2023-07-20 06:44:46 ET
Summary
- Atea, a multinational IT software and hardware company, has shown solid growth and profitability, despite periodic instability. It has a strong market share in the Scandinavian home markets in both hardware and software sectors.
- The company's annual sales exceed 45B NOK, with a current EBIT margin of between 3-4%. It has a 1.03x net debt/EBITDA and interest coverage of almost 8x, indicating solid fundamentals.
- Despite its strong performance, I argue that Atea stock is currently overvalued and would only consider buying if the price fell.
Dear readers/followers,
Atea ( OTCPK:ATAZF ) is a company I have followed for many years. My first article on the company was in fact not that long ago after I began writing on Seeking Alpha. The arguments for Atea can be argued to be timeless. We have a solid yield, a solid foundation, decent growth, and a good market share in the Scandinavian home markets both in the hardware and software sectors.
In this article, I mean to provide you with my first coverage for Atea for over 1.5 years and tell you why this company is one on my watchlist here.
Atea - Nation-spanning IT infrastructure with a good market share
The company, which began its corporate life as the company Ementor, can trace its roots farther than most IT companies - all the way back to the 1960s, with a native Oslo stock exchange listing as early as 1985.
Multi-national IT software and hardware is the company's battlecry, with representation in all of the regions 5 nations, and beyond.
Atea's business idea is selling, implementing, installing, and supporting IT products, services, solutions, and technologies. Over the years, it has sold a multitude of brands, but now represents among others, Citrix, VMware (VMW), Apple ( AAPL ), Cisco ( CSCO ), HP, Microsoft ( MSFT ), Lenovo, IBM ( IBM ), Readdle and many others. This makes it not that different from other local, regional, and international players, but what Atea brings to the table is local scale and expertise.
The company has annual sales of over 45B NOK, and on those sales, it makes a current EBIT margin of between 3-4% which puts it in the same range as your typical Scandinavian grocer. At this time, the company isn't a margin leader when it comes to the sector. It's a margin-average company at 26-27% gross margins and a 3-5% operating margin. But its fundamentals are solid, with a 1.03x net debt/EBITDA and interest coverage of almost 8x.
The company's contract structures and sales are also more stable than its share price development since COVID-19 would suggest. The company fell like a rock tied to a sack with other rocks, only to bounce up over 150%, only to fall down - where I bought a small position, seeing the company quite recently go up, with a decline now having begun again. We can illustrate this here.
From this graph, you can see that Atea is a profitable company that while, having some periodic instability and downturns in earnings, do maintain a very solid overall profitability and impressive EPS growth trajectory. You can also see, tendentially, that there are prices where you would want to "BUY" Atea, and ranges where you definitely will not want to hold it for too long.
It should not come as a surprise to you that I sold most of my stake when the company climbed to 18x P/E, and am currently waiting for the company to go below P/E 15x.
The latest report from the company we have to go by is 2Q23. The quarter saw good top-line growth coupled with good EBIT growth, but an EBIT margin decline of 40 bps.
What we should mark here is the company's revenue growth in all regions, and all business lines - those business lines being Hardware, Software, and Service. Out of this mix, we have double-digit growth in every segment, with a 21% top-line growth in services.
Atea remains a mostly hardware-focused company. While the company's official breakdown is geographic...
...we also have the data to provide you with what exactly the company sells, and how much of it. Hardware makes up 69.2% of the top-line mix for 2Q23, with services at second place, and software still at an unfortunately "minor" position here.
In terms of geography, you can see that SWE/NO/DEN remains the major player here, with Finland at 11% and Baltics really at no substantially higher position than when I first reviewed the company several years ago. This was part of my forecast at the time, and it's encouraging to see that it materialized.
Other things that have been happening since is that Atea has mostly fixed its problematic Denmark-segment, and substantially improved its debt. At the right valuation, this is a 6%+ yielding IT business with a very good upside - today it's unfortunately a bit more overvalued with perhaps somewhat of a long-term downside or flat potential despite forecasted growth - but more on that in valuation.
What I want you to focus on for Atea here is an impressive amount of underlying sales growth. This is not just pricing, it's a fair share of volume growth as well, which implies that Atea is seeing some good sales traction in all of its home markets, delivering double-digit quarterly growth rates.
On a TTM basis, the company can also, actually, present a much better mix, with a growing software portion where Hardware "only" makes up 50% of the overall mix.
The underlying trends for this company are very encouraging, and something I want you to be aware of when we're talking valuation because the fact is that very few non-Scandinavian hardware-based IT businesses manage this sort of sales development, that I am aware of.
What I would be looking at when it comes to Atea trends going forward is continued overall sales growth across all of the company's various geographies. Current estimates are for continued top-line sales growth, that will accelerate significantly due to customer replacement needs and other trends in 2026-2027. S&P Global analysts see accelerating sales growth in 2024-2025, with an average double-digit growth rate of 12.7% for the next few years. This would imply, in fact, a premium, when we consider that the company yields 4.5% here which turns it into a potentially attractive mix of a growth and an income stock - at least in part. If we were still at low-interest rates, this company would become much more of a no-brainer investment at even a higher price - but we can now get 3.5-4.5% relatively easily from savings accounts or essentially risk-free investments, like IG-rated bonds.
