National Instruments Looking To 5G, Autos, And New Strategic Priorities To Drive Better Results

Summary

• Upside in NATI shares is tied to end-market opportunities like 5G and auto tech driving a sustained period of better-than-cyclical revenue growth, as well as achieving sustainably better full cycle margins.
• Improvements in short cycle end markets will help revenue growth in the near term, as will increased 5G deployments, with the transitions to mmWave holding even more potential.
• Leverage to auto investments in electrification and autonomous driving is positive, but tempered by exposure to legacy combustion engine-based business.
• NATI shares look reasonably valued today, with outperformance tied to beat-and-raise quarters that build confidence that the new strategic priorities will drive sustained growth.

The balancing act between past performance and future opportunities is a tricky one, particularly when a company is implementing new business strategies and/or seeing meaningful new end-market opportunities. If you drive solely by looking in the rear-view mirror (focusing only on what a company has been), you’re going to have some problems. If you ignore what’s in the rear-view mirror, you’re also going to have some problems.

Test equipment and instrumentation specialist National Instruments (NASDAQ:NATI) is an interesting case in point. The historical performance is not that exceptional – mediocre revenue growth little better than GDP growth, consistently okay FCF margins but no upward trajectory, and a trailing stock performance record that is pretty lackluster next to the S&P 500, let alone rivals like Keysight (KEYS).

Now the question is whether the future will be different. End-market opportunities like 5G (particularly mmWave) and auto electrification and autonomous driving are meaningful potential growth drivers, but a lot of the business is still linked to general economic cycles (as measured by the PMI). A focus on increased system sales and software should drive better margins, but there’s a lot to prove beyond “should”. Allowing that National Instruments certainly has room to surpass my expectations, I think the shares are at best reasonably priced today.

An Improving Near-Term Outlook

Fourth quarter results were better than expected, and while there are still going to be some seasonal headwinds in the first quarter of 2021, the overall outlook has improved here relative to the start of the year (before National Instrument’s previewed better fourth quarter results).

Perhaps most importantly, orders rose 7%, reversing a run of negative numbers. System-level orders rose 13%, and both the semiconductor and aerospace / defense / government businesses saw double-digit order increases. While “Portfolio” orders were up low single-digits (a catch-all bucket for the various industrial, electronics, academic/research, and other markets the company serves), auto orders declined at a low single-digit rate.

Historically, the Portfolio segment has made up close to 50% of National Instruments’ revenue and the revenue growth has generally tracked the PMI. That’s not a bad thing now, as the PMI moved back above 50 in June of 2020 and has been working its way higher ever since, with February’s number just shy of 61. With that, I’d say National Instruments is pretty well leveraged to an ongoing recovery in the global economy and renewed spending from a range of end-markets as spending freezes meant to preserve liquidity during the pandemic are lifted.

The one potential soft spot in the near-term outlook is in autos, a major market for National Instruments. While auto production is re-accelerating (hampered as it is given the chip shortage), auto OEMs and auto suppliers have still been relatively cautious so far on capital spending, though I expect that to improve later in the year.

Trying To Leverage Secular Drivers And Self-Improvement

National Instruments management is trying to offer more to its shareholders than just a cyclical yo-yo tied to the short-cycle trends. The extent to which the company succeeds here will have a significant influence on the share price.

The biggest near-term opportunity for the company is 5G, largely within the Semiconductor business, but also somewhat in the Portfolio segment as well. NATI is significantly leveraged to validation and production stages (as opposed to Keysight, which has more exposure at the R&D/design level), and the ongoing rollout of 5G should drive meaningful acceleration in the coming years.

At least some of that acceleration is tied to the evolution from sub-6GHz to mmWave, though, as NATI has seen some meaningful equipment re-use at sub-6GHz. The timing of such a transition is still uncertain and seems to be slipping some, as carriers have recently acquired significant mid-band spectrum (C-band), but it will happen at some point in the coming years.

The auto opportunity is likewise mixed. On the positive side, electrification and autonomous driving offer meaningful new test opportunities for NATI. On the negative side, that exposure to validation and production means that the upside is still relatively modest in the short-term, as EVs are still a small part of overall production. Longer term, the company will also have to manage the decline in its traditional combustion-based auto business, though the trend toward more OEM insourcing for xEVs should be a positive one for the company.

As far as self-improvement goes, National Instruments is still in the midst of some important strategic shifts. The company has moved away from a product focus for the R&D and sales efforts and instead embraced an end-market focus, but it remains to be seen if that will translate into better share and/or meaningfully better long-term margins.

Likewise with the increased focus on system-level solutions and software. While system-level solutions should be more profitable for the company, I do wonder if there will be even greater cyclicality over time. With software, National Instruments has long viewed its software capabilities as a key differentiator, particularly where it pertains to automating test tools and processes. In theory, this should improve the company’s recurring revenue opportunities and margins over time, but this is another “show me” story today.

The Outlook

I do expect opportunities in 5G and autos (electrification and autonomous driving) to drive better revenue growth over the next decade, with leverage to aero/defense also making a meaningful positive contribution as well.

I’m expecting long-term revenue growth in the mid-single-digits, with the short-cycle recovery, 5G deployments, and auto OEM investments driving above-trend growth for at least three years (as well as double-digit growth in 2022). As more mmWave, xEV, and autonomous driving systems approach commercialization over the next three to five years, there could definitely be some upside and an extended period of above-trend revenue growth.

I am giving NATI some benefit of the doubt on margin improvement as well, with non-GAAP operating margins improving from pre-pandemic levels in the mid-18%’s to over 19% in 2021 and 2022. Getting above 20% and holding margins above the mid-teens for a full cycle is another key part of the “show me” story; I’m not convinced the company will do it, but I am comfortable with idea of mid-teens FCF margins at least for the near term.

The Bottom Line

National Instruments doesn’t look all that cheap on discounted cash flow, nor on EV/EBITDA basis. I like the sensitivity/leverage here to the short-cycle recovery, as well as the opportunities in 5G and auto technology, but I think a lot of that is captured in the price today.

I do see beat-and-raise potential here, but at today’s price, I think the shares are going to need beat-and-raise results to meaningfully outperform the larger industrial sector.

Analyst’s Disclosure: I/we 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.