SMRT - SmartRent: Positive On The Profitable Growth Approach

2023-08-22 02:31:48 ET

Summary

• SmartRent's 2Q23 revenue exceeded expectations, with strong growth in all areas and closer to breakeven EBITDA.
• SmartRent's adoption of a profitable growth approach, reflected in its 2Q23 results, demonstrates a sensible move that aligns with investor preferences and future profitability prospects.
• The partnership with ADI is set to enhance SMRT's long-term FCF margin profile.

Summary

SmartRent ( SMRT ) is a software company that offers a smart home operating system for residential property owners, operators, and homebuilders. Their system is fully integrated and can be used by any enterprise, regardless of brand. Readers may find my previous coverage via this link . My previous rating was a buy, as I believed the real estate market represented a significant opportunity for SMRT's growth and expansion, and the company is well-positioned as a leader in the industry. While upside is less attractive now, I am reiterating my rating as I believe the profitable growth approach is a sensible move that will be welcomed by investors once SMRT starts to turn EBITDA positive (consensus expects this to be in FY24). In addition, the partnership with ADI should improve SMRT's long-term FCF margin profile, which is another positive point.

Financials/Valuation

SMRT's 2Q23 revenue of $53.4 million was up 26% and greater than the guided range of $50-$55 million at the midpoint. Hardware sales increased by 33%, Professional Services by 10%, and Hosted Services by 26% year-over-year, demonstrating strong growth in all areas. EBITDA of -$6.4 million is getting SMRT closer to breakeven as revenue growth continues to be robust. Revenue is now expected to be between $57 and $62 million for 3Q23 and FY23 revenue to be up from the previous range of $225 to $250 million to $233 - $250 million. Adjusted EBITDA projections also went from a range of -$25 million to -$15 million to -$22 million to -$18 million.

Based on my view of the business, SMRT's growth is unlikely to meet my previous expectations. With management's focus on profitable growth, I now expect growth to meet FY23 guidance and likely follow at a similar pace in FY24. With the slowdown in growth expectations, I expect the valuation multiple to stay at the current level as growth is still strong on an absolute basis, although it is unlikely to move further upwards. My price target remains in a similar range, but given the rise in share price since my initiation (26% increase), I think the return profile is a lot less attractive now.

Comments

So far, everything has worked perfectly, which is in keeping with my anticipation of rapid growth. Strong Hardware and Hosted Services gross margins and 26% revenue growth highlighted a successful 2Q23. Bookings for SaaS increased dramatically in 2Q, with the average bookings per user jumping to $8.74 from $5.40 in 1Q23 thanks to up-selling and cross-selling initiatives like self-guided tours and Alloy Access. Considering that SaaS ARPU was only $5.16 in 2Q, there is clearly room for significant growth. The new ADI distribution offering was also a highlight of the quarter, and it should lead to a leaner cost structure and stronger financials in the long run. SMRT will now use ADI's warehousing space, which is crucial because it allows SMRT to reduce its inventory over time. Ultimately, this leads to a more cost- and cash-effective business model. By reducing the amount of inventory held on the balance sheet, this agreement should improve FCF conversion (less working capital needs) and make scaling operations more cost-effective. The shift from fixed to variable costs should also improve margin stability in periods of slower growth or decline.

However, the quarter was not without its problems; new unit deployments dropped 21%, and Professional Services gross margins shrank 19pts sequentially. This demonstrates that there is still a fair amount of variability in management's efforts to switch to a growth strategy that generates profits rather than merely focusing on growing the business. For example, in Professional Services, the drop was attributable to slower unit deployments, which management is doing on purpose to improve profitability in light of the business's high fixed cost base. But I am positive that margins will improve as management anticipates a material improvement in margins in 4Q23. Using more general contractors for overseeing of projects, in addition to implementing technology initiatives to increase efficiency and oversight of installations, should lead to higher margins in the Professional Services segment.

In addition, SMRT's booked units dropped significantly to 20,000 in 2Q23, from 65,000 in 1Q23. However, I attribute this to the decision to slow down the rate of unit deployments in favor of optimizing profits. The fact of the matter is the growth is not demand constraint but supply constraint as customers are waiting for SMRT to fulfil the demand. In my opinion, SMRT faces little competition for customer loyalty because of its dominant position as a full-service provider of smart home technologies.

Overall, I believe the focus on profitable growth is more sensible and will be more welcomed by investors who are looking for growth and profits. The issue to monitor is whether management can continue to execute and pivot to this approach.

Risk & conclusion

Flawed execution will be the risk here as SMRT transitions its growth strategy to focus on profitable growth. If the profitability of new businesses is lower than expected, it could result in low growth and poor profitability, a double whammy that could send the stock nosediving. In conclusion, SMRT is navigating a shift towards profitable growth, reflected in its 2Q23 results and strategic moves. Despite a slower growth outlook, driven by a focus on profitability, I maintain a positive outlook on SMRT due to its strategic positioning and successful execution. The ADI partnership and its impact on cost structure and FCF conversion are notable positives. Execution remains crucial, as flawed implementation could pose risks to growth and profitability. Overall, SMRT's evolving approach to profitable growth is poised to resonate positively with investors seeking both growth and profits.

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