebound when macro conditions ease, that valuation could look like a bargain in retrospect, particularly considering its solid revenue pipeline and sizable addressable market.
Harsh Chauhan has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Zscaler. The Motley Fool has a disclosure policy.
