2023-08-11 07:17:34 ET
Summary
- Motorola Solutions has experienced strong growth in its Software & Services, Video, and Command Center business through acquisitions and organic investment.
- The company has generated strong free cash flow, built a record backlog ($14.3 billion, or ~6x of Q2 revenue), and rewarded shareholders with strong dividend growth and share buybacks.
- Motorola Solutions has significantly outperformed the broad market over the past three years and is expected to continue rewarding shareholders in the future.
- Q2 results were so strong; MSI raised its full-year guidance. That being the case, investors can expect another double-digit dividend increase announcement in November.
Over the years, Motorola Solutions (MSI) has built a very sticky business with its land mobile radio ("LMR") networks and devices. But the company did not rest on its laurels. Instead, management adopted a wise strategy to grow its Software & Services, Video, and Command Center business through acquisitions and organic investment. The combination of these successes has enabled the company to generate strong free cash flow, build a record backlog, and reward shareholders with double-digit dividend growth and meaningful share buybacks. As a result, Motorola Solutions' stock has significantly outperformed the broad market - as represented by the Vanguard S&P500 ETF ( VOO ) and Invesco Nasdaq-100 Trust ( QQQ ) - over the past three years (see chart below).
That is likely to continue going forward, and I'll explain why in this article. MSI is a BUY.
Investment Thesis
I have covered MSI extensively on Seeking Alpha and the stock has returned 60.5% since my initial BUY recommendation in February of 2021 (see MSI : Record Backlog, Strong FCF, 11% Dividend Boost, Emerging ARR Story ). That is almost 4x the returns of the S&P500 since that time.
One reason for the stock's excellent appreciation is the company's strong free cash flow profile that has resulted in excellent growth in the dividend (see Seeking Alpha's Editor's Pick: MSI : 5 Years Of Double-Digit Dividend Increases ).
Another reason is that the company's core LMR business remains strong while its growth initiatives have been successful at growing both the top- and bottom-lines. As the slide below taken from the company's August Investor presentation shows, MSI's asset-light business model enables it to allocate only ~20% of operating cash-flow to cap-ex. That, of course, potentially leaves ~80% of cash-flow to devote to its growth strategy and/or to reward shareholders, which is exactly what MSI has been doing:
Note the $7.3 billion in share buybacks since 2015 haven't simply been a gift to the CEO and executive management team by off-setting their stock options. That's because the buybacks have meaningfully reduced the outstanding share count (by ~23%) and the average cost of the repurchased shares since 2015 is $90.46/share (note the stock closed Wednesday at $281.22). Clearly, ordinary shareholders have directly benefited from MSI's share buybacks.
For example, last year MSI generated $1.567 billion in free cash flow, which equated to an estimated $9.12/share based on the 171.9 million average outstanding shares at the end of the year. With the current annual dividend obligation of only $3.52/share, clearly, MSI's free cash flow profile bodes well for strong double-digit dividend growth going forward. That's because MSI's legacy LMR business is still robust while several catalysts indicate its growth strategy in Software & Services, Video, and Command Center is working. Let's take a deeper look at MSI by starting with the Q2 earnings report.
Earnings
MSI released its Q2 EPS results on August 3rd and it showed continued strong financial performance that beat on both the top- and bottom-lines. Highlights included:
- Revenue of $2.4 billion (+12% yoy)
- GAAP Earnings were $2.15/share (+62% yoy)
- Non-GAAP EPS was $2.65 (+28% yoy)
- GAAP operating margin was 21.6% (up 490 basis points yoy)
Top-line revenue growth was driven by strong results in both of MSI's operating segments: PSI (Products & Systems Integration) and Software & Services (which includes LMR Services, Video, and Command Center).
Better still, the company ended Q2 with another record backlog of $14.3 billion - that's up 6% yoy and was driven by record Q2 orders across both segments. The backlog was up $211 million on a sequential basis and now equates to almost 6x Q2 sales - giving investors a clear line-of-sight into continuing strong financial returns for at least the next year and a half.
