Zscaler’s Resilience: Navigating Success Beyond COO’s Departure (NASDAQ:ZS)

Investment Thesis

Zscaler’s (NASDAQ:ZS) Chief Operating Officer has resigned, effective immediately. Given that Zscaler has succeeded in once again reigniting its traction and revenue growth rates, I declare that investors should look beyond this resignation as a material detraction from the bull case and instead focus on the company’s underlying prospects.

According to my estimates, Zscaler is priced at 68x forward non-GAAP operating income. I believe this multiple is justified for a company possibly going to grow by 36% CAGR in its fiscal 2024.

Rapid Recap

Back in November, I found myself on the sidelines on this stock, when I said:

I make the case that Zscaler has plenty of positive elements supporting its stock, but there are also negative elements that will continue to weigh on its stock, particularly having to pay 71x forward EPS for Zscaler.

It’s not that there’s anything meaningfully wrong with Zscaler, although I do highlight some pesky detractions from its bull case, it’s simply that its high valuation means that its stock is slightly ahead of its narrative already.

Following another set of quarterly results from which to base my rating, together with the expectations of a lower interest rate environment, suddenly the detraction to the bull case, namely Zscaler’s high valuation recedes. Therefore, I now find myself bullish on this stock, and upwards revised my rating to a tepid buy.

Zscaler’s Near-Term Prospects

Zscaler is a cybersecurity platform focused on providing seamless access to applications. Their Zero Trust Exchange platform eliminates the need for traditional on-premises security appliances, offering an efficient and secure way to connect users and devices.

Zscaler’s solutions cover SaaS access, data protection, and secure private application access. They address diverse use cases, including protection against cyber threats, data loss prevention, and secure access to internal and external applications.

The company’s emphasis on data protection and secure application access has gained the trust of many enterprises, allowing them to safeguard their networks and data from cyber threats. Consequently, as a reference point, consider the graphic that follows.

What you see above is that Zscaler’s customer adoption curve is stably growing in the mid-teens. This should reinforce my bull thesis that this business still has a lot of steam left in the tank and that there’s no immediate need to be overly concerned about the potential for customer adoption maturation.

Incidentally, along these lines, consider the graphic that follows where you can see investors’ appetite for cybersecurity stocks.

I own and recommend Palo Alto Networks (PANW) and SentinelOne (S). And I find it impressive that even the group’s laggard, PANW, has delivered tremendous performance and is up more than 40% in the past 3 months. In other words, investing in cybersecurity has been terrific, where even the laggard has outperformed the S&P 500 (SPY).

Accordingly, given this backdrop, I now come to the crux of my argument.

News that Chief Operating Officer Dali Rajic is setting down should not cause undue concern for investors. Not only is investor appetite for this sector very strong as we’ve already discussed, but also, Rajic didn’t own a lot of stock in the company as it was, meaning not a lot of skin in the game.

With this backdrop in mind, let’s turn to Zscaler’s fundamentals.

2024 Is Going to be Another Sizzler

Zscaler has guided for close to 32% CAGR for fiscal 2024. For a company that in fiscal Q1 2024 delivered 40% CAGR, this outlook appears to be very much achievable.

What’s more, consider the graphic that follows.

What you see above, is that if put aside fiscal Q3 2023 (ending April 2023), for the most part, Zscaler is extremely conservative with its guidance, so that they often beat on the topline by approximately 4 percentage points or slightly more.

Consequently, when Zscaler is guiding for close to $2.1 billion on the topline, it’s fair to presume that closer to $2.3 billion in revenues may be the final figure that its revenues arrive at in fiscal 2024, meaning 36% CAGR for fiscal 2024.

Next, we’ll discuss its valuation.

ZS Stock Valuation – 68x forward non-GAAP Operating Income

I estimate that Zscaler is likely to make $500 million of non-GAAP operating income as a forward run-rate this upcoming year. On the surface, this appears expensive. Indeed, I recognize this assertion too, particularly when the share price has already been on a tear in the past year, plus its Chief Operating Officer is stepping down.

However, when it comes to investing, it makes no difference where the share price has come from. The only thing that matters is where the share price is headed over the coming year.

Moreover, given that its customer adoption curve remains strong and stable, which is allowing the company to guide toward 32% to 36% CAGR for the year ahead, I don’t suspect that paying 68x forward non-GAAP operating profits is a fair entry point.

While Zscaler is not the cheapest stock in cybersecurity, it’s certainly not a bad investment either.

The Bottom Line

In wrapping up, notwithstanding the recent departure of Zscaler’s Chief Operating Officer, my optimism regarding the investment thesis is due for an upgrade.

Zscaler has effectively reignited traction and demonstrated robust revenue growth rates, projecting a potentially noteworthy 36% CAGR for fiscal 2024. Despite the COO’s exit, I urge investors to shift their attention to the company’s underlying potential.

Granted Zscaler’s seemly rich valuation, which stands at 68x forward non-GAAP operating income, my conviction is that this figure is justified. This is especially true when considering Zscaler’s solid fundamentals, the steady growth in its customer adoption curve, and the broader strong performance of the cybersecurity sector.

In essence, despite not being the most affordable stock in the cybersecurity realm, I believe Zscaler represents a compelling investment, given its potential for sustained growth and success.