VZ - Karooooo: Profitable Software Opportunity Based On Cartrack IoT

2024-01-04 09:52:35 ET

Summary

• Karooooo is a unique software provider with exposure to emerging markets, offering car tracking software and other services.
• The company's Cartrack platform has seen strong growth and high customer retention rates.
• The global expansion of Karooooo presents both risks and opportunities, but the company's financial profile and valuation are favorable.

Introduction

Karooooo Ltd ( KARO ) is a software provider that is unique both in industry and market focus. The company is a leading provider of car tracking software thanks to the Cartrack platform. With a dual-base of Singapore and South Africa, KARO offers excess exposure to the emerging markets of the world. This is quite unique for software firms outside of China, and I believe the EM secular opportunity and diversification are two major catalysts investors can rely on. Then, the benefits of extremely competitive growth and profitability just add to the thesis that Karooooo belongs in the portfolios of long-term investors. And, while slow to roll out so far due to competition, the opportunity to enter developed markets like the US will provide longevity in the decades to come.

Cartrack Preparing for Global Dominance

While KARO does have two other operational segments of used car sales in South Africa with Carzuka, and a logistics software platform that has just been released, over 90% of sales are based on Cartrack. This platform was founded by South African entrepreneurs in 2004 and has had successful growth ever since. As one of the original IoT software companies of the world, Cartrack has a well-developed cloud ecosystem for SaaS style recurring revenue streams.

The goal of Cartrack is for fleet management in complex environments and customers can expect lower operating costs, increased productivity and efficiency, and even increased safety from driver monitoring. With the wide range of services from just a small hardware integration to a fleet vehicle, the value proposition is high for customers and this can be seen with a 95% retention rate and steady upward subscriber growth.

Even with a mostly singular focus on the medium-sized South African market until a few years ago, subscriber growth has been strong for more than a decade. As an example, Cartrack saw 19% annual active unit growth between 2011 and 2016. In 2023, this growth rate has increased to 22% per year in terms of revenues over the past five years. But as I find most important, growth has been conservative and Cartrack is extremely profitable. The key way to measure this is with the Rule of 40, and Karooooo beats it handily at 63% on average over the past five years, or 60% on a TTM basis.

The majority of this success is based on EBITDA margins at over 40% thanks to an asset-lite business model. However, the global expansion is becoming expensive and EBITDA margins are facing downward pressure, leading to headwinds for the stock. But, as the business economy scales in new markets, the top-tier profitability will return once again (not to mention 30-35% margins are still much better than most peers).

Risk vs Opportunity

The major risk for Karooooo is that the profitable expansion in emerging markets is slowing down as the global economy stagnates. Forward analyst expectations are tepid at less than 12% for revenues, and earnings have missed goals in the past three years. Therefore, expectations should be measured over the next year or two as the company finds organic growth amongst weaker economies (predominantly due to China).

Thankfully, the chance for upside remains within the Asia and US expansion plans, as this segment has been growing almost twice the rate of the European and South African segments. These regions only account for 10% of revenues, but will likely be the torch-bearers by the end of the decade and into the future.

My thesis remains bullish on the fact that the company can expand successfully and if not, offers diversified exposure to markets outside of the US. Other reasons why the global expansion may be successful is through the current customer base of global companies outside of current regions of use. As an example, the Cartrack website lists a few global majors as customers such as Hertz ( HTZ ) and Avis ( CAR ) rental car companies, consumer goods and industrial conglomerate LG, global brewer Heineken ( HEINY ), and Michelin tires ( MGDDY ). If these larger firms are able to lead the expansion and help establish operations in new regions, costs will be far lower and risk averted. I believe this is what is at play, especially with profit margins still remaining high.

Due to the more risky nature of KARO, despite the great financial profile, the valuation is far lower than may be expected. In fact, I am surprised by the current 22.8x trailing GAAP P/E, EV/EBITDA less than 10x, and miniscule 3.6x P/S. The P/S is also around 14% lower than average since the IPO in 2021 due to the growth risk. When compared to other Rule of 40 beating companies, KARO has the chance to increase by up to 10-fold from a P/S basis alone.

As shown in the image I compiled of a few profitable software companies below, KARO is far below average in value but among the top performers in terms of the Rule of 40. One important factor is also that KARO is a recent IPO, and unlike more AI or Data focused peers, has yet to see a major move up from lows, so timing may end up being key. While I will keep my position small for the time being, I believe value expansion alongside organic growth will be a key catalyst of investor return in the years to come.

While I can compare KARO to other profitable software companies, I can also compare it to direct peers. The main US fleet management public comparables are Samsara ( IOT ), Verizon Connect ( VZ ), and Manhattan Associates ( MANH ). However, there are a wide range of smaller private groups that are some of the reasons why it is hard for Cartrack to find traction in the US. But it is clear that Karooooo’s financials and value are far better at the moment.

For example, Samsara is growing revenues faster at over 40% over the trailing period, but they do not meet the Rule of 40 with EBITDA margins that are -30%. With a P/S of 19x, I do not think paying 5x more is worthwhile. The same goes for MANH who on average has slower revenue growth below 10% per year, and EBITDA margins at around 20%, all at a 14x P/S and 78x GAAP P/E. So either these peers will fall down to KARO valuations or vice versa. I am sure the end result will be somewhere in the middle, but that is pure upside for KARO.

Conclusion

While my crystal ball is saying that investors will be quite happy investing in KARO by the end of the decade, the current valuation differential highlights the risk at hand. While I believe that even with a lackluster expansion across the world, KARO will not see a large decline in share price. This is because the company has done well to temper the profit decline over the past few years, even as ex-South Africa sales increase at a faster rate. I believe much of the risk is temporary due to the reliance of Emerging Markets on Chinese productivity, and any favorable developments across the Pacific will be positive for Karooooo’s expansion plans.

It will also be interesting to see how the US market expansion performs, as the competition is fierce. If the 20 years of development inside the South African market has created enough unique advantages to support a fair market share holding, the market is huge. I look forward to what is to come, and will look to add shares anywhere below $30 per share.

Thanks for reading. Feel free to share your thoughts below.

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