Iteris (NYSEMKT:ITI) provides intelligent transportation solutions (ITS) through three segments:
- The roadway sensors segment provides vehicle detection systems used for traffic intersection control, incident detection and highway traffic data collection applications.
- The transportation systems segment provides transportation engineering and consulting services as well as transportation management and traveler information systems.
- The iPerform segment provides performance measurement and information management solutions as well as predictive traffic and weather analytics.
A stock stuck in traffic due to underappreciated growth potential
Despite its small size, ITI should be able to capture a meaningful portion of the large and growing markets (see chart below) due to its high market share (e.g. >115,000 video detection sensors operational worldwide), broad product offerings, superior technology that creates high barriers to entry and a proven, long-term track record (e.g. introduced its first vehicle detection product in 1993).
Source: Company presentation (free registration required)
Any quarterly volatility in results due to the timing of orders or unfavorable weather should not distract investors from the secular demand driven by increased infrastructure spending (in both developed and emerging markets) as well as the desire to reduce traffic congestion and improve transportation safety. In the U.S. alone, traffic congestion wastes $100+ billion annually, not to mention the time commuters will never get back from sitting in a car.
Its products can allocate green traffic light time based on demand* while allowing traffic managers to detect/respond to accidents faster (saving lives) and modify traffic signal timing to reduce congestion. Moreover, its detection systems can be accessed wirelessly (no need to lay fiber) and mounted on traffic poles as opposed to in the road, which requires expensive trenching that can affect the integrity of the road. The fact that replacement of unreliable legacy loop systems (see "inductive loop detectors" for detailed explanation) represents 65-70% of the market should provide stable demand and increased revenue visibility.
As a result, the low level of penetration in the intersection traffic market is more an opportunity than a risk (as it is cited in the 10-Q), especially given the continued roll out of new products. For example, SmartSpan and SmartCycle increase the number of intersections that its products can be installed on by >100,000 as the former allows for installation on span wire (as opposed to a rigid traffic signal mast arm) while the latter accurately detects bicycles.
Public/private partnerships (e.g. with the Department of Transportation to develop technology used to more accurately predict road conditions) and long-term federal contracts provide much needed credibility and funding. ITI leveraged its strong performance on existing contracts in California to expand within the state as well as into other states for similar or even new products.
In July 2013, ITI launched a next generation 511 traveler information system in South Carolina (one of 17 systems globally) with features including mobile apps, Twitter feeds, enhanced interactive voice recognition and personalized email/text alerts delivering real-time traffic conditions. If any (much less all) of these features were provided by a standalone company (preferably based in San Francisco), the valuation alone would probably be larger than for all of ITI. However, the market has completely overlooked this growth opportunity as it is only part of the larger investment story.
Many of the factors that previously limited growth over the past several years have receded. For example, a budget has been passed, the debt ceiling has been raised, the government is no longer shut down, residential construction is improving (which requires new traffic signals), state finances are much healthier and the critical federal highway bill was passed, which should result in increased ITS spending. Management specifically cited this bill on the most recent conference call for the increase in requests for proposals (RFP).
In the mrq, revenue increased 18% to $16.5 million driven primarily by the higher margin roadway sensors segment, which also drove a 60 basis point expansion in the gross margin to 37.4%. Although revenue in the transportation systems segment only increased 6%, growth should accelerate in the coming quarters due to the previously mentioned RFP activity and the pursuit of larger contracts. While management intends to focus on the core domestic intersection market, this should not diminish the large international market opportunity (currently <~10% of revenue), especially in Latin America and the Middle East.
iPerform revenue decreased 8%, however this is less concerning for three reasons. First, this segment only currently accounts for a small portion of overall revenue so the effect is muted. Second, the decrease was largely due to delays in contract awards, which should eventually be released. Third, the focus should be on the bullish long-term outlook (see iPerform section below) rather than short-term fluctuations.
The chart below further highlights the growth potential and high operating leverage. Although revenue increased 14%, operating income increased 56% despite elevated spending in support of iPerform.
*One of the key features is the ability to maintain a green light longer to allow an approaching car to get through the intersection. This benefits not just the driver but also other commuters and pedestrians as it would decrease the "need" to floor it in order to make a light, which decreases the potential for accidents.
Does the end justify the means? The importance of how growth is "bought"
ITI is funding its growth initiatives using stable cash flow generated from the more mature roadway sensors and transportation systems segments, which is preferable compared to a dilutive equity raise or incurring leverage. However, despite the elevated spending FCF (including capitalized software costs) increased from ~$200,000 in FY12 to $3.2 million in the LTM. The strong balance sheet with no debt and a large cash balance (31% of the market cap) is another "low cost" funding source.
