Zscaler: Time to Be a Contrarian?

Shares of IT security company Zscaler Inc. (NASDAQ:ZS) plunged nearly 20% after reporting fourth-quarter and fiscal year 2019 financial results on Tuesday.


While the company beat analysts' expectations for both revenue and earnings, its guidance for the first quarter and full fiscal 2020 were below the consensus forecasts.

Zscaler is a global provider of cloud security services. It operates through two main business verticals: internet access solutions and private access solutions.

The internet access solutions unit connects users to externally managed applications, including software-as-a-service applications and internet destinations. The private access solutions division provides access to internally managed applications and private or public clouds.

It serves clients in several industries, including consumer goods, retail, financial services, technology and communication services, among others.

The company is reportedly facing increased competition. At a recent investor conference, Kathy Bonanno, the chief financial officer of rival company Palo Alto Networks Inc. (NYSE:PANW), told investors that the Santa Clara, California-based cybersecurity company had taken clients form Zscaler, Symantec Corp. (NASDAQ:SYMC) and CrowdStrike Holdings Inc. (NASDAQ:CRWD).

During the earnings call, Zscaler CEO Jay Chaudhry was asked about the potential impact of competition from Palo Alto Networks and others. He said the customers the company loses to rivals are a distinct minority, adding that it wins almost every deal it competes for out in the market.

Quarterly financial highlights

Chaudhry's response to analysts would appear to be correct based on the company's most recent quarterly results. In the fourth quarter, revenue grew 53% year over year to $86.1 million. There was also a significant improvement in the bottom line as the GAAP net loss was $5.3 million, up from a $7 million loss in the same period last year.

Zscaler's gross billings also impressed with 32% growth to $125.8 million, while non-GAAP net income of $9.1 million improved from a loss of $1.4 million last year.

However, after delivering a market-beating earnings report, Zscaler issued guidance for first-quarter earnings of 0 cents to 1 cent per share. Analysts surveyed by FactSet had a consensus estimate of 2 cents per share. The company's full-year 2020 earnings forecast also fell short at 12 cents to 16 cents per share, compared to expectations of 19 cents.


Zscaler's top line is expected to continue to experience steady growth through 2021 as the company expands its addressable market by adding more industries to its portfolio of customers.

The cloud security services market will continue to experience increasing demand in the coming years, with new markets like cloud mining and other blockchain and cryptocurrency-related services driving growth. Some of the traditional computing software and service providers like Adobe Inc. (NASDAQ:ADBE), Kaspersky and McAfee, among others, have also switched to subscription-based business models.

These companies now offer their services via the cloud rather than off-the-shelf software in storage devices. This is creating accretive business opportunities for companies like Zscaler because enhanced cloud and cybersecurity services will be required.

From a valuation perspective, shares of Zscaler trade at a forward price-earning ratio of 155. This looks very expensive, but when you factor in the company's growth prospects for the next five years, the valuation becomes more compelling to growth investors. The current price-earnings to growth ratio (five-year expected) stands at just 1.53, which implies there are exciting times ahead.

In summary, given the stock's decline and the expected revenue and earnings growth in the coming years, buying now could prove to be profitable. Therefore, it could be time to be a contrarian on Zscaler.

Disclosure: No position in the stocks mentioned.

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This article first appeared on GuruFocus.