ADT - ADT: Security Products Aiming To Give Safe Returns

2023-05-29 02:31:53 ET

Summary

• ADT, Inc. started the year strong with stable revenues and returns.
• Its financial positioning remains decent, but I am concerned about its sustainability.
• Macroeconomic headwinds are still intense, but opportunities are visible.
• It is an ideal dividend stock with consistent payouts and reasonable yields.
• The stock price has been sluggish since the company went public.

Millions of businesses are having a hard time dealing with macroeconomic volatility. Recession woes persist, which may impact the production capacity and demand across industries. But as summer comes and hybrid work setups become more common, some markets are seeing more opportunities. Even the companies in the consumer discretionary sector may regain their footing. One of these is ADT, Inc. (NYSE: ADT).

ADT had a wonderful start to 2023 with its sustained revenue growth and stable margins. Also, it has a decent financial positioning, allowing it to cover its current size and capital returns. The only concern is the massive value of goodwill and borrowings relative to the total assets. They may suggest overspending, overacquiring, and overborrowing, which may erode its intrinsic value. With that, it may have to be more cautious about interest rate hikes and recession. Unsurprisingly, the stock price has remained flat over the years. The downtrend since 4Q 2022 is consistent with the pessimistic economic view. Even so, the stock price reduction was higher than expected. It becomes cheaper, increasing its upside potential.

Company Performance

Macroeconomic headwinds are evident as interest rate hikes persist. There may be more risks in various industries as investments and borrowings may be affected. Even so, these also have unexpected tailwinds for companies like ADT, Inc. It shows it can maneuver its operations with prudence amidst market volatility. It also proves it can use the recent changes to its advantage.

It started 2023 with some decent results as it regained its footing. Its operating revenue reached $1.61 billion , a 5% year-over-year increase. It was also the second-highest revenue in the past five quarters. Even better, the company stayed stable despite the unfavorable impact of inflation. Its resilient business model maintained its momentum in generating revenues and cash inflows. One of the primary contributors was its move to step out of its comfort zone. Through its partnership with Google Nest, it increased its exposure to DIY customers. But what helped drive its revenue growth was the relaxing inflation. After peaking at 9.1% , it disrupted the relocation plans of many customers. It was still favorable concerning client retention. Yet, it was more challenging to set strategic pricing and entice new customers. But as it decreased in 4Q 2022, operational stability improved. The downtrend sped up in 1Q 2023 as it landed at 5%. It became easier for the company to fortify its customer base through pricing strategies. It also stabilized the purchasing power of customers.

The increased hybrid work flexibility was also a driving force behind its strength. We can combine it with digital transformation, allowing virtual transactions. In the US, 55% of businesses have hybrid work flexibility. It is consistent with another survey wherein nearly 50% of employees work remotely at varying levels. As such, more than two-thirds of them were able to travel more often. Given this, ensuring home protection while traveling and working away became more vital. It was reflected by a report, showing that the number of burglary incidents increased by 33% in NYPD and 35% in CPD. Even in other countries, the same trend was evident. Let's take Ireland as an example since ADT has stores there as well. Burglaries reached 9,500 , 10% higher than in 2021. It is no wonder, alarms and other devices against burglary and fire became more of a staple.

But what made ADT a solid company is its operational efficiency. It was able to keep its operating costs low relative to revenue. In fact, the trend was relatively flatter, which we can also attribute to lower inflation. As a result, the gross profit margin moved in an uptrend. It reached 42% versus 34% in 1Q 2022. It was also the highest in five quarters, showing that the company was most efficient in 1Q 2023. Its operating expenses were also flat, proving the efficiency of the company. Its operating leverage increased from 30.3% to 30.6%. ADT managed its variable costs better, making the core operations more scalable. And if not for goodwill impairment, the operating margin would have been 15%, and not 3%. On a lighter note, the core operations stayed viable. Also, goodwill decreased, improving the intrinsic value of the company.

This year, the company may face the same combination of risks and opportunities. But it may have more tailwinds from its partnerships. It strengthened its market presence with its partnership with Google Nest. In turn, it can improve customer experience through its innovative products. We will discuss more of its risks, opportunities, and financial capacity in the following section.

