Investors who've been around a while know to be skeptical when established companies attempt to pivot their business toward hot new trends. It has happened many times in biotech, it happened with the rise of e-commerce and cloud/SaaS, and it's happening again with ag tech as concepts like data analytics and Internet of Things are applied to this huge market.
That doesn't mean that investors should automatically dismiss Iteris (NYSEMKT:ITI). After all, well-run companies are supposed to figure out how to apply their existing know-how and expertise into emerging and adjacent sectors to grow their business. But it does at least argue for investors to approach this name somewhat cautiously for now.
If Iteris can build real share in its addressable segment of ag analytics and achieve the sort of margins and cash flow that other companies have managed with a SaaS model, a double-digit fair value is not unreasonable. On the other hand, if the company cannot make a dent in the ag market over the long term (and/or the market fails to emerge as expected) and the traffic business performs more or less as it has in the past, a return to the low single cannot be ruled out.
Keeping The Traffic Flowing
Iteris is not a new company. For quite some time, the company has been in the business of developing and marketing advanced traffic sensors, monitoring/management systems, and consulting services for transportation departments. Iteris claims to have pioneered the use of video detection to optimize traffic signals and of data analytics to manage traffic congestion, with the company having its sensors in about one-quarter of "connected" intersections and having designed close to a third of the connect intersections in the United States.
Many readers are probably aware that municipalities will use magnetic loops embedded in the pavement to help control traffic lights and/or monitor traffic types. These systems have been around for a while and they work reasonably well, but are nevertheless limited in what they can do. What Iteris offers (as well as rivals like Imaging Sensing Systems (NASDAQ:ISNS), FLIR Systems (NASDAQ:FLIR), Siemens (OTCPK:SIEGY), and Citilog) are more modern sensing options that collect and report a wider range of data with more accuracy and flexibility.
Iteris's systems can not only detect the presence of vehicles, but also monitor their number, type, and speed, as well as detect the presence of bicycles and pedestrians. With in-pavement loop detectors representing about 70% of the traffic management systems in place, but limited in what they can do, there's a meaningful ongoing replacement/upgrade opportunity here.
Iteris generates about a third of its traffic-related revenue from its sensors, with its engineering and consulting services making up the rest. Iteris helps transportation departments design and implement software-based traffic control systems.
These systems integrate sensors and surveillance equipment, computer systems, and communications systems, allowing operators to monitor traffic in real time, change system settings to respond to current conditions and dispatch EMS crews. With its data analysis capabilities, Iteris can offer more insight into traffic patterns, help predict future traffic patterns, and develop and simulate mitigation strategies.
All told, Iteris's traffic/transportation business serves a market worth about $4 billion a year, with the device/sensor segment worth around $350 million today and the bulk of the opportunity in system design and planning. This should remain a decent growth opportunity into the future, as building roads is expensive and disruptive, so maximizing/optimizing the flow of traffic on existing infrastructure can drive significant value. What's more, congestion is an irritant to drivers, a contributor to pollution, and generally a waste of time and resources, so improving traffic flow is pretty much a "win win" proposition.
Ag Is The Sizzle
Seeing an opportunity to apply its data analytics capabilities into new growth markets, Iteris launched its ClearAg product in 2013. ClearAg combines weather and agronomic data with surface modeling to allow users to simulate field conditions, predict how crops and products will perform in certain situations, and help determine the best times/approaches for planting, applying chemicals, and harvesting. Iteris does not have a sensor component to this business (though it could in the future...), but it accepts data from a wide range of sources including drones, radar, satellite imaging, and user-generated inputs.
Precision agriculture (in all its many, and often ill-defined forms) is a hot area, with Monsanto's (NYSE:MON) acquisition of Climate Corp. in 2013 for $1B arguably bringing the trend into widespread awareness. Adoption has been slower than initially expected, with the company expecting around 25M paid acres in FY 2017 for FieldView.
Adoption has been hurt by the significant downturn in the ag sector, but I'd still note that Climate Corp. had less than 6 million paid acres in FY 2015, so there has still been meaningful growth. I also want to note that the acreage figures that Iteris quotes regarding the reach of ClearAg are not comparable and Iteris doesn't price on the basis of acreage.
