DAKT - Daktronics: Below 8x Growing EPS As Their Industry Grows 20%

2023-12-10 09:45:06 ET

Summary

• Daktronics is a large company with a defensible moat, strong growth prospects, global operations, and thousands of employees, yet it trades below 8x P/E.
• The recent sell-off in Daktronics' stock is likely due to profit-taking, as there are no major concerns about the company's performance.
• Daktronics has the potential for significant future growth, with capacity expansions, a high backlog, and opportunities in software and services.

There is no other company in the stock market that I am aware of that has prospects for >15 % growth, is an at scale global leader with thousands of employees, and trades below 8x PE.

Daktronics (DAKT) is a large company with > $800m in revenue and > $60m of operating profits. They are the at scale leader in their market with no close competition, global operations and 3,000 employees. All this and they trade at a market cap of only about $400m and are relatively unknown with no investment bank coverage and only one question on the recent conference call.

Daktronics is currently trading below 8x run rate PE despite excellent prospects for growth, and likely below 7x 2025 FY PE. There is no other company in the stock market that I am aware of that has prospects for >15 % growth, is the at scale global leader with thousands of employees, and trades below 8x PE.

Why has Daktronics sold off in the past week?

The first thing to address is why Daktronics is down 30 % from its recent peak, is there something concerning to be aware of? I don’t see any evidence of any major problem and believe this was due to profit taking as the company has had a tremendous run from all time lows one year ago.

The conference call comments were positive and included a confirmation that they expect the industry to grow 20 %+ going forward. Orders were reasonably solid, not tremendously strong but should be enough to support future revenues as they continue to work down a backlog (and inventory) that is very far above historical levels. The biggest part of this backlog should be the installation of the Halo in the Intuit Dome , one of/the largest Daktronics projects in history and by far the most expensive display in the NBA, is ongoing and should provide support to revenue for at least the upcoming quarter and possibly further. Backlog jumped by a full $150m when Daktronics won this project, so the full value of it is likely over $100m. By the time this backlog is worked down to a more normalized level, perhaps two quarters or more, the overall industry growth rate should have increased baseline orders revenues by 5 % or more, which should support earnings of $1.2 per share or greater.

It’s also important to remember that current orders, while not tremendously impressive compared to historical orders, likely carry higher margins than the historical order book and are therefore much more favorable.

The 10-Q also stated that there are continuing investments in automation happening which should further boost long term margins and also provide a reduction in capex when complete in the next few quarters. Daktronics is also hiring heavily, and stated in a recent investor presentation that they had about 3000 employees globally, up about 10 % in the last six months. That represents strong growth for a company of this size and is a very bullish indicator.

This article will be divided into a discussion of what current run rate earnings actually are (higher than it looks), and a discussion of future growth prospects.

Current Run Rate Earnings

Reported earnings in the most recent quarter are heavily suppressed by several factors. Removing these factors would result in an earning run rate solidly above $1.1. These factors should be removed over the next 1-2 years, and Daktronics should grow revenue at the same time, meaning in 1-2 years the earnings run rate will likely by $1.4 or higher, so purchasing shares at current prices is somewhat similar to buying at under 6x earnings. This is an extraordinary opportunity to buy an at scale market leader at 6x earnings.

As detailed by the 10-Q, there are four major one-time items included in the recent earning report that should be removed over the next 1-2 years. There was $1.3m of interest expense, $10.6m in change in the fair value of the convertible note, and $1.3m of debt issuance costs, and at least $1.9m of one time startup expenses of an employee benefit plan. I believe it was actually much higher than this but to be conservative I call it $1.9m. $15.1m in total.

Imagining if all these items are removed pretax income would be something like $35m, which would be over $.56 cents per share in the most recent quarter. Daktronics should be rapidly paying down debt towards 0 over the next 1-2 years so these items should be removed.

The most recent quarter hugely obscures Daktronics current earning power. However, Daktronics is a seasonal business and the January and April quarters typically have significantly lower earnings per share, so overall I think an earnings run rate of something like $1.2-1.3 is reasonable and conservative.

Clearly, Daktronics is cheap on current earnings, especially because it is an at scale market leader. However, can the company’s claims of the end market growing at 20% + be trusted? I believe so.