As the slide below taken from the Q2 Presentation shows, order flow in MSI's PSI Segment continued to be strong and diverse during the quarter:
Motorola Solutions
The PSI Segment is the larger of MSI's two segments ($1.437 billion in revenue, or ~60% of total revenue). That being the case, it bodes well for shareholders going forward that non-GAAP operating margin in the PSI segment (19.8%) grew a full 5.3 percentage points yoy. Clearly, MSI is benefiting from a more normal supply-chain environment. Indeed, on the Q2 conference call , CEO Greg Brown - referring to the PSI Segment - said:
... continued robust demand and improved supply chain availability led to a 12% growth in revenue and a 52% growth in operating earnings in the segment.
Order flow continued to be strong and diverse in the Software & Services Segment as well:
As you might guess, the non-GAAP operating margin is much higher in the S&S segment (36.9% in Q2) as compared to the PSI segment, and it was also up nicely on a yoy basis (80 basis points). It is important for investors to note that the higher-margin S&S Segment represents $9.5 billion (~67%), or a majority, of the $14.3 billion backlog.
During the quarter, MSI repurchased $224 million of shares, paid $148 million in cash dividends, while incurring only $53 million of capital expenditures.
Bottom line: MSI saw double-digit revenue and earnings growth across both segments and, as a result, raised its full-year revenue and earnings guidance:
Motorola Solutions
As can be seen, the midpoint of FY23 revenue guidance ($9.8875 billion) was raised $100 million+ from the previous midpoint ($9.75 billion). The midpoint of non-GAAP EPS ($11.44) was raised by $0.19/share.
Risks
The biggest risks for investors is likely MSI's current arguably rich valuation:
In addition, despite the impressive track record of double-digit dividend increases, MSI's stock price appreciation means that the current $3.52/share annual dividend obligation equates to a yield of only 1.27%. This means that MSI trades at a TTM premium valuation to the S&P500 (PE=25.5x) while its yield is below that of the S&P500 (1.54%) .
That said, I would note that MSI has had a premium value based on P/E for years now, yet the stock continues to grow into that valuation:
And that is likely for three primary reasons:
- MSI's strong backlog gives investors a clear line-of-sight for at least the next 6 quarters.
- MSI's growth strategy, primary in Software & Video, is working and is an excellent compliment to the legacy LMR business.
- MSI's sticky LMR business - with customers like state/local/federal governments, first responders, and public safety departments - has high switching costs.
Investors may not fully understand this last point. Motorola's mission critical LMR networks are typically customer owned and private. That is, these networks have their own towers and base-stations and do not share these assets, or communications frequencies and bandwidth with major carriers. This is why Motorola's networks and devices are so reliable and so popular for mission critical applications like first responders, governments, and public safety organizations. But the important point here is that since their customers pay for these networks, and own them, the cost of switching to another vendor for their communications solutions is very high - it would pretty much cause them to write off all their previous investments in the Motorola network and the handheld devices that use them. This is what I mean when I say the LMR business is "sticky". And this is why MSI's customers continue to renew their services contracts with Motorola and why they continue to buy Motorola's very popular handheld devices that are designed specifically to work on the Motorola custom-designed network.
From a balance sheet perspective, Motorola Solutions CFO Jason Winkler said this on the previously referenced Q2 conference call:
Second, earlier this week, Moody's upgraded our credit from two Baa2 from Baa3. This higher credit rating underscores the strength of our balance sheet, including the strong liquidity position, our balanced debt maturity profile, significantly improved pension status, along with a track record of consistently growing earnings and cash flow.
Summary & Conclusion
Despite Motorola's arguably high valuation level, I still find the stock a BUY based on the continued strength of its legacy and sticky LMR business as well as the growth in its high-margin Software & Services Segment, which is driven by its Video and Command Center solutions and which currently equates to ~67% of Motorola's record $14.3 billion backlog.
The company's asset-light business model enables it to deliver impressive dividend growth and share buybacks that have greatly benefited ordinary shareholders over the years.
Motorola Solutions typically announces a dividend increase in mid-November: the last increase was 11% and was announced on November 17th last year. On the heels of the strong Q2 report, and the increased guidance for full-year 2023, investors can expect another double-digit dividend increase this November. A 10% increase in the quarterly would, for example, take it to $0.968/share. Let's round that off to $0.97/share, which equates to a $3.88 annual dividend obligation. Yet it would not surprise me if the dividend increase came in above 11%.
I'll end with a 5-year total returns chart comparing Motorola Solutions with the returns of the broad market averages as represented by the VOO, QQQ, and DJIA ETF ( DIA ):
For further details see:
Motorola Solutions: An Excellent Dividend Growth Stock