Daktronics: Industry Leader, Record Backlog Equates To Great Investment Opportunity

Summary

• DAKT is currently experiencing an all-time high backlog for their products.
• We believe the recent federal infrastructure bill should benefit DAKT.
• Through the combination of being an industry leader and a significant backlog, we consider DAKT to be an attractive investment opportunity.
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Daktronics (NASDAQ:DAKT) is the world’s industry leader in electronic display systems. It's showing strong demand with record orders and a backlog at an all-time high. It's also expected to benefit from the government infrastructure bill. We're reinitiating with a buy rating and an $8 price target.

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Investment Thesis

• Daktronics, Inc is showing strong orders coming out of the COVID-19 lockdowns. It received a record $163.7 million of orders in the most recent quarter. These amounted to an increase of 20.7% for the second quarter and a 34% increase year to date.
• Their backlog is at an all-time high of $282 million. This is due to the high demand but also due to material supply and labor shortages which are increasing lead times and extending the timing of converting some orders to sales. As supply chain issues improve, DAKT should show dramatic increases in sales.
• Even with these supply chain issues the company provided impressive sales growth in the most recent quarter (29.1%) They accounted for this sales growth by saying it was due to the high demand and an improvement in the conversion rate of orders.
• The company should benefit from the federal infrastructure bill as its transportation business should be extremely strong.
• Daktronics, Inc. is undervalued and trades at 20.3 times our 2022 EPS of $0.25 and only 9.77 times our 2023 EPS estimate of $0.52. Our price target is based on a conservative 15 times FY2023 PE valuation blended with a DCF model price.

Primary Risks

• Just like many companies, DAKT has been impacted by supply chain issues and inflationary pressures. These factors could cause volatility in their revenue cycle and production costs over the next year.
• Restrictions caused by COVID-19 would have a negative impact on the company’s outlook.

Investment Thesis

Daktronics, Inc. is headquartered in Brookings, South Dakota. Its name is a blend of the words “Dakota” and “electronics”. It's the world’s industry leader in designing and manufacturing electronic scoreboards, programmable display systems and large screen video displays for sporting, commercial and transportation applications. DAKT offers a complete line of products, from small scoreboards and electronic displays to large multimillion-dollar video display systems as well as related control, timing, and sound systems. Their business is organized into five business units: Commercial, Live Events, High School Park and Recreation, Transportation, and International. Their products have been installed in venues from grade school gyms to premier sports facilities, destination sites and in over 100 countries throughout the world (company information).

Our thesis is that Daktronics, Inc. is an undervalued, compelling company which will deliver value for shareholders because:

• Daktronics, Inc. is a company that's seeing significant demand for its products as we return to a more normal environment. In its most recent quarter, it received a record number of orders ($163.7 million) and its backlog is at an all-time high.
• Sales growth was impressive during the second quarter (29.1%). This was despite there being some supply chain issues and labor availability issues in the quarter.
• The transportation segment of the business should see a boost in future sales from the government infrastructure bill.
• There has been recent insider buying. We believe this may be a positive for the stock.

We initiate coverage with a buy rating and an $8 price target.

Daktronics is a Truly Diversified Leader in Electronic Display Systems

Daktronics, Inc. is a world-leading supplier of electronic scoreboards, large electronic display systems, digital messaging solutions, software and services for sporting, commercial and transportation applications. The company serves its customers by providing the highest quality standard display products as well as custom-designed and integrated systems and offers a complete line of products, from small scoreboards and electronic displays to large multi-million-dollar video display systems as well as related control, timing, and sound systems. Daktronics is recognized as a technical leader with the capabilities to design, market, manufacture, install and service complete integrated systems displaying real-time data, graphics, animation, and video (source).

Revenue contributions

Company Filings

Live Events

This business line includes video display solutions for large sports venues and live entertainment facilities including professional sports facilities, college and university facilities and arenas. Facilities may increase spending on video displays to enhance the attendee event experience, increase revenue from advertising and due to a natural competitive nature to outperform other facilities.

