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SUMMARY
Parkev Tatevosian, CFA, analyzes Zscaler's recent quarterly results, which led to a sharp decline in the company's stock price. The discussion covers revenue growth, profitability metrics, valuation, and whether the current drop represents a favorable entry point for investors.
MAIN POINTS
- Zscaler's quarterly financial results led to a 31% drop in share price following investor disappointment.
- Annual recurring revenue growth slowed, raising concerns about the sustainability of Zscaler's revenue growth rate.
- Operating losses increased in absolute terms but improved slightly as a percentage of revenue, while free cash flow showed mixed results.
- Zscaler benefited from a reduced long-term projected non-GAAP tax rate due to recent U.S. tax legislation.
- The company forecasted decelerating revenue growth and a significant drop in free cash flow margin for fiscal year 2026.
- Despite negative trends, Zscaler's updated valuation suggests the stock is undervalued and may present a buying opportunity.
DETAILED ANALYSIS
Zscaler, a cybersecurity company, experienced a sharp 31% decline in its stock price after releasing quarterly financial results that fell short of investor expectations. The company reported a 25% year-over-year revenue increase to $851 million, a figure that appears solid on its own. However, when excluding the impact of the Red Canary acquisition, annual recurring revenue (ARR) growth slowed to 21%, and net new ARR rose by only 14%.
This deceleration in ARR growth raised concerns about the sustainability of Zscaler's revenue momentum, especially for a company with a premium valuation. Zscaler's forward price-to-earnings ratio stands at 41.6, and its forward price-to-operating cash flow is 24, both of which are reasonable for a high-growth company but not low compared to broader market averages.
The company reported an operating loss of $29.6 million, which increased in absolute terms from the previous year's $25.4 million loss, despite higher revenues. However, as a percentage of revenue, the operating loss improved from 4% to 3%. Free cash flow reached $136 million, up from $119.5 million, but declined as a percentage of revenue from 18% to 16%.
Deferred revenue, representing future contracted sales, grew 25% to $2.477 billion, aligning with current revenue growth and indicating a healthy backlog. Zscaler also announced a reduction in its long-term projected non-GAAP tax rate from 23% to 21%, a structural benefit resulting from recent U.S. corporate tax cuts, though future political changes could alter this advantage.
Looking ahead, Zscaler forecasted revenue growth of 22% for the next quarter, down from the current 25%, and projected a full-year 2026 free cash flow margin of 22.8% to 23.3%, a notable decrease from previous estimates of 26.5% to 27%. The company attributed the lower margin to increased capital expenditures, driven by higher component costs rather than expanded business activity. Despite these headwinds, a discounted cash flow analysis values Zscaler at approximately $185 per share, while the post-drop market price stands at $127.
This substantial discount suggests that, despite recent negative trends, Zscaler may represent an attractive buying opportunity for long-term investors.
LINKS
- YouTube channel membership for exclusive perks and early access.
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- Parkev Tatevosian's book on a 6-step investing framework.
- Fiscal.ai investment research platform with viewer discount.
- Webull investing platform sign-up with bonus shares.
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