As shares of Zebra Technologies (NASDAQ:ZBRA) have shown some signs of life in recent weeks, it is time to see what the outlook for 2024 holds after the business has seen a terrible 2023 on the operational front.
In August, I believed that Zebra was still hurt badly from supply chain disruptions, as the long term secular growth play saw a backdrop from a decline in sales following the pandemic. While this is not too shocking itself, it was the degree of the shortfall in the results which was rather shocking, which made me cautious to add to an existing position, despite a (renewed) sizable dip, leading me to a Hold rating.
A further dip took place later in the fall, at which shares simply looked too cheap to ignore, given the long-term growth prospects, yet a recent 35% rally makes me tempted to take some profits and consider shares to be a hold here. This comes as no immediate recovery is seen, based on management’s comments, yet we have seen improved margins with end customers as of recent (which forfeited capital investments), making me upbeat amidst cooling inflation and interest rates.
Enterprise Asset Intelligence
The header of this paragraph is the technical term what Zebra stands for with the EAI solution provider making and supplying products and services which allow for automatic identification and capturing of data. Typical applications to think of include RFID scanners, printers and related products, used in e-commerce, warehouse and logistic settings.
Zebra came to its current existence when it acquired Motorola Solutions Enterprise in 2015, a deal which initially created a (debt) overhang, but over time has started to pay-off. Pre-pandemic, that is the year 2019, the company generated $4.5 billion in sales on which it posted earnings of $544 million, equal to roughly $10 per share, easily supporting a $250 per share valuation at the time.
Revenues were flat in 2020, but jumped in a convincing manner in 2021, driven by a combination of organic sales growth and M&A efforts, with revenues reported at $5.6 billion. Moreover, strong sales growth supported adjusted earnings improving to $18.50 per share, as enthusiasm among investors meant that they extrapolated these excess earnings. This enthusiasm pushed shares up to levels over $600 in 2021. The combination of strong operating conditions and rising expectations (valuation multiples) was a dangerous cocktail for investors.
Given the tough comparables and tougher operating conditions, it made that 2022 has turned out to become more difficult. In the end, 2022 revenues rose a mere 3% to $5.8 billion, with adjusted earnings down a dollar to roughly $17.50 per share. This number, however, excluded some real expenses (such as stock-based compensation charges) making that realistic earnings came in closer to $15 per share. Net debt of $1.9 billion appeared manageable, with EBITDA surpassing $1.2 billion, for leverage ratios around 1.5 times.
The company originally guided for 2023 sales to fall by a percent (plus or minus two percent) with EBITDA margins seen between 22-23%. This was nothing inspiring, but a $15 realistic earnings number for 2023 (based on that outlook) should in theory support a $300 prevailing share price at the time.
After all, a 20 times earnings multiple for a solid operator in a long term growth industry looks to be quite a reasonable valuation, as this multiple was in line or below the valuation multiple at which shares traded in recent years.
2023 – A Bombshell
After an apparent resilient first quarter, the company cut the full year sales guidance, now seeing sales down 4% on the year, with EBITDA margins seen around 22%.
In August, a bombshell second quarter earnings reports was released, with quarterly sales down 17% to $1.21 billion, and adjusted earnings down 29% to $3.29 per share. Moreover, the company guided for third quarter sales to be down 30-35%, with EBITDA margins seen at just 10-12% of sales.
As the company guided for a 20-23% decrease in full year sales, no recovery was seen in the fourth quarter, with full year EBITDA margins seen around 18% of sales. That suggests a full year revenue number around $4.5-$4.6 billion, with EBITDA seen around $800 million, for a 2.7 times leverage ratio based on a net debt load of $2.15 billion.
Given this situation at $250 in August, I was compelled to the further pullback in the share price, but still shocked by the degree of the shortfall in the performance, with near term earnings potential being very limited and leverage concerns rapidly increasing. Hence, I decided to ride out the storm on an existing long term long position, but was not compelled to buy more around the $250 mark.
Coming Down – And A Recovery
Since August, shares have actually fallen to levels around the $200 mark in early November, as I doubled down at $210 around the time of the release of the third quarter results. A fierce rally in recent weeks sent shares up to levels around the $270 mark today.
The dip coincided with the release of the third quarter results late in October. Third quarter sales fell some 30.6% to $956 million, being slightly better than guided for, with adjusted EBITDA of $111 million coming in at 11.6% of sales, as the company posted a small GAAP loss of $0.15 per share. Net debt was reported at $2.22 billion, which means that leverage ratios rise quickly, following the suboptimal earnings, although this is likely manageable if the business stabilizes here (on a sequential basis).
Fourth quarter sales are actually seen down 32-36% year-over-year, which suggests a further deterioration, yet the impact of some cost actions (set to reduce costs by $100 million per annum) means that EBITDA margins are expected to improve (sequentially) towards 16% of sales. This should support an adjusted earnings number of $1.60 per share, plus or minus twenty cents.
This marks a rather spectacular improvement from an $0.87 per share number posted in the third quarter on this adjusted basis. Based on this guidance, I believe that EBITDA might trend closer to $600-$700 million per year, alleviating leverage concerns.
What Now?
The shortfall in the results is quite shocking, driven by the tough comparable and inventory de-stocking, as well as higher interest rates which reduce the likelihood of committing large capital investment projects here.
With the company not seeing clear signs of a recovery in the first half of 2024, I am tempted to take profits on the position initiated again in October, now up $60 bucks, as there still is potential for some new operational setback given the less than convincing comments about 2024.
Once these headwinds are overcome, aided by easier comparables, growth should return in line with the long term growth (potential) of the industry. On top of easier comparables, end customers might benefit from a decline in inflation levels which induce demand as lower interest rates might provide an uplift to business cases of Zebra’s clients as well.
In the long haul, the business should easily be able to post earnings of $10 per share (and likely a bit more) and command a premium multiple given its positioning, but that is still some time out here. Hence, I am still upbeat on the business in the long run, but lured into selling some rips higher here after a spectacular rally in recent weeks (after having doubled down in October) as the lack of clarity on the business in the near term leaves room for a renewed setback in the share price as well.
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