NATI - National Instruments: Attractive Upside If Management Can Pull It Off

Summary

• National Instruments has repositioned itself to take advantage of long-term growth opportunities in strategic industry segments while reducing dependence on cyclical end-markets.
• NATI strategic review suggests that it is well-positioned for future growth, particularly in the aerospace, defense, government, and electric vehicle markets.
• Despite a weak macroeconomic environment, NATI expects to increase its operating margin by over 300 basis points in 2023 due to factors such as an improving supply chain, revenue visibility.

Summary

I think the upside for National Instruments ( NATI ) will be attractive if it can pull off its guidance and announced strategic review.

NATI has been repositioning itself to take advantage of long-term growth opportunities in strategic industry segments, while decreasing reliance on the more cyclical end-markets served by its Portfolio business. To lessen the segment's propensity for cyclicality, NATI is shifting Portfolio customers to a subscription model and emphasizing GTM efficiencies via tiering. More importantly, even in a moderately recessive environment, management has forecasted an increase in operating margin of more than 300 basis points in FY23, with an additional 100 basis points expected in the out years.

Considering the shaky past, it's wise to be wary of both the company's exposure to cyclical end markets and its ability to execute on the transformation despite the difficult macro environment.

Earnings overview

NATI's adjusted fourth-quarter EPS of $0.63 was in line with market expectations. Despite this, the adjusted EBIT margin of 24.9% was higher than the consensus of 22.2%, and sales of $448 million were short of the consensus estimate of $45 million. NATI guided revenue of $415 million to $445 million and adjusted EPS of $0.48 to $0.62 for 1Q23, which was below the consensus estimate of $420 million and $0.48. Notably, management has stated confidently that they anticipate more than 300 bps expansion by the end of this year.

Earnings takeaway

Revenue, margins, and earnings all came in lower than expected for NATI in the fourth quarter, but the company's outlook for the first quarter was more optimistic. This is due to some slight delays in both supply and customer orders, which is the main reason for the unusual seasonal changes, but the results for the fourth quarter and the first quarter are still similar when viewed together. Investors' attention from the earnings print, in light of the forthcoming strategic review, was on orders, and NATI proved quite resilient, with the decline of 3% attributable largely to tough comps while orders expanded q/q. In addition, margins were also paid attention to. Operating margin in the fourth quarter hit a record 24.9%, and the company's projection of 23% for the first quarter was well above market expectations. Both of these crucial components show that progress is being made toward the transformation goals, so I expect investors to feel confident in the strategic review's eventual success.

Despite the strong demand, NATI noted the overall industry-wide macroeconomic downturn and warned that the semiconductor testing sector will continue to struggle in the first half of 2023. On the other hand, if the global economy were to suffer a downturn, the portfolio would likely suffer as well, though it would likely fare much better than in previous downcycles thanks to the portfolio's continued growth. Despite this, management expects the automotive sector to grow strongly due to the company's complete electric vehicle battery testing solution, which was developed through a combination of internal investments and acquisitions. The Aerospace/Defense/Government market is also predicted to expand steadily.

Meanwhile, management has restated its intention to increase operating margin by 300 basis points in 2023 thanks to the combined effects of increased revenue scale, improved gross margin as broker purchases decrease, expanded use of distribution partners and digital channels, and more efficient use of operating expenses.

My expectations

The company's expectation of over 300 bps of EBIT margin expansion in 2023 is consistent with my view that there is room for NI to expand margins. The combination of NI's exposure to growth markets like aerospace and defense (A&D) and electric vehicles and advanced driver assistance systems (EVs/ADAS), emphasis on research and development (R&D) test, and software revenue mix should help the company weather the weaker macro environment. Orders fell by 3% in the fourth quarter, and I still think macro will have a negative impact on revenue in 2023.

Thoughts on the strategic review

That NATI is conducting a strategic review is, in my opinion, further evidence that NATI is well positioned for the future in all of its key end markets. With the advent of 5G and wireless technologies, NATI's semiconductor and electronics exposure has shifted away from cyclical production and toward research and validation. Likewise, the demand for EVs and ADAS, as well as M&As, should cause transportation exposure to grow as a percentage of sales. Recent acquisitions and greenfield growth have led me to conclude that NATI is on its way to becoming one of the two most dominant ADAS/autonomous test & measurement providers.

In addition, NATI has received interest from prospective alliance partners. A strategic buyer is more likely, I think, given the increasing pressure from competitors to focus on recurring software sales and the skewed nature of the backlog with respect to secular trends. I believe that size and market dynamics may restrict the number of interested financial buyers.

Guidance

For 1FQ23, NATI forecasts sales of $415 to $445 million, which is relatively close to the consensus estimate of $420 million. The adjusted EPS guidance of $0.48 to $0.62 is higher than the consensus of $0.48. Despite the potential economic downturn in FY23, management is anticipating a growth in EBIT margins of more than 300 basis points due to an improving supply chain, strategic view, and revenue visibility.

Valuation

I think the key debate driver for NATI stock now is margin expansion, which management has given a very strong guidance this year. Suppose management can pull that off and along with my expectation that margin can continue to expand, I expect NATI to generate ~470 million in FY26. Attaching the forward P/E multiple to it would suggests a share price of near $80, or 46% upside. (Sales is based on consensus figures.)

Conclusion

I expect NATI to have an attractive upside if it can execute its guidance and announced strategic review. The company has been repositioning itself to take advantage of long-term growth opportunities in strategic industry segments, and management has forecasted an increase in operating margins of more than 300 basis points in FY23. The fourth quarter earnings showed lower revenue and earnings than expected, but NATI's outlook for the first quarter was more optimistic and the company's projection of EBIT margins was well above market expectations. Also, the strategic review is further evidence that NATI is well positioned for the future in its key end markets

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