So we need more potential RoR than those 3-5%.
Most of the company's challenges or risks that I would consider relevant have to do with inventory and SCM. Because the company is primarily a hardware and not a software player, stocking and destocking trends matter, and we all know that the shelf-life for these products is relatively short (though obviously not at the level of groceries).
The company did go through a significant inventory buildup over the past two years in expectation of 2020E supply chain constraints at the time. These were still present a year ago, but are no longer as present now. The company has planned well to reduce inventory over the past 12 months, to where the current level, according to management, is somewhat more normalized (actually lower as a percentage of revenue than before the buildup). The company has also, this time around, avoided any write-downs here, which also goes to show us that Atea has managed this well.
The company also doesn't expect significant cost increases from here on - instead, the company's main cost issues are found in the employee/staff portion of the financials - so Atea has already guided that we won't see the scale the number of employees all that quickly here.
Current estimates are for the company to deliver an EBIT of 1.4-1.5B NOK - and this is what I would consider to be an impressive level.
Let's look at valuation trends.
Atea Valuation - There are things to like, but I see more downside than upside and want more of a downturn
Atea is a good "BUY" at a good valuation - as, of course, most companies tend to be. However, what I want to do with Atea is to forecast the company at a conservative P/E 15x, which unfortunately at this particular point would entail a below-average RoR for the business. Yes, the return would still be around 11.35% per year or 30% in 3 years, but this is almost a 5% yield and a relatively high premium at 17x.
I can definitely see why some would consider the company a "BUY" here. However, after a few years of going "in and out" of the company in a successful manner, I believe myself to be well-versed in how to make money with Atea. It's entirely reasonable for this company during uncertainty to go below 15x P/E, sometimes as low as 13.5x, which points your RoR even to a level like today could be well above 40% exclusive of dividends.
The 13.5x P/E average at this time would imply a share price of around 118 NOK/share. This is too low - and I'm not saying that I would demand 13.5x P/E. But I won't touch Atea above 15x P/E, not easily. And that 15x P/E normalized is around 130 NOK per share here, so that's where I end up in terms of what I want to see.
The S&P Global average for Atea is above that though. 4 analysts follow the company, and these put the business at between 140 NOK and 180 NOK, with an average of 160 NOK. However, only one of those analysts is currently at a "BUY", implying what I would consider being a limited conviction for this investment.
Other valuation methods we can employ, including Lynch valuation, median sales multiples, and projected FCF considerations, would imply the company should be no higher than 90-100 NOK - which I obviously view too low. But I do maintain that the "truth" of the matter in terms of where the company should be trading over time in order for it to be an appealing prospect, is around 130 NOK/share or below. At that valuation, I can buy it - around 5% yield over time, with a good enough upside during times when we see 160-180 NOK.
As for the growth prospects that Atea offers according to forecasts, I give you the forecast accuracy as to Atea's earnings growth - which shows you that analysts have a non-trivial tendency to overestimate Atea.
Based on that, I would not hold my breath for the company seeing exactly the positive trends here that are being forecasted.
I give you my updated thesis for Atea as of 2023.
Thesis
- Atea is one of the market-leading IT companies in the Nordics, not in their own software, but in selling other companies' hardware and software and servicing this. The company's market share and exposure to multiple geographies and currencies make this an attractive play if you're interested in higher-yielding IT with Scandinavian organizations as their backbone.
- At the right valuation, this company has the real potential for 50-150% RoR while paying a 5-6% yield, as I have invested in Atea in the past. For the time being, however, it's coming out of what I view as being somewhat overvalued.
- I rotated most of my shares, and I give Atea a conservative PT based on a relatively low EBIT margin and a volatile history despite a strong forecast, and would buy below 130 NOK/share.
- This makes the company a "HOLD" here.
Remember, I'm all about:
1. Buying undervalued - even if that undervaluation is slight, and not mind-numbingly massive - companies at a discount, allowing them to normalize over time and harvesting capital gains and dividends in the meantime.
2. If the company goes well beyond normalization and goes into overvaluation, I harvest gains and rotate my position into other undervalued stocks, repeating #1.
3. If the company doesn't go into overvaluation, but hovers within a fair value, or goes back down to undervaluation, I buy more as time allows.
4. I reinvest proceeds from dividends, savings from work, or other cash inflows as specified in #1.
Here are my criteria and how the company fulfills them (italicized).
This company is overall qualitative. This company is fundamentally safe/conservative & well-run. This company pays a well-covered dividend. This company is currently cheap. This company has a realistic upside based on earnings growth or multiple expansion/reversion.
This means that the company fulfills every single one of my criteria, making it relatively clear why I view it as a "BUY" here.
Thank you for reading.
For further details see:
Atea: Scandinavian IT In A Recovery, But Too Expensive - 'Hold' (Rating Downgrade)