Live Event Example

Company Filings

Commercial

Commercial offerings are primarily used for third-party advertising, on-premise advertising and producing the spectacular to entertain and/or advertise. Primary offerings include digital billboards, message centers, video display systems/display walls, petroleum displays and dynamic messaging systems.

Commercial Example

Company Filings

High School Park and Recreation

This business line creates video and scoring systems and message centers for elementary and high schools, junior colleges and park and recreation departments. Its primary funding is through local sponsors and advertisers.

High School Example

Company Filings

Transportation

This business line includes intelligent transportation systems (an example of this is electronic toll collection), airports and mass transit. Long-term growth drivers for this business include an increase in transportation management, government funding and investment in infrastructure projects and advertising needs.

International

The international business line’s main products include commercial video systems, sports video systems, digital billboards, architectural lighting, and transportation systems. Growth opportunities include third-party advertising, live events facilities/sports, European/Middle east transportation systems and a general increase in geographical coverage.

As we return to normal, DAKT is seeing record demand, orders, and backlog

As COVID-10 restrictions have reduced, improving general economic outlooks, customers placed a record $163.7 million in orders for the second quarter of fiscal 2022 and for the first six months of the year at $345.5 million. These levels amount to an increase of 20.7% for the second quarter and a 34% increase for the first half of the year. Every business unit saw an increase in the first half of fiscal 2022. Product backlog is at an all-time high of $282 million. Backlogs are contractually binding sales agreement or purchase orders for electronic display systems and related products and services. Many of these orders should be fulfilled in next six months. Not surprisingly, before last year, the backlog has been an excellent predictor of future sales (correlation of 71% including last year).

Exhibit 1: End of Fiscal Year Backlog versus Sales During the Next Fiscal Year

Backlog

Company Filings and Singular Research Estimates

Returning to Normal will Boost Order and Improve Conversion Rates of To Sales

Orders and demand will continue to increase as customers have more confidence in the economic outlook. This has already been demonstrated in record number of orders that were placed during the first half of FY2022 (April – October 2021). As activities in venues increase, there will be more demand for these kinds of products. COVID-19 also has had an impact on the conversion of the backlog to sales. The conversion rate has been constrained by supply of components, freight and labor availability which has increased the lead times and extended the timing of the conversion of order to sales. While the company is working on their supply chain issues, a return to a more normal environment, will boost the conversion rate thereby increasing sales. These issues in their conversion rate should be seen as temporary. The combination of an increase in orders and an increase in the conversion rate makes it likely that the company could exceed expectations. Future sales are most likely underestimated by investors.

The government infrastructure bill should provide a boost in the transportation segment

The $1.2 trillion bipartisan Infrastructure Investment and Jobs Act should be beneficial to Daktronics’ transportation segment. During the earnings call, the CEO mentioned that the transportation business for the US and Canada should be strong due to continued investment in transportation systems, the stability and potential in federal infrastructure spending and increasing advertising and on-premise promotions.

Management and Leadership

Reece A. Kurtenbach is the Chief Executive Officer for Daktronics, Inc. and currently serves as Chairman of the Board of Directors. Previously, Mr. Kurtenbach served as Executive Vice President for Live Events and International and provided corporate oversight for the company’s design and development engineering. After graduation, Kurtenbach started working at Daktronics. He also worked for a few years at two other technical companies, and then returned to Daktronics in 1991 to work as an Applications Engineer on large display projects. In 1994, he became manager of a design group, leading the development of Daktronics' first full color LED video display product. Since then, Daktronics has become a leader in the technology of large screen LED video displays, and the acknowledged world leader in sales in this product category.

Sheila M. Anderson serves as Daktronics’ Chief Financial Officer. Anderson holds a bachelor's degree in accounting from Southwest Minnesota State University in Marshall, Minn., and a master's degree in business administration from the University of South Dakota in Vermillion, S.D. She became a certified public accountant in 1996. Anderson joined Daktronics in 2002 as a project accountant. Her accounting experience prior to joining the company includes a senior accountant role at Dakota Minnesota and Eastern Railroad, as well as responsibility for accounting and auditing functions at two public accounting firms. In 2006, Ms. Anderson became the corporate controller for Daktronics, assuming responsibility for the company’s