2023-09-11 13:38:09 ET
Summary
- We remain buy-rated on Zscaler, Inc.
- Despite increased macro uncertainty and competition, we think Zscaler is uniquely positioned to benefit from the industry-wide shift towards new architecture in the zero-trust market.
- We think Zscaler's approach to selling its full platform suite over its traditional sales method will drive faster growth.
- Large projects put on hold in late 2H22 and 1H23 are starting to move forward again, which leads us to believe that demand in the SSE market will improve further.
- Despite its high valuation, we expect Zscaler, Inc. to continue to outperform its peer group.
We maintain our buy on Zscaler, Inc. ( ZS ), as we expect the stock to outperform the peer group. The zero-trust market is projected to reach $126.02B by 2031, growing at a CAGR of 18. 5 % from 2022-2031, and we believe ZS remains uniquely positioned to benefit from the shift to new architecture in the zero-trust market. ZS exchange protects thousands of customers and clients from cyberattacks and data loss by securely connecting users and applications at any location. With over 150 data centers globally, the SSE-based zero trust exchange is the world's largest inline cloud security platform. We see a favorable risk-reward profile for the stock into 2024.
ZS has outperformed the S&P 500 (SP500) YTD by 27%; the stock is up an impressive 52% over the past six months and 11% over the past month, outpacing the S&P 500 by 37% and 11%, respectively, during those periods. Macroeconomic headwinds, i.e., higher interest rates and inflationary pressure, saw the stock bottom at $84.93 per share alongside the broader cybersecurity peer group, including CyberArk (CYBR), Fortinet (FTNT), Palo Alto Networks (PANW), before jumping more than 20% on May 8th when ZS raised forecast above expectations improving FY23 outlook. Although investor concern exists over high valuation and slowing growth, we believe ZS will outperform the peer group in 2024, driven by new architecture and resilience to macro uncertainty.
Below is the ZS YTD chart compared to the S&P 500.
YCharts
What is Zero-Trust?
Zero-trust security was founded on the principle of never trust always verify; unlike the traditional ways of cyber protection that assume trust is given once access is granted, zero-trust operates assuming that threats come from both external and internal sources. In other words, imagine a house with different rooms; in the zero-trust model, every time you want to enter a room, you have to identify yourself, while in the traditional model, you get access to every room once you enter the house. To implement zero-trust, you need stringent identity verification, you need to grant access to necessary data rather than a range of related data to tighten access pathways, and the network for data management needs to be segregated and limited in access to users and devices with abnormal behavior. Zero trust security is relevant now more than ever in our digital landscape, and that's where we expect ZS to thrive. We're seeing more and more remote work and a digital transition of workloads to the cloud; this is why cybersecurity continues to be a top IT spending priority despite macro uncertainty. While cybersecurity stocks' performance this year has been rocky, we don't think this is due to a lack of growth but due to a combination of a cost-cautious environment and investor concern over the macro environment. At the end of the day, we think cybersecurity is relatively recession-proof and believe ZS is uniquely positioned to benefit from the Zero-Trust market opportunity.
This quarter, ZS successfully doubled annual recurring revenue, or ARR, from $1B to $2B in seven quarters, a milestone achieved by only a handful of SaaS companies. ZS amassed a customer base exceeding 7,700, with more than 41M users benefiting from its services. In a world driven by cloud, A.I., and mobility, everyone is seeking to embrace zero-trust architecture. ZS sets its eyes on a $5B in ARR objective, and its mission is clear: to extend the reach of zero-trust everywhere to users, workloads, and OT systems and become the preferred platform for vendor consolidation and cost-cutting, all while providing top-notch cybersecurity and data protection. We think this is a realistic goal given how A.I. has both expanded the threat landscape and simultaneously provided new avenues to secure data. Additionally, we think ZS's approach to selling its full platform suite over its traditional sales method will drive faster growth into 2024.
Below is a figure from ZS's earnings presentation highlighting the multiple new records set during the past quarter.
Double-digit growth to continue into 2024
ZS delivered strong results this quarter ; billings, revenue, and profitability exceeded expectations and were well above sell-side estimates. In the fourth quarter, the company reported revenue up by 43% Y/Y, reaching $455M. Calculated billings showed robust growth with 38% Y/Y growth totaling $719.3M. Deferred revenue also saw a substantial uptick of 41% Y/Y to reach $1.44B. Bottom line, the company's GAAP net loss decreased significantly to $30.7M compared to a GAAP net loss of $97.7M on a Y/Y basis. Additionally, the company reported non-GAAP net income of $100.9M compared to the non-GAAP net income of $36.4M the previous year.
Gazing at the company's fourth-quarter guidance, ZS anticipates adjusted net income per share of around $0.48-$0.49 on revenue of $472M to $474M. We think management's outlook is favorable, above estimates of $0.46 on revenue of $464.7M. The below graph summarizes ZS's impressive guidance for 1Q24 and FY24.
Post-earnings, ZS stock dropped around 8% on a disappointing growth outlook. Management expects revenue in the range of $2.05B to $2.065B for FY24, while analysts predict revenue of $2.05B. Based on ZS's outlook, sales growth would slow to roughly 27% in FY24 from 48% in FY23. Nonetheless, we believe that ZS will have ample opportunities to increase guidance given the fact that large projects put on hold in 2H22 and 1H23 are starting to move forward again, leading us to believe that the demand in the SSE market will improve further into 2024. Below is the chart outlining 4Q23 highlights, with more than 40% of their customers coming from Fortune 500 companies, 30% from global 2000 companies, and 43 companies having a $5M plus ARR.
Valuation
ZS is trading above the peer group average, but despite the higher valuation, we see attractive entry points as we see the stock outperforming into 2024. We believe ZS should be seen on an Enterprise to Value ratio; for CY24, ZS is trading at a 10.1 multiple compared to the industry average of 6.7x. On a Price-to-earnings ratio, ZS is trading for CY24 at 67x with an EPS of $2.43 versus the peer group average of 78x. We believe ZS is at the front of a large secular growth opportunity as architectures move to the cloud in SSE environments. This is why we think ZS will grow into its hefty valuation.
The below figure was made using Refinitiv data and outlines ZS's valuation.
TSP
Word on Wall Street
Wall Street shares our bullish sentiment on the stock. Of 43 analysts covering the stock, 29 are buy-rated, 14 are hold-rated, and zero are sell-rated. The stock closed on Friday 8th of September at $163. Using the median of the Wall Street price target of $185, we can calculate a 14% upside and a 12% using the mean price target of $182.
The below outlines ZS sell-side ratings and price-targets.
TSP
What to do with the stock
Despite growing macroeconomic uncertainties and heightened competition, our rating for Zscaler, Inc. remains a buy, as we believe the company is well-positioned to thrive in the current landscape. ZS stands out due to its strategic advantage and capitalizing on the industry-wide shift towards new architecture within the Zero-Trust market. Their approach of offering the full platform suite is expected to fuel growth with the support of the resurgence of large projects previously put on hold. The SSE market is on a favorable path, and ZS maintains dominance. While ZS has a high valuation, we believe it'll continue outperforming its peer group and reiterate our buy rating.
For further details see:
Zscaler: Maintaining Buy, Expected To Outperform Into 2024