Although analysts and investors may normally prefer for stable cash flows to be returned in the form of increased buybacks or dividends, in this instance the current capital allocation decision is the correct one given the significant growth opportunity. Even so, since the start of a buyback program in August 2011, ITI repurchased ~2.3 million shares at an average price of $1.54 or ~22% lower than the current price.
The recent contract awards, distribution agreements and technological advances, as a direct result of this spending, further support this approach. For example, the current backlog of $36.8 million is the second highest in >5 years and only slightly below the peak level of $38.6 million in FY13. As a result, once these current growth initiatives are largely complete, the previously mentioned FCF growth should accelerate due to increased revenue, lower capex and stable SG&A.
The next Markit?
ITI recently agreed to distribute its predictive traffic and weather information products on Tinga's AIR Exchange, a cloud-based marketplace designed for asset managers, hedge funds and corporate buyers. However, the stock has dropped ~20% since the announcement, which provides an opportunity for investors who recognize the potential in expanding beyond the core market. Moreover, the market for actionable financial intelligence is inelastic given the eternal pursuit of alpha and as managers are increasingly being forced to justify their high fees, which are under pressure from "dumb" index funds.
A perfect example is the ability to apply analytics to turn weather information from the National Weather Service that is accurate to within 10-12 kilometers into accuracy of 1-2 kilometers. This provides much more granular detail (pun intended) of conditions in a small section of a corn field. Furthermore, if this agreement fails to meet expectations, ITI could seek distribution through a more well-known provider such as Bloomberg.
There are multiple similarities between ITI and Markit shown in the chart below that highlight the low implied value.
iPad vs. iPerform: Same strong growth but only one is overlooked
Although ITI has decades of experience in the ITS market, its iPerform segment is relatively young (established in 2011). However, this does not translate into less opportunity, especially given the recent trend of tech startups going from a simple idea to multi-billion dollar businesses in short order (e.g. WhatsApp). Its real time and predictive solutions should meet increasing demand from both consumers and governments. For example, arguably the primary reason Waze is so popular (enough so that Google acquired it) is not because it provides a superior mapping solution because there are many other providers that already offer this. Rather, it is the ability to leverage big data (in this case user reports) to help commuters save time by avoiding congestion.
On the government side, iPerform recently introduced its ClearPath Weather analytics platform in beta form to two new public agencies. The continued platform development and superior performance (e.g. efficient deployment of snow plows saves money and makes roads safer) should attract other agencies, who may be taking a wait and see approach as the idea of being a guinea pig is not attractive from a risk/reward standpoint*.
Even though current targeted applications alone should provide exponential growth, there are multiple tangential markets offering similar opportunities. For example, iPerform could be used in scheduling (e.g. when to leave based on congestion), consumer apps, fleet management and improved media reporting.
Moreover, iPerform should provide a recurring revenue stream (based on subscriptions) once it transitions from a consulting model to SaaS with 60% gross margins compared to 45% for roadway sensors.
*It works and someone says "good job" as there is no "carry" to be earned for government workers. It does not work and your agency receives less funding going forward after reports of "wasted taxpayer dollars" land on the front page. This is also an asymmetric trade but in reverse.
The peer comp shown below is subjective given the limited number of pure play and direct competitors, however it does highlight the attractive relative valuation even at this stage of lower EBITDA due to the previously mentioned elevated spending.
Moreover, ITI may be an attractive acquisition target for larger tech companies such as Google or Facebook, both of which have a history of spending seemingly absurd amounts of money on companies or projects that may not even pay off for years. However, ITI has products and technologies that are useful today and could be integrated into existing offerings (e.g. providing real-time traffic and weather updates to mobile users).
The following are the primary risks to the investment thesis, in order of importance:
- ITI is heavily dependent on government spending at all levels (national, state, local), which is subject to change, especially during periods of lower economic growth and/or budget pressures.
- Some of its contracts are fixed price, which results in a greater potential for cost overruns and lower margins (compared to cost plus contracts). However, this risk is offset by the potential for greater profitability if it is able to manage project costs.
- Although the currently depressed free cash flow should rebound once spending returns to a more normalized run rate, ITI still must dedicate a meaningful amount of cash flow to capex/software costs in order to remain competitive.
The target price is based on a 1x revenue multiple, which is conservative given the higher peer multiples and expected growth acceleration.
The stop loss should be placed below the recent low at ~1.90 or ~4% below. The time frame is 12-24 months.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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