Zscaler: A Textbook Buy-the-Dip Opportunity

Key Points

• Zscaler's price plunge following the FQ1 release is a textbook buy-the-dip opportunity for investors. 
• The robust report's only flaw is that it failed to impress analysts who had set a high bar.
• Ironically, the analysts are raising the consensus price target following the release, leading the market to a nearly one-year high. 

Zscaler NASDAQ: ZS shares tanked more than 7% in premarket trading following its FQ1/CQ3 earnings report, opening a textbook buy-the-dip opportunity. The results failed to impress the analysts, but that is the only thing wrong with the report. The analysts had set a high bar for the company to beat, and the results were as expected, which is excellent. The takeaway is that sentiment took a hit but not the fundamental outlook, which is robust. 

Zscaler is on track to produce GAAP profitability, has solid cash flow, and is building value for investors in a world where its services are in high demand. The world continues to digitize, and businesses need to capitalize on their data and be secure while doing so. That is where Zscaler excels—aiding businesses in digital transformation, keeping them secure, and helping them scale to new heights. 

Zscaler Growth Slows But Continues to Outpace Expectations

Zscaler’s growth is slowing, but this is due to the law of large numbers, and the results continue to outpace the consensus estimates. For FQ1, ZScaler produced $627.96 million in net revenue, up nearly 26.5% compared to last year and 360 basis points ahead of the consensus. The outperformance is good but aligns with the revision trend, leading to the high-end range and more as-expected than not. New client engagement and deepening service penetration drive growth and aid strong margins. 

The company’s GAAP net loss fell more than 50% year-over-year (YoY) in FQ1, putting it on track to achieve GAAP profitability soon. The adjusted net income grew by roughly 40% to outpace the top-line strength by 1300 basis points. The net result is an adjusted EPS of $0.77, up 15% YoY, and outpaced the consensus by a strong 2200 bps. The guidance is also solid, outpacing the consensus estimate but aligning with the revisions trend. The takeaway is that Q2 and FY revenue and earnings were guided to above consensus levels and will likely be increased again later this year. 

Zscaler’s positive cash flow improved its value over the past year. The company logged a 12% increase in its cash balance in Q3 on receivables, sustained its asset base, and lowered total liability to increase shareholder equity by 12%. Total leverage is very low at roughly 2x equity and 2x cash, leaving the business with ample financial flexibility to pursue acquisitions and invest in growth. 

Analysts Sentiment Firms: Zscaler Is Indicated Higher

The analysts' response to Zscaler’s FQ1 results is mixed, including a single price target reduction issued within the first 12 hours of the report. However, the bulk of revisions are bullish, and one initiated coverage aligns with the bullish trend in 2024. That is by Needham, which initiated a Buy rating with a price target of $240. The $240 target is well above the consensus of $225, as are the remainder of the revisions. The takeaway is that analysts' sentiment is firming in Zscaler and leading the market to the high-end range and a nearly 12-month high above a critical resistance target. 

The price action in ZS stock is tepid following the release, but the 7% discount is an attractive opportunity. The market remains above support targets, including the 150-day EMA and the mid-point of its trading range, which are likely targets for strong support. Assuming the stock price does not fall below $190, the rebound should begin soon and take this market to the top of the trading range by year’s end. If not, ZS shares could fall to the low end of the trading range near $175 or lower. 

The institutional activity will be the deciding factor in where ZS stock price ends in 2024. The institutions own about 50% of the stock, presenting a significant force and selling on balance in 2024. If this trend continues, it is unlikely that ZS price action will gain sufficient traction to hit the top of the range, much less break to a new high.