Can Zscaler Still Scale Up in Q3?

Cybersecurity specialist Zscaler (NASDAQ: ZS) had the best-performing IPO of 2018, and though the first half of this year looked like it was going to be a repeat performance, the cloud-based solutions provider stumbled hard in August when an analyst cast doubts on whether it could keep up its torrid growth.

It was a prescient call, as Zscaler followed up in September with a fiscal fourth-quarter earnings report that, while beating expectations, provided guidance that suggested growth would slow in the year ahead.

Data warping into a safe

Image source: Getty Images.

Whereas the cybersecurity firm grew revenue 59% in fiscal 2019, it looks like 2020 will be more muted, with revenue growth at around 31%. That's not too shabby, but it underscores how increasing competition might be nibbling away at Zscaler's trajectory.

Now it's scheduled to report first-quarter earnings on Tuesday, Dec. 5, so let's see what investors might expect.

A tough, competitive environment

Cloud software firms of all stripes were struck by lightning this fall, with the likes of Atlassian, Slack, and Zoom Video all tumbling hard. These were some of the most popular stocks over the past year or so, and analysts suggested their valuations could not keep up with their growth prospects.

ZS Chart

ZS data by YCharts.

Yet Zscaler's business still looks solid. As the biggest provider of cloud-based web security gateways, its platform channels customer data traffic to data centers, where its security software looks for malware embedded within.

Zscaler also just announced a partnership with CrowdStrike (NASDAQ: CRWD), a leading cybersecurity outfit that uses artificial intelligence to scan data streams. Zscaler's senior VP of business development, Punit Minocha, said in a statement, "Zscaler's robust platform with AI and (machine learning) capability, combined with CrowdStrike's endpoint telemetry, will provide our customers a significantly improved security posture and automated remediation across their organizations."

Blue-sky potential

Zscaler said it expects its adjusted earnings to break even in the first quarter or to at least rise by a penny per share, an outlook that had been below the consensus estimates of Wall Street of $0.02 per share. It had also forecast revenue of $89 million to $90 million, which was slightly ahead of the $87 million analysts were looking for.

Wall Street has since revised its forecasts to be in line with management's, but cybersecurity stocks like Zscaler still offer some of the biggest potential for growth. Computer security technology remains a priority for enterprise-level companies as cyberattacks continue unabated, and Bank of America just upgraded Zscaler's stock.

The analyst believes the cybersecurity specialist presents "an opportunity too big to ignore," because web security gateways such as those Zscaler supplies are a $3 billion business, and it is the leading provider in the space.

Expensive but worth it

Zscaler's stock surged on the upgrade, which does nothing really to help its valuation, which now stands north of 170 times next year's earnings. But businesses just getting into profitability will often seem wildly unbalanced like that.

An investment in Zscaler would be a bet on hackers still breaking into systems for years to come and businesses angling to thwart them. This cybersecurity stock still seems poised to benefit greatly from that trend.

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Rich Duprey has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Atlassian, Slack Technologies, Zoom Video Communications, and Zscaler, Inc. The Motley Fool owns shares of CrowdStrike Holdings, Inc. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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