ZS - Zscaler Q1: Incredible Earnings But Valuation Is Hard To Justify

2023-11-29 09:00:00 ET

Summary

• Zscaler reported robust fiscal first-quarter earnings, with revenue of $496.7M, up 39.7%.
• The company upgraded its full-year revenue outlook and adjusted operating profit estimates for FY24, demonstrating its resilience.
• Zscaler's zero-trust cloud security market leadership has fended off threats from legacy vendors while taking share against point vendors.
• The company remains well-positioned to benefit from secular tailwinds in the cloud security space as customers continue consolidating with the leading players.
• I argue why, while ZS is a solid stock, I'm not convinced it's worth paying a forward adjusted P/E of nearly 80x to buy more into its growth story now.

Zscaler First Quarter Earnings

Zscaler ( ZS ) reported its fiscal first-quarter or FQ1 earnings release this week. While there were initial concerns over a slowdown in its billings growth cadence, investors have shrugged them off as ZS recovered remarkably. As a result, ZS last traded close to the week's highs, at the $195 level, in line with last week's optimism. Notwithstanding its steep growth premium, investors aren't duly concerned, as buyers returned to the leading cloud-native cybersecurity stocks.

Zscaler is the leading zero-trust leader in its field. In my previous article , I highlighted lingering concerns with Microsoft's ( MSFT ) entry into the SSE space. However, given Zscaler's market leadership, I stressed that I remained constructive on ZS, although I preferred to buy on a steeper pullback. However, while there was a selloff toward its mid-August low ($130 level), buyers returned confidently in defending against a further slide as ZS bottomed out. As a result, ZS Bulls, who added at that level, have enjoyed a remarkable three months, as ZS gained nearly 50% through this week's highs.

I admit I didn't anticipate such a remarkable recovery for ZS in such a short period as it re-tested its September 2022 highs. The company's recent earnings release underscored that market participants have looked past a near-term growth normalization as investors focus on the company's ability to gain operating leverage.

Accordingly, Zscaler reported revenue of $496.7M in FQ1, up 39.7%, justifying investors' optimism. Therefore, I believe the company has managed the increasingly competitive landscape confidently, even as legacy operators intensify their investments and focus on cloud security. Notably, the company upgraded its FY24 guidance, lifting its full-year revenue outlook to a range of between $2.09B and $2.1B for a midpoint metric of $2.095B. Moreover, the company also lifted its adjusted operating profit estimates to $$362.5M at the midpoint, up from its previous midpoint guidance of $335M, representing an uplift of more than 8%.

Notwithstanding a near-term expected slowdown in its full-year calculated billings growth (midpoint: 25%), investors likely have priced in the challenges.

Management's commentary suggests it continues to see deal scrutiny but observed a " slight reduction " in intensity. In addition, the company doesn't expect the macroeconomic headwinds to worsen, which aligns with the current market consensus. Therefore, I assessed that dip buyers who added more positions in August have been duly rewarded for their conviction that ZS should continue to see market share gains as it cross-sells and consolidates from point vendors. In addition, the company experienced solid growth momentum in the federal business, up 90% YoY. Therefore, it's reasonable to assume that Zscaler remains well-positioned as a zero-trust cloud security leader, benefiting from industry consolidation and customer confidence.

With ZS priced at a forward adjusted P/E of 78x, I believe it's justified to be increasingly cautious about adding more ZS at the current levels. While I have yet to assess clear red flags (sell signals), it's arguable that ZS looks fully valued at the current levels. Even bullish Wall Street analysts' consensus price target of $199.6 suggests a potential upside of only 3%. Coupled with the re-test of ZS's September 2022 highs, I believe buying enthusiasm could be tempered at the current levels, allowing some welcomed shake-out of late buyers.

Is ZS Stock A Buy?

Zscaler is a high-quality cloud security company that has proved its worth and performance. Its sticky and robust product portfolio demonstrates significant growth momentum as customers consolidate with the leading vendors.

However, caution must be heeded with a forward adjusted P/E nearing 80x, as ZS advances with little potential upside to spare against bullish Wall Street's consensus price targets. Investors keen to add exposure should consider adding aggressively at its next steep pullback.

Rating: Maintain Hold.

Important note: Investors are reminded to do their due diligence and not rely on the information provided as financial advice. Please always apply independent thinking and note that the rating is not intended to time a specific entry/exit at the point of writing unless otherwise specified.

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