Where ClearAg will ultimately fit in is a huge unknown, as the business is tiny today. Unlike Monsanto, which is actively targeting growers, Iteris has been positioning ClearAg as a tool/platform for crop science and crop insurance companies. Iteris has already signed up Syngenta (NYSE:SYT) and Bayer (OTCPK:BAYRY) as customers, and the company has achieved a 100% renewal rate with its crop science customers. Iteris also announced relatively recently that QBE NAU signed a multi-year subscription agreement, and that it intends to use the platform to help agents price insurance and to help agents and policyholders to reduce crop loss.
Iteris has identified its target market at about $1.2 billion today, with crop science and insurance making up around $500 million of the opportunity (and large growers making up a similar amount). I think management's projection of a $2.3 billion addressable market in five years is ambitious, but I do believe that more and more ag players will look to data analytics to reduce costs and improve yields - inputs like fertilizer, pesticides, and irrigation all cost money and it makes sense to maximize their value.
What's more, crop science companies can use ClearAg to reduce the number of field tests they have to conduct, as well as improve yields (remember, seed companies like Monsanto literally grow their product). Longer term, the modeling and simulation capabilities should allow growers and insurers to respond in real time to changing weather/environmental conditions and plan accordingly.
Iteris does not lack for competition. In the traffic sensor market, the company competes with the likes of FLIR, Siemens, Econolite, Imaging Sensing, and there are a lot of imaging and machine vision technologies that could be turned to this market. The engineering/consulting side is likewise competitive, with companies like SAIC (NYSE:SAIC), Kimley-Horn, Siemens, and others involved to varying degrees. I'd also note that the traffic business is budget-sensitive. A recent increase in federal spending on infrastructure should help, but government spending on infrastructure has been erratic.
The agriculture opportunity is much more speculative. Many companies, including several start-ups, are looking to bring similar analytical platforms to the market, and farmers can be surprisingly conservative (if not stubborn) about adopting new technologies.
I think Iteris might be relatively advantaged in that it's not looking (at this point) to sell into the rank-and-file farmer market, but I don't think there's any question a company like Monsanto has enormous advantages in terms of scale, recognition, and resources that can be invested into system development. To that end, I also have to wonder whether the company's relationship with Bayer will survive the Bayer-Monsanto merger (if that goes through).
I think it's worth noting that Iteris has a relatively long operating history with its traffic-related businesses and the growth performance there has been pretty mixed. Revenue growth has been relatively solid since the sale of the vehicle sensor business back in 2011, but margins have been weak.
I believe that Iteris can likely maintain mid single-digit growth in the traffic business. Self-driving and/or connected cars, not to mention a greater focus on data-driven design and management, could drive better growth but I do believe that there will be budgetary headwinds. While I don't expect Iteris's addressable precision ag market to grow as quickly as management has suggested, I do believe this business can grow at a long-term compound rate of over 30%. Even at that growth rate, Iteris would still only have a single-digit share of its addressable market. Conservative perhaps, but I'd note that Iteris is basically building this business from the ground up.
Even though the revenue base is tiny today, the ag business is already generating gross margin close to 40%, and I believe this can be a very profitable business at scale (an 80% gross margin target is not unreasonable). I expect margins from the traffic business to offer less upside, though greater adoption of data-driven systems could offer some scale opportunities.
The key issue with modeling Iteris, then, is estimating how large the ag business will get. I suspect most investors would be deeply disappointed if this is just a $20 million business in FY 2021 and less than a $100 million business in a decade, but that would still have the company on a trajectory to double-digit FCF margins and a fair value over $6. At over $200 million in revenue, though, the FCF margins can move closer to 20% and the fair value can move into the double digits. Of course, if the ag business can't produce a long-term CAGR above 20%, the fair value can drop into the $3 range pretty easily.
The Bottom Line
I like how Iteris has been signing on ClearAg subscribers, and although precision ag's status as a new hot topic makes me nervous, this is an interesting opportunity. The limited amount of due diligence I've been able to do leads me to think this could be a viable competitor and the financial upside is impressive.
I want to emphasize, though, that this is a really speculative idea. I don't think the traffic business alone can support a higher valuation, so it all comes down to management's ability to execute in the emerging precision ag market. As a risky and speculative idea, I think it's worth consideration, but the operating track record here is minimal and the challenges to growing that business are many, varied, and significant.
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Disclosure: I am/we are long MON.
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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