Ubiquiti: Fast Growing Network Infrastructure Provider

Summary

• Ubiquiti is a fast growing (5 year average revenue growth of 21.66%) network infrastructure provider.
• Their profitability shown by EBIT margin, EBITDA margin, and Net Income margin is clearly at the top of their industry.
• Despite market leading growth and profitability, their valuation is on par with the sector.
• I expect 10-20% upside from the current price level.

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Investment Thesis

Ubiquiti (NYSE:UI) provides network infrastructure equipment and comprehensive software platforms worldwide. I believe UI presents a great investment opportunity for a growth oriented investor because:

1. Their revenue growth is impressive (over 20% on average in the past 5 years), and the ever-growing demands for network infrastructure will maintain their momentum.
2. Their profitability exceeds the industry average, and cash from operations is increasing.
3. Their stock is valued on par with peers despite their industry leading profitability and growth, giving upside potential.

Impressive revenue growth, and it's accelerating

UI's revenue has been growing at an impressive pace (5 year average of 21.66%) over the past decade. The ever-growing demand for network infrastructure feeds demand for UI's products, leading to an acceleration in revenue growth. The most recent quarter revenue growth came in at 47.77% YoY. I don't expect this trend to slow anytime soon, as the global demand for internet connectivity continues to grow. A post pandemic society with more remote work options will further spur demand. The revenue trend for UI, below, shows steady growth since 2012 with a recent uptick.

Data by YCharts

Industry-leading profitability and increasing cash flow from operations

UI's profitability metrics clearly demonstrate that they are far above industry averages. EBIT margin (39.12%), EBITDA margin (39.76%), and Net Income margin (32.48%) are all well above the sector median. Also, the off-the-chart high Return on Total Capital (101.16%) and Return on Total Assets (69.20%) show that the company is highly effective at capital deployment. Thanks to these high margins and the effective use of capital, cash from operations is rapidly increasing. It has grown from $81.8 M in 2012 to its current mid-year level of $612 M. They have been putting the cash towards repaying long term debt ($273 M in 2021) and buying back shares ($220 M in 2021), which gives further evidence of effective utilization of capital. Various profitability metrics are summarized below.

Source: Seeking Alpha

Attractive stock is currently valued only on par with industry average

Despite strong growth, above-industry profitability, and effective usage of capital, they are valued on par with peers. Their TTM P/E of 31.24 is almost identical to the sector median of 31.25, and FWD P/E of 26.96 is actually below the sector median of 30.19. This is a clear sign that the market is undervaluing UI. I expect the market to realize this mispricing, and that the stock will ultimately command the 10-20% premium that it justly deserves.

Intrinsic Value Estimation

I used the DCF model to estimate the intrinsic value of UI. For the estimation, I utilized EBITDA ($754 M) as a cash flow proxy and the current WACC of 9.0% as the discount rate. For the base case, I assumed EBITDA growth of 25% (5 year average) for the next 5 years and zero growth afterward (zero terminal growth). For the bullish and very bullish case, I assumed EBITDA growth of 32% and 40% respectively for the next 5 years and zero growth afterward. Given that the last quarter EBITDA growth came in at 56.32%, the growth rate used in the calculation appears reachable.

The estimation revealed that the current stock price represents 10-20% upside. The ever increasing demand for network infrastructure and trends in remote work will positively impact the revenue growth of UI, making this upside achievable. Also, as mentioned before, UI is currently traded on par with its peers, and given their superior profitability and growth, that shouldn't be the case. This estimation supports the argument that UI is indeed undervalued by the market.

	Price Target	Upside
Base Case	$258.70	-15%
Bullish Case	$329.66	8%
Very Bullish Case	$430.38	41%

Click to enlarge

The assumptions and data used for the price target estimation are summarized below:

• WACC: 9.0%
• EBITDA Growth Rate: 25% (Base Case), 32% (Bullish Case), 40% (Very Bullish Case)
• Current EBITDA: $754 M
• Current Stock Price: $305.53 (10/29/2021)
• Tax rate: 30%

Risk

The whole world is experiencing a chip shortage, and many electronic device companies are suffering from a manufacturing bottleneck and the resulting problem of increasing costs. However, several foundries are expected to come online during 2022, and many government or industry leaders are also working on the issue. Therefore, I expect this to be a short-term challenge compared to the long-term growth trajectory of UI.

Pressure from inflation and a disrupted supply chain may increase costs. However, UI has a network of over 100 distributors around the world, and they have consistently managed costs better than their competitors. I don't expect things to be any different this time around. Also, similarly to the chip shortage challenge, I expect these issues to be a relatively short-term problem, which won't materially impact UI's long term trajectory.

Conclusion

I believe UI presents an excellent investment opportunity for the growth oriented investor. They are growing at an impressive pace, and this growth trajectory is accelerating. Also, they clearly lead the industry in profitability and the effective usage of capital, and cash from operations is increasing at a fast pace. The global chip shortage and inflation may present challenges to UI, but I expect these challenges to be relatively short term when compared to the company's long-term growth trajectory. Furthermore, I expect their management team to address the key issues effectively. Therefore, I believe the current stock price represents 10-20% upside.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of UI either through stock ownership, options, or other derivatives. 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.