2023-03-22 15:03:52 ET
Summary
- MSI has a healthy demand outlook reflected by a backlog of $14.3 billion at the end of Q4 2022.
- The company has highlighted video and software as key priorities for future growth.
- MSI currently trades at a premium valuation at a forward EV/EBITDA of 17.3x vs. the sector median of 13.1x.
- I believe there are limited chances of a multiple re-rating from this level in the near term and hence prefer to wait for a better entry point.
Thesis
Motorola Solutions, Inc.'s ( MSI ) stock is currently trading at premium multiples compared to its historical average. I believe the company’s premium valuation is justified given MSI's strong competitive position, solid operating leverage, shift towards software and services, and record backlog. I also believe there are limited chances of its multiple re-rating from this level in the near term and hence prefer to wait for a better entry point.
Post Q4 Outlook
MSI's fourth-quarter results for 2022 were impressive partly due to better-than-anticipated supply during the quarter, and strong demand reflected by a record backlog of $14.3 billion at the end of the quarter. The company's outlook for the first quarter of 2023 and the full year is positive, with a broad demand for products, supported by an ARPA-spurred favorable funding environment that should have benefits into 2026. There is potential for growth, with the APX NEXT upgrade cycle in its early stages and momentum in demand across regions at higher average selling prices. Going forward, challenges related to components, freight, and foreign exchange are expected to ease. While operating expenses are expected to rise, mainly due to acquired business costs, there is strong operating leverage in the model, given the company's modest incremental investments despite a positive revenue outlook.
The management of the company continues to execute well, thanks to increased demand in video analytics and LMR business, which is being supported by favorable funding conditions. However, there are risks related to foreign exchange and supply, which could impact the company's near-term performance. Nevertheless, the record backlog levels provide some support to the company's visibility in the short term and throughout the year. The company is currently valued at a premium, and I believe that a pullback in the stock price would present an opportunity to invest in this high-quality company.
Macro update
According to management, the supply chain has improved, and demand remains strong. The company is adjusting prices for inflation on new devices and contract renewals. There may be some margin headwinds due to a focus on manufacturing premium products. Public safety is expected to remain resilient during a recession, but there may be a contraction in the commercial side of the business after backlog fulfillment. Management is not very concerned about competitive risks or Hytera anti-trust litigation. While there are still FX headwinds and a volatile macro backdrop, there is better visibility, and the company is well-insulated against shocks in a recessionary scenario due to high mission-critical spending and early APX Next product upgrade cycles.
Demand Remains Robust With High Backlog
There are several structural factors that are favorable for MSI, including the National Defense Authorization Act (NDAA), the Secure Equipment Act being implemented by the FCC, and international countries expressing concerns over Chinese-owned electronics, particularly in video security and access control. Although MSI primarily serves the public safety vertical, it also has key verticals such as education, healthcare, and public venues.
Despite the current economic conditions, I have not observed any signs of a recession or decline in demand within the company's business. The focus on public safety and the nature of the company's products and solutions helps it to protect it from macroeconomic volatility. The company's business is primarily focused on public safety (75%) with the remaining portion serving the Enterprise and Education verticals. Education is particularly important for the company, not only in video security but also in LMR. The majority of the company's backlog is from government contracts, and the funding environment remains strong, with federal funds available through 2026.
Positioned for Long Term Value Creation (Company Presentation)
Continues to take share in Video and Command Center
The company has highlighted video and software as key priorities for MSI's future growth. Currently, video security and software and services generate slightly over half of the company's total revenue. While LMR remains the core of the company, MSI now has more sales people focused on video security than LMR. Video is expected to grow at a high double-digit rate in the coming years, which is multiple times higher than the market growth rate. The Command Center segment is also growing at a low double-digit rate, while the overall market is expected to grow high-single-digits. Both Video and Command Center markets are fragmented. MSI’s Command Center growth tends to be lumpy with a few big orders.
An Integrated Ecosystem with $50b TAM (Company Presentation)
Valuation
MSI trades at a premium valuation at a forward EV/EBITDA of 17.3x vs the sector median of 13.1x. The company continues to execute well and has demonstrated strong performance in a challenging macro environment. Although I believe that MSI’s premium valuation is justified due to the company's solid operating leverage, shift towards software and services, and record backlog that provides better visibility in the long run, I believe there are limited chances for its multiple to re-rate higher from this level in the near term and hence prefer to wait for a better entry point.
Final Thoughts
Motorola Solutions reported strong Q4 2022 results, and management provided positive guidance for Q1 2023, with a broad demand for products supported by favorable funding conditions. The management continues to execute, and MSI is experiencing strong demand for video analytics and LMR business due to favorable funding conditions. The company has highlighted video and software as key priorities for future growth. Despite the challenging global macro environment, I believe there is room for growth in the company’s software and video segments. However, MSI currently trades at a premium valuation at a forward EV/EBITDA of 17.3x vs. sector median of 13.1x. I believe there are limited chances of multiple re-rating from this level in the near term and hence prefer to wait for a better entry point.
For further details see:
Motorola Solutions: Premium Valuation Keeps Me Sidelined For Now