Capacity Expansion

One very strong indicator of Daktronics expectations for future revenue is their large capacity expansion. In 2022 Daktronics began expanding their factories in Brookings, SD, Ireland, and Shanghai, doubling their total SMD LED capacity. Most of Daktronics revenue is SMD, so to double their capacity means they have truly expanded their revenue generating capability dramatically. Whereas capacity was previously at least $610m per year, with the combination of price increases and capacity expansion total revenue generating capacity is very likely now at least $1 billion. The increasing of their employee base by 10 % in the last six months is consistent with them viewing their decision to expand capacity in 2022 as the correct decision, and their job board shows that they are still hiring very heavily at this moment.

Orders and Backlog

Daktronics current backlog of $300m is still tremendously high compared to historical data points. They still likely have at least 1-2 quarters of needing to work this backlog down, which should support revenue for the next 2 quarters as revenue grows. Orders in the most recent quarter of just over $180m are reasonable/solid, they should be enough to give Daktronics plenty of revenue for the near term while they complete the very large backlog and the industry grows.

Services and Software Component

Daktronics also makes software to run the scoreboards for its installations, there is a significant potential software component with high margins that could grow and become much more prominent. This is especially so because it has a large commercial segment that is partly oriented towards advertising (i.e., digital billboards).

Recent Commentary

There was some recent positive commentary in an October article which should support continued decent order flow:

“We’re starting to see teams get back into the normal buying cycle,” he said. “Right now, we’re selling baseball and softball. In the next year or two, we’ll see a lot more NFL stadium projects come back (including new stadiums for the Buffalo Bills and Tennessee Titans). The college space continues to be really busy. That landscape is changing. They’re upgrading the experience for the fans, but it’s also about recruiting and retaining student-athletes. We’re still seeing a lot of demand there.”

Narrow Pixel Pitch

Narrow pixel pitch alone is a tremendous tailwind for Daktronics. Narrow Pixel Pitch means the distance between pixels is smaller (more narrow) than traditional versions of large LED screens. A typical difference might be between 10mm and 2.5mm. This creates a very large increase in the total number of pixels, (in this example 16x) and therefore causes a very large increase in the overall price of the product. A product that has 16x more pixels might easily be 3x or more as expensive as the traditional product. This one factor alone should support tremendous growth for Daktronics, and is further quantified on slide 11 of this investor presentation.

Daktronics has many other tailwinds as well, including:

1. Billions of federal aid supporting the high school and parks business (where Daktronics is market leader)

2. The infrastructure bill supporting the transportation market, where Daktronics is also market leader .

3. The World Cup in 2026 and the Olympics in 2028, the world cup in particular will be played at 16 different stadiums in North America.

4. A tailwind to long term margins from automation

Factors That Have Increased Margins

Part of the opportunity in Daktronics is that margins have increased significantly. This is due to automation, more strategic business decision making, improvement of their supply chain, and the increasingly technically complex and expensive nature of the displays. The substantial increase in margins has caused a large increase in profitability that the market has not fully priced in. More automation is on the way which will further support margins.

Daktronics Installed Base

Daktronics has an incumbent advantage that cannot be overemphasized. Most stadiums at high school, college, and professional levels have some Daktronics products. These products have a 7-12 year upgrade cycle that provides a huge predictable revenue stream, and as these products are upgraded to newer, more expensive ones, there is significant embedded growth just in the upgrading without selling any new products.

Catalysts

Future catalysts include:

1. A share repurchase, as Daktronics does have $30m of repurchase capacity available, and they have bought back shares at times in the recent past.

2. Continue revenue and earnings growth, paying off the modest amount of debt

3. Daktronics should be a very attractive acquisition to many possible acquirers at current prices.

Risks

Daktronics faces possible competitive threats. While they are the at scale leader with 45 % North American market share and nobody else close, they could face price competition from an Asian competitor. Mitsubishi, Samsung, and others have won some large displays in NFL stadiums for example. Thus far this has not been a serious threat however as the impetus to buy American in a sports venue is fairly strong, and more importantly Daktronics physical presence in North American and very large sales team, operating history, software, and other advantages give it a large advantage. This might become more of a risk if there is a paradigm shift in the industry towards a new technology in which a competitor has a large advantage.

The other risk is pricing. Electronic component companies have a long history of price competition and that has historically been part of the reason that Daktronics profitability has been limited even though it built up a tremendous installed base. Daktronics already does not compete on price as it is a unique offering with superior engineering and many other components, however it is possible that there could be price suppression.

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