ZBRA - Zebra Technologies: Supply Chain Disruptions

2023-08-02 14:33:18 ET

Summary

• Zebra Technologies Corporation is a long-term secular growth play, which initially benefited from the pandemic and now sees the downfall.
• The degree of sales declines is shocking to me, as current results, but notably the outlook looks particularly weak.
• While I still like the long-term outlook, I think that the shortfall is serious enough to prevent me from buying the current dip.

In January of this year, I believed that it was time for Zebra Technologies Corporation ( ZBRA ) to prove itself. This came as the company was hit by a cocktail of component shortages, a stronger dollar, and softer order growth from its clients.

With sales having come to a standstill in 2022, margins held up quite well, as valuations started to look reasonable, although the uncertainty would prevail for some time to come.

Forwarding nearly half year in time, I am shocked by the second quarter results , but moreover the guidance for the second half of the year. This means that shares are down for good reasons, as quite frankly I am not willing to double down here.

EIA Business

Zebra is what is called an EAI solution provider (Enterprise Asset Intelligence) whose products and services allow for automatic identification and capturing of data. Products and services to think of include RFID scanner, printers and related products, often used in e-commerce, warehousing, and logistics applications.

The current business was dominated by the 2015 purchase of Motorola Solutions Enterprise, a deal which created a leverage overhang for quite a while, but over time has started to pay off. Pre-pandemic, a $4.5 billion business in 2019 posted solid earnings of $544 million, equal to about $10 per share based. These results made that the company was awarded a $250 per share valuation at the time, that is the pre-pandemic.

With sales coming in flat in 2020, sales jumped to $5.6 billion in 2021, largely on the back of organic growth, but aided by some bolt-on deals as well, with adjusted earnings coming in at $18.50 per share. The rapid growth, and investors optimistically extrapolating these earnings, made that shares rose to highs above the $600 mark in 2021. This meant that valuation multiple expanded, all while the underlying business was peaking as well, a very dangerous cocktail.

With the pandemic on its retreat, 2022 was set to become a tougher year as the company guided for a mere 5% increase in 2022 sales, amidst flattish margins. That outlook turned out to be too optimistic as first quarter sales rose 6%, second quarter sales rose 7%, but third quarter sales fell 4%, despite the contribution of bolt-on deals. Moreover, buybacks and dealmaking made that net debt ticked up to $2 billion, still manageable with EBITDA seen around $1.2 billion, but higher than traditional as Zebra has long operated with a very strong balance sheet.

Believing that adjusted earnings should come in around $17 per share, which adjusted for about $2 per share in stock-based compensation expenses, means that realistic earnings could come in around $15 per share. This made that multiples looked pretty fair at 21 times earnings, that is at $315 per share in January.

While I saw long-term appeal and held a long position on the back of this, I saw no reason to add to the position, as there were risks as well, notably related to lower capital spending by industries which benefited from the pandemic in previous years.

Falling Again

After shares rose to $350 in February, shares have largely traded around the $300 mark in the first half of the year, yet shares fell more than $50 overnight to $254 per share, as shares are testing the lower end of the range again.

In February, Zebra posted a 2% increase in fourth quarter sales to $1.50 billion, which meant that full year sales rose by a mere 3% to $5.8 billion. Adjusted earnings fell by a dollar to $17.47 per share, although that GAAP earnings have nearly been cut in half to $8.80 per share. Fortunately, net debt ticked down to $1.9 billion, and with EBITDA surpassing $1.2 billion, leverage ratios were reasonable at 1.5 times.

The 2023 guidance was rather underwhelming, with sales seen between down three percent, and up a percent, with EBITDA margins seen between 22-23% of sales.

In May, Zebra posted a 2% fall in first quarter sales to $1.40 billion, with adjusted end earnings per share down just seven cents to $3.94 per share, although GAAP earnings fell to $2.90 per share, with the discrepancy split quite evenly between amortization charges and stock-based compensation expenses.

Despite a resilient first quarter, the company cut the full year guidance, seeing sales down 4% at the midpoint of the guidance, with EBITDA margins seen around 22% of sales. This is driven by the expectation of a roughly 10% fall in second quarter sales with adjusted earnings seen between $3.20 and $3.40 per share.

Early in August, Zebra announced rather bombshell results with second quarter sales down as much as 17% to $1.21 billion, although that margins held up quite well, with adjusted earnings per share down 29% to $3.29 per share, as the earnings metric was in line with the guidance. Even worse, Zebra guided for third quarter sales down as much as 30-35%, as it shows that the declining capital spending cycle is really hurting the business, seen having a detrimental impact on adjusted EBITDA with margins seen at just 10-12% of sales.

More so, for the year sales are seen down 20-23%, implying that no recovery is seen in the fourth quarter as well, with full year adjusted EBITDA margins seen around 18%. This suggests that full year sales are only seen between $4.5-$4.6 billion, as full year adjusted EBITDA is seen just over $800 million. With net debt ticking up to $2.15 billion, the leverage ratio comes in at 2.7 times, while the EBITDA metrics are arguably seen lower in the second half of the year.

And Now?

The reality is that with Zebra Technologies Corporation shares revisiting the lows of $250, I am shocked to see the degree of the earnings and revenue shortfall, as leverage ratios are jacked up quite a bit.

Given all this, I am pleased to see more Zebra Technologies Corporation cost-saving measures, but arguably the picture is pretty bleak. After all, near-term earnings power is largely non-existing, limiting the potential to deleverage.

Finding myself sitting with a long position, I am a bit in doubt. The fundamentals provide little reasons to be upbeat and to double down at these levels. While a big storm is seen, the long-term potential remains, which means that I am deciding to ride out the storm, but I do not expect calm waters anytime soon.

For further details see: