Time To Buy This Cloud Pioneer On The Dip?

Cloud security company Zscaler, Inc. (NASDAQ:ZS) started in 2007 with the forward-thinking concept that the internet would turn into the main network for companies. They predicted early on that cloud technology would be the new data center and they were right. Today, over 40% of Fortune 500 businesses are using its services.

The company has over 41 million users using its services across a customer base of more than 7,700. Zscaler, which is now worth around $26 billion in the market is down 16% year-to-date, so is this an opportunity to buy a great company on the dip?

Cybersecurity Focus Paying Off In Spades 

In March, the company made public its new AI Security Report for 2024 spanning the period from April last year to January of this year and incorporating data from more than 18 billion artificial intelligence-driven transactions on the Zscaler Zero Trust Exchange cloud security platform.

It gives information about how businesses are using tools based on artificial intelligence and machine learning. The researchers at Zscaler ThreatLabz studied the changes in different industries and places, showing how companies change their ways to fit into the changing world of AI and how they address security threats when they use AI tools.

As businesses add new functions and tools that rely on AI, transactions volumes increase. ThreatLabz examined almost six times more transactions and handled 569 terabytes of data from businesses that were sent to artificial intelligence tools between September 2023 and January 2024.

The report showcases Zscaler’s expertise in AI-driven security solutions, enhancing its reputation and attracting more enterprises seeking advanced protection measures.

Plus, Zscaler’s collaboration with BT, which grew in March, strengthens its position in the market by providing a complete range of managed security services. These are built on its artificial intelligence-powered Zero Trust Exchange™ platform. The joint venture creates additional sources of income for Zscaler and brings more customers to it, pushing forward its business growth and increasing profits.

Zscaler has also shown a strong dedication to making the customer experience better by adding new and advanced features like ZDX Copilot, Hosted Monitoring, and Data Explorer to its Zscaler Digital Experience service. 

Furthering its focus on cybersecurity, Zscaler made a key move by acquiring Airgap Networks. When it combines Airgap’s tech into its own Zero Trust SD-WAN, full security options can be offered to devices linked to IoT/OT.

It also means Zscaler can take more market share and keep its advantage over competitors.

Revenues Still Growing Rapidly

Beyond cybersecurity, three primary elements contributed to Zscaler’s success during the fiscal 2024 second quarter.

Initially, the business was experiencing ongoing success in marketing its expanded suite of offerings, which encompasses ZPA, Data Protection, ZDX, and Zero Trust solutions for workloads and branch locations.

The number of customers who bring in $1 million annual recurring revenue increased by 31% compared to last year, reaching almost 500 such customers at quarter’s end.

It wasn’t a surprise to see that Zscaler reported a strong fiscal quarter with significant success in selling more services to top-tier government agencies. It has plenty of opportunity to expand further in the market.

Next, the company established a second-quarter record for adding new brands, displaying positive initial results from investing in its partner networks.

Second quarter earnings impressed too. Billings, revenues, and operating profits were higher than what the company had originally expected because customers embraced the Zscaler Zero Trust Exchange platform.

More customers understand now that old-style firewall security has problems, so they approach Zscaler with plans to replace their old security systems in favor of the Zero Trust architecture.

The result has been a boon to the top line with revenues reaching $525 million, an increase of 35% compared to last year and a rise of 6% from the previous sequence.

Looking at different regions, the Americas made up 54% of this income, EMEA contributed 31%, and APJ accounted for 15%.

In the second quarter, total calculated billings rose by 27% from last year, reaching $628 million. Compared to the previous quarter, total billings were up by 37%.

The company’s operating profit increased significantly. It was over two times higher compared to the same period last year, and the company achieved its highest-ever free cash flow margin for the second quarter.

During the same period, management made progress towards their goal to hit annual recurring revenues of over $5 billion.

Zscaler noticed an increase in customers with $100,000 annual recurring revenue this quarter. The number rose to 2,820 by adding 112 more customers. This persistent increase in the number of hig-paying customers shows how important Zscaler is for digital change projects.

Will Zscaler Stock Rebound?

Zscaler is succeeding in attracting new high-value customers paying more than $100,000 which suggests it’s only a matter of time before the stock rebounds.

Management is projecting revenue will land between $534 million and $536 million, indicating growth of close to 28% compared to last year. The gross margin is at 80%. Operating profit is between $98 million and $100 million, with other income at $15 million. Earnings per share is predicted to come in somewhere between $0.64 and $0.65.

For the full financial year, the company raised its forecasts and expects sales of between $2.118 billion and $2.122 billion, representing close to 31% growth compared to last year.

Expected billings are between $2.55 billion and $2.57 billion, which indicates an increase of 25% to 26% compared with last year’s numbers. Earnings per share are estimated at between $2.73 to $2.77.

Management anticipates an increase in its free cash flow margin compared to last year, aiming for just over 20%. It also maintains the forecast that spending on data center capital expenditures will be a high single-digit percentage of annual revenue. This is estimated to contribute around a 3% to 4% drag on the company’s free cash flow margins.

It’s cleat that management’s strategy is to invest heavily in order to grow over the long term and, at the same time, be profitable. With ever more high-paying customers, the prospects look promising for long-term shareholders.

How Do Analysts Rate Zscaler?

Zscaler now has customers in the double digits who spend over $10 million with them every year. 

For the ongoing quarter ending in July 2024, analysts expect growth of 24.2% in the top line and a raise of 4.5% in EPS from last year’s numbers for this period, with predictions of $565.03 million in revenue and an EPS value of $0.67.

Additionally, for the complete financial year of 2024, it is forecast that the company’s revenue and earnings per share will increase by 31.3% and 54.3%, compared to last year, reaching $2.12 billion and $2.76, respectively.

The company is succeeding on the margin front with its gross profit margin over the past 12 months at 77.55%, significantly above the industry average of 48.70%. Also, for this same period, levered free cash flow margin stands at 32.11%, far exceeding the industry’s average of only 9.52%.

Moreover, Zscaler’s capital expenditure relative to sales over the last 12 months, which is at 5.95%, exceeds the industry average of 2.32% by a margin of 156.5%. So, the fundamentals of the company seem to be in a good position right now.

Of 37 analysts, 28 recommend buying and 9 consider it a Hold. Analysts forecast fair value to be $258.52 per share, suggesting lots of upside still for new investors.

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The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.