Zscaler: Preliminary Results Showcase Strength in Sales, Improved Profitability

Zscaler Stock at a Glance

• Fair Value Estimate: $170
• Morningstar Rating: 5 stars
• Morningstar Uncertainty Rating: High
• Morningstar Economic Moat Rating: Narrow

Zscaler Earnings Update

Narrow-moat Zscaler ZS put out preliminary fiscal third-quarter results ahead of its full release slated for the beginning of June, with sales and profitability exceeding our estimates. While we are not changing our $170 fair value estimate as we wait for full results, Zscaler’s impressive performance underscores our thesis that cybersecurity firms are relatively insulated from ongoing IT budget cuts. The shares are up more than 20% following the May 8 announcement. Despite the pop, we believe that Zscaler is undervalued, trading at an attractive price for long-term investors willing to stomach near-term volatility.

Zscaler indicated that third-quarter sales would be around $417 million, up from prior guidance of $397 million, both at the midpoint. Similarly, it expects adjusted operating profit to be around $62 million for the quarter, up from $56 million previously expected. While the firm didn’t lay out the source of the sales outperformance, we think it is likely to be a mixture of overly prudent guidance coupled with strong customer buying behavior as cybersecurity spending remains resilient despite the macro-induced spending slowdown.

Last quarter, investors focused on Zscaler’s billings growth, which had decelerated 300 basis points sequentially to 34%. As this is a forward-looking metric, investors were concerned about the company’s future performance. In the May 8 announcement, Zscaler alleviated these concerns, saying it expects third-quarter billings growth of 38%-39% year over year, or a 450-basis-point sequential increase at the midpoint. We believe that the strong billings growth, coupled with Zscaler’s strong revenue outlook, should allay investor concerns about the firm’s performance in a tight macro environment with clients optimizing spending and cutting parts of their IT budgets.