How ADT, Inc. May Remain Secure This Year

Macroeconomic risks remain evident. Although we saw how inflation and interest rate hikes helped ADT, Inc., disruptions must not be discounted. Interest rates have exceeded the 4.5-5% forecast by many analysts. In 2022, The Fed increased rates by 75 bps for four consecutive quarters. As such, ADT must be more careful due to its high borrowing levels of $9.98 billion . The amount is equivalent to 55% of the total assets. Higher interest rates mean higher borrowing costs, which will increase interest expenses. The only consolation is that borrowings decreased by about $10 million from 1Q 2023. Assets also increased despite the decreasing goodwill, which I will discuss more in the succeeding paragraphs. Given this, the ratio of borrowings to total assets is lower today versus 58% in 1Q 2022. Also, interest rate hikes have started cooling down since the first board meeting of The Fed for the year. The Fed already hinted that it may stop raising rates. So the current rate may stay flat for the rest of the year.

Meanwhile, inflation continues to relax, landing at 4.9% in the most recent report. It is already 46% lower than the 2022 peak. Indeed, The Fed was successful in stabilizing inflation. If it stays conservative, inflation may decrease more. The inflation downtrend may help ADT in setting more strategic prices. It may lower or maintain prices to increase customer retention and entice new ones. It can even manage its costs better to stabilize margins. It may be easier today since lower inflation means more manageable wages and purchasing power.

Also, lower inflation can improve the capacity to buy homes. As of this writing, the median home sales price is 9% lower than the 2022 peak. Mortgage rates are also more stable today. It is no surprise home sales and loan demand increased in 1Q 2023. While it may entice relocation, it may also lead to new homeowners and demand for home alarms. But of course, it may not materialize in the near future due to recession woes.

More potential growth drivers for home and business alarms include the prevalence of hybrid work setup and revenge travel. A recent study shows that 56% of hiring managers believe that hybrid work will become the new norm. In the same study, 74% of companies in the US use or plan to implement hybrid work. This trend may drive revenge travel some more. It is consistent with another study, showing that 49% of Americans will travel more this year. It may peak this Summer, with over 80% of the respondents saying they will travel more this summer. More importantly, summer means higher burglary and fire risks. Aside from that, recession can impact many households, which can increase the risk of burglary. These make ADT home and business alarms more important. The company may increase its market exposure as it offers virtual solutions amidst the digital transformation peak.

But what can help ADT, Inc. stay afloat is its decent financial positioning. My worries, though, are its high borrowing and goodwill levels. Given this, the company may have to track its spending, borrowing, and acquisition. These may erode the book value of the company. Despite this, I noticed that borrowings have always been at that level since its IPO. The value has continuously decreased over the years. The percentage of borrowings to total assets has remained flat at 58%, but in 1Q 2023 it decreased to 55%. The good thing about it is that the company has managed its financial leverage better. Likewise, goodwill has decreased in the past year. Its value relative to the total assets decreased from 35% to 32%. Meanwhile, cash levels have increased substantially. Thanks to the increased returns of the company. It is enough to pay most of the borrowings maturing this year. Even better, its Net Debt/EBITDA Ratio remains reasonable at 3.6x. It is still lower than the maximum ratio of 4x. So, ADT has enough core income to cover borrowings. In fact, its EBITDA is more than enough to cover all current borrowings even in a single payment. The remaining amount is also more than enough to cover dividends. We can confirm it using the Cash Flow Statement. Its Cash Flow From Operations can cover CapEx. The FCF of $88 million is also enough to cover dividends. Given this, the company can sustain its operating capacity while covering borrowings and dividends. The company keeps the balance between growth and viability with liquidity and sustainability.

Stock Price Assessment

The stock price of ADT, Inc. has been flat over the years. But the downtrend has become more visible recently. At $5.8, the stock price is 20% lower than last year's value. Even so, it makes the stock price cheaper. Investors can see it in the PB Ratio, given the current BVPS and PB Ratio of 3.6 and 1.62x. If we use the current BVPS and average PB Ratio of 1.93x, the target price will be $6.94.

Moreover, it is a secure dividend stock, given the consistent payouts. Yields are decent at 2.29%, way higher than the S&P 400 average of 1.73%. Also, they stay well-covered since cash levels and FCF are about ten times and twice the value of dividends. To assess the stock price better, we will use the DCF Model.

FCFF $1,097,000,000

Cash $303,550,000

Borrowings $9,981,530,000

Perpetual Growth Rate 4.4%

WACC 9.8%

Common Shares Outstanding 921,660,000

Stock Price $5.8

Derived Value $11.98

The derived value adheres to the supposition of a potential undervaluation. There may be a 107% upside in the next 12-18 months. The stock price is a good bargain.

Bottomline

ADT, Inc. maintains a solid performance with its steady revenue growth and adequate returns. Its adequate cash levels allow it to cover its current size, borrowings, and dividends. It can stimulate its expansion with its marketing strategies and potential opportunities. Even better, the stock price stays undervalued with decent upside potential. The recommendation is that ADT, Inc. is a buy.

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