Is Zscaler Stock a Buy After Earnings?

Zscaler ZS released its second-quarter earnings report on July 31. Here’s Morningstar’s take on Zscaler’s earnings and stock.

Key Morningstar Metrics for Zscaler

• Fair Value Estimate: $213.00
• Morningstar Rating: 4 stars
• Economic Moat: Narrow
• Morningstar Uncertainty Rating: High

What We Thought of Zscaler’s Q2 Earnings

• We were quite happy with Zscaler’s results and top-line growth in its core and emerging businesses.
• Management is undertaking a sales reorganization which will depress billings in the first half of the year, which is likely why the stock dropped after earnings. We view these headwinds as temporary and believe Zscaler is attractively priced for investors looking for high-quality cybersecurity exposure.
• Emerging products constituted 22% of new business, which the firm believes will scale up to 25%, showing robust adoption of its newer products. We view this as a good sign which dovetails with our vendor consolidation thesis as well: Customers are buying more security from fewer vendors, a trend we see benefitting large players like Zscaler.
• We’d remind investors again that while they are an important forward-looking metric, billings cannot be used as a proxy for long-term growth. If the firm faces a billings deceleration due to a shift in go-to-market strategy, we see billings growth reaccelerating as the sales reorganization is done properly. While one could argue for execution risk amidst a change in the go-to-market strategy, we think Zscaler’s track record of strong execution and impressive product capabilities will let it manage the shift and execute strongly.

Fair Value Estimate for Zscaler

We are maintaining our fair value estimate of $213 per share after the firm closed fiscal 2024 with robust financial results offset by weaker-than-expected top-line guidance for fiscal 2025. As in previous quarters, we continue to be impressed by Zscaler’s strong execution in its emerging products category, which offers the firm a new leg of top-line growth over the medium term. In a fragmented security market, we believe large vendors like Zscaler have a great consolidation opportunity as customers increasingly turn to multisolution vendors at the expense of point-solution providers.

The firm’s shares dropped sharply after hours, as investors were likely left disappointed by its initial guidance for fiscal 2025. We view this adverse reaction as unwarranted for two reasons. Management previously told investors that fiscal 2025 would start weak due to changes in sales organization, with an uptick in sales personnel churn in the third quarter. Secondly, we believe a near-term bump shouldn’t deter investors from watching Zscaler’s attractive long-term growth and profitability opportunities. Overall, we view Zscaler as undervalued and see shares trading at an attractive price for long-term investors seeking high-quality cybersecurity exposure at a discount.

Read more about Zscaler’s fair value estimate.

Economic Moat Rating

We assign Zscaler a narrow moat, owing primarily to strong switching costs and a network effort associated with its offerings. We believe the company’s industry-leading zero-trust security solutions will continue to see robust enterprise adoption, allowing it to both retain and expand its footprint within existing organizations, while also allowing the company to land new customers. As a result, we forecast Zscaler to generate excess returns over invested capital over the next decade.

As we look at the broader cybersecurity space, we believe the complexity and intensity of threats are always increasing. Enterprises continue to adopt software-as-a-service solutions, undergo digital transformations, and migrate to the cloud, all while employees continue to work remotely part-time. In turn, we see the number of attack vectors rapidly growing. Similarly, the intensity of digital threats is on the rise, with higher costs for a data breach, including punitive fines.

Read more about Zscaler’s economic moat.

Financial Strength

We view Zscaler’s financial position as healthy. The firm ended fiscal 2024 with around $2.4 billion in cash and liquid investments. While Zscaler does carry debt of around $1.1 billion on its balance sheet, we believe that the firm’s cash reserves coupled with its ability to generate healthy cash flow from its business will be sufficient to cover its commitments over our explicit forecast.

Read more about Zscaler’s financial strength.

Risk and Uncertainty

We assign Zscaler a High Uncertainty Rating due to the ever-shifting cybersecurity space. While the company has positioned itself well to benefit from secular tailwinds, such as a shift to zero-trust security and the convergence of networking and security, the cybersecurity space is known for rapid development. Large incumbents like Zscaler stand to be disrupted by upstarts that could offer better performance in key modules. To stay ahead of the pack, Zscaler has invested a great deal in building out its ZIA and ZPA solutions. However, a shifting demand landscape and newer products that impact Zscaler’s competitive positioning are a risk.

Read more about Zscaler’s risk and uncertainty.

ZS Bulls Say

• Zscaler has strong secular tailwinds, as the convergence of networking and the security market is in its early innings.
• Zscaler has market leadership and high enterprise penetration through its offerings related to secure web gateways and zero-trust network access.
• The consolidation of security vendors should benefit Zscaler, which has a wide array of solutions across an enterprise’s network security stack.

ZS Bears Say

• Large public cloud vendors often offer their own cybersecurity solutions, which could hamper Zscaler’s growth opportunities.
• Zscaler faces competition from vendors like Palo Alto Networks PANW and Fortinet FTNT, which have increasingly invested in the key areas where the firm has market-leading positions.
• There always remains a risk that Zscaler may miss out on the next big technology, allowing competitors to catch up.

This article was compiled by Frank Lee.