KRNT - Kornit Digital: Upgrading On Expected Return To Growth And Profitability Next Year

2023-08-30 06:54:23 ET

Summary

• Earlier this month, shares of Kornit Digital sold off after the company reported in-line Q2 results but guided Q3 well below consensus expectations.
• Management attributed the shortfall to prevailing softness in system sales as customers continue to deal with excess capacity.
• However, even at lower-than-expected revenue levels, the company still expects to break even on an Adjusted EBITDA basis by Q4.
• Further progress is expected next year with management projecting a return to revenue growth and Adjusted EBITDA profitability.
• With the near-term outlook having been de-risked and the stock price likely being supported by ongoing buyback activity, I am upgrading Kornit Digital's shares from "Hold" to "Speculative Buy".

Note:

I have covered Kornit Digital Ltd. ( KRNT ) previously, so investors should view this as an update to my earlier articles on the company.

Earlier this month, shares of leading digital textile printing solutions provider Kornit Digital Ltd. or "Kornit" sold off by more than 20% after the company reported Q2/2023 results within the range provided by management in the Q1 earnings release but guided Q3 well below consensus expectations:

On the conference call , management attributed the shortfall to prevailing softness in system sales as customers continue to work through excess capacity:

System sales volumes remained soft during the quarter, mainly due to continued challenges in capital equipment spending. And as our customized design customers continue to work through excess capacity. While we anticipate the prevailing softness in system sales volumes to continue in the short term, we have implemented strategic measures to attract new customers including brands, retailers, and digital platforms.

The lower system sales contribution continues to impact gross margins.

While substantially improved from multi-year lows recorded in the first quarter, margins remain a far cry from the 2021 high days:

That said, management projected further improvement through the balance of the year with more higher-margin consumables favorably impacting the H2 sales mix (emphasis added by author):

Consumable revenue grew at a strong double digit rate across our customer segments, including key strategic accounts and throughout all our operating regions. So far in the third quarter impression growth is again on pace to increase at a double digit rate year-over-year which gives us confidence in solid consumable growth for the second half of the year. (...)

We continue to expect gross margin improvement throughout the balance of this year, given the historical cadence of consumables as a percentage of sales being progressively higher in the third and fourth quarters .

Despite substantially lower operating expenses, Kornit Digital reported a material net loss:

Cash, deposits and marketable securities of $591.7 million were down by $32.2 million from the end of Q1 due to negative free cash flow of $17.3 million and additional buybacks under the company's recently extended up to $75 million share repurchase program . Kornit Digital continues to have no debt.

Since the beginning of 2023, the company has repurchased approximately 0.94 million shares at an average price of $23.20 per share.

Looking ahead, management now expects Kornit Digital to break even on an Adjusted EBITDA basis in Q4 with " profitable growth " targeted for next year (emphasis added by author):

In addition to diversifying our customer base and entering new markets, we have taken various actions to increase efficiencies throughout our operation. Based on our progress to date, we currently expect to report breakeven on adjusted EBITDA basis for the fourth quarter of this year, even at the quarterly revenue run rate in the mid $60 million range due to a favorable sales mix of higher margin consumables, and quarterly OpEx in the low to mid $30 million range. We are also aiming to deliver profitable growth for the full year 2024.

Management's optimism regarding 2024 and beyond is largely based on the company's strong performance at the recent International Textile Machinery Association ("ITMA") trade show in Milan with 60% of orders signed with new consumers thus opening the door for additional systems and consumables sales and providing Kornit Digital with a healthy pipeline for 2024 and beyond:

As a result of our focused R&D, marketing and other efforts, we had a hugely successful ITMA trade shows in Milan. We had very high customer engagements with new customers from key textile regions such an India, China, Turkey, Morocco, and from LATAM countries such as Argentina, Brazil and Mexico.

According to statements made by management on the conference call, the company closed multiple orders across its key product lines with the brand-new Apollo system being an " unbelievable success " (emphasis added by author):

The Apollo was unbelievable success was running around the clock, people were amazed for the first time they can see a system that running at 400 garments and our full productivity with one operator. This is a breakthrough for this industry based on MAX technology. We got multiple orders for the Apollo . As I mentioned, we already running the beta and installing the second one the feedbacks are great. This will position us deeply into the screen market. And we expect substantial growth on the Apollo next year. The recognition of the units that we are going to -- that we install and we're going to install this year will happen only in Q1.

Please note that the Apollo system represents Kornit's entry into the very large screen printing market which could spur growth for many years to come.

In addition, the company landed its first order from a leading Indian textile manufacturer thus opening up a new market with very meaningful growth potential for Kornit Digital's traditional direct-to-fabric system business.

With the outlook for the remainder of the year having been de-risked and a much stronger sales pipeline for 2024 and beyond, I am upgrading Kornit Digital's shares from " Hold " to " Speculative Buy ".

With sequential improvement expected for both Q3 and Q4 as well as prospects for the company achieving Adjusted EBITDA break-even in the final quarter of the year, I wouldn't be surprised to see shares recover most of their recent losses over the balance of the year.

In addition, I would expect ongoing share buyback activity to provide solid support for the stock at current levels even in a weaker market environment.

Risks

While the near-term outlook has been de-risked, Kornit Digital still needs to convert parts of its sales pipeline to firm purchase orders and convince customers to accept deliveries for next year. Further deterioration in consumer demand trends could impose risks to the company's anticipated 2024 performance.

Bottom Line

Kornit Digital's business continues to be impacted by macroeconomic pressures, with customers holding back on system purchases in times of uncertain demand trends.

That said, with progress expected over the balance of the year and a likely return to double-digit revenue growth and Adjusted EBITDA profitability in 2024, I am upgrading the company's shares from " Hold " to " Speculative Buy ".

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