Amidst The Financial Risks, Diebold Nixdorf Secures Topline Stability

Summary

• Recent contracts in self-checkout products, DN Series, and Vynamic software licenses will drive DBD's topline.
• Increased opportunities in managed services can drive the business in the medium-term.
• The company's margin may come under pressure due to rising costs related to supply chain restraints.
• Negative shareholders' equity and negative cash flows can pose financial risks.

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Strong Drivers But Risk Factors Are Present

Diebold Nixdorf (NYSE:DBD) is likely to maintain a steady revenue base following the self-checkout products and cash recycling in the near term. The rapid introduction of DN Series terminals can multiply the topline from value-added managed services like cardless transactions and video teller access. In the next couple of years, the company's gross service margins are expected to inflate.

However, the outlook is not free of challenges. There is sufficient inflationary pressure on input and freight costs, which, along with longer semiconductor lead time, will lead to lower FY2021 EBITDA than anticipated. Also, the cash flows staying negative in 1H 2021 would become a concern. Owing to several quarters of net losses, the shareholders' equity is negative, indicating possible bankruptcy risks. However, the stock is undervalued versus its peers. I think investors should be cautious about the downsides and hold their investment until the financial situation improves.

Multiple Business Contracts

Source

DBD's long-term core strength lies in self-checkout products and the market leader in cash recycling. During Q2, it agreed to implement the self-checkout solutions at a multinational clothing and home products retailer based in the UK in ~1,000 stores. For recurring revenue, it depends mainly on the managed services and value-add software. As customers look to reduce costs, the trend should continue in the short-to-medium term. Read more on the company's strategy in my previous article here.

DBD's DN series claims to be actively displacing its competitors in the banking operations following the booking of the 700 DN Series terminal orders. Recently, it has received two contracts with the National Bank of Egypt and Egypt National Post for its DN Series and Vynamic software licenses and maintenance. The technological advantages of the DN Series are its advanced, self-service capabilities. For example, its Video-as-a-Service offering sees demand improving while adding new capabilities such as cash recycling, cardless transactions, and video teller access. In Vynamic Payments offering, expanding its capabilities to include all transactions having more than 15,000 ATMs over the next few months. The company's retail business has the advantage of a high degree of modularity, ready availability, and has an open architecture. The current capacity of 1 million transactions per day is expected to increase by 5x by the end of 2021. I think the added revenue base should push the company's margin higher in the medium term.

Growth Strategies

I expect some of the recent deals to perk up the company in the near term. Among these is a five-year managed services contract with an Italian bank, while in retail, it secured a multi-year agreement with an international health and beauty retailer. Because of the company's multi-vendor approach can monitor hardware and software performance through a single user interface.

Challenges

The most potent challenge before the company is to mitigate the concerns arising out of the complex supply chain environment. Typically, we see longer lead times on semiconductors and other components and transportation schedules. Also, there is inflationary pressure on steel, plastics, and other electronics and higher freight costs. Strong global demand for semiconductor chips outpacing supply due to higher demand for electronic devices contributes to the inflationary pressure. Because semiconductor chips are essential components in DBD's ATM devices, higher input costs would cause the company's 2021 profit and cash flow outlook to re-adjust.

The Outlook: FY2021

While the management kept the FY2021 revenue estimates unchanged (i.e., an estimated 3.8% growth compared to FY2020), it revised down its adjusted EBITDA estimates. Despite the growth drivers as discussed earlier, its adjusted EBITDA growth can decline due to higher supply chain costs. Its free cash flow growth for FY2021, too, has been reduced from the earlier level.

What Are The Current Drivers?

In Q2 2021, the company's revenues remained nearly unchanged compared to Q1. Its Americas Banking segment revenues saw steady demand as customers kept adopting the DN Series ATMs. In addition, it expanded maintenance services in the US, Brazil, Mexico, Spain, Argentina, and Chile. In Eurasia Banking, although revenues increased marginally, the product order growth increased by 39% in the past year due to the market share gains in the next-generation DN Series ATMs.

Also, it is rapidly increasing the deployment of AllConnect Data Engine at the connected machines, reducing the number of service calls, increasing effectiveness, and reducing costs. So, by 2023, the company's gross service margins are expected to increase to 32%-33% range. In the past year, the company's service margins improved by 130 basis points due to lower labor and spare parts usage. On the other hand, the gross margins contracted by 350 basis points to higher freight and input costs and an unfavorable geographical mix.

Balance Sheet Reflects Risks

In 1H 2021, DBD's cash flow from operations (or CFO) did remain negative (-$144 million), but was an improvement compared to a year ago, as the year-over-year revenues remained resilient. Free cash flow (or FCF) also remained in the negative territory in 1H 2021. In FY2021, the company expected to generate $120 million to $140 million in FCF. It reduced the range versus the previous guidance following the global supply chains tightening and lower profit outlook. Despite that, it expects EBITDA to free cash flow conversion rate to improve from 12% in 2020 to 30% in 2021.

DBD has been incurring net losses over the past several quarters, which led to accumulated deficits. A huge accumulated deficit has turned its shareholders' equity into negative territory. On top of that, the company has a leverage ratio of -3x and net debt of $2.1 billion as of June 30, 2021. Its liquidity was $500 million as of that date. It has little debt maturities until November 2023.

Relative Valuation

DBD's forward EV-to-EBITDA multiple contraction versus the adjusted trailing 12-month EV/EBITDA is steeper than its peers because its EBITDA is expected to increase more sharply than the rise in EBITDA for its peers the next four quarters. This would typically reflect a higher EV/EBITDA multiple than the peers. The stock's EV/EBITDA multiple is significantly lower than its peers' (NCR, ORCL, and FISV) average of ~16.2x. So the stock, I think, is undervalued at the current level.

Target Price

According to Seeking Alpha, three sell-side analysts recommended a "Bullish" (BUY) on DBD (includes "Strong Buy"), while two recommended a "Neutral" or "Hold." None recommended a "Sell." The sell-side analysts' target price is $17.25, which, at the current price, yields 71% returns.

What's The Take On DBD?

Source

At the moment, Diebold Nixdorf has pinned its hopes on self-checkout products and cash recycling. The company's managed services and value-add software are the sources of recurring revenues. Following the DN Series terminal order bookings in recent months, it can now add services like cash recycling, cardless transactions, and video teller access, which can become additional sources of revenue. Plus, in retail, it secured a multi-year agreement with an international health and beauty retailer. As a result of the various added services, by 2023, the company's gross service margins are expected to inflate. So, the stock outperformed the SPDR S&P 500 Trust ETF (SPY) in the past year.

Currently, the most critical challenge is to manage the complex supply chain environment. Due to higher lead times on semiconductors and other components, inflationary pressure on steel, plastics, and other electronics, and higher freight costs, EBITDA estimates for FY2021 may take a haircut. Also, despite the company's expectations of a healthy FCF in 2021, cash flows stayed negative in 1H 2021, which raises some suspicion over its ability to deliver on the promises. The balance sheet remains weak with negative shareholders' equity, which keeps it under substantial financial risks. Despite solid returns potential, I think investors should hold before considering any further investment in the stock.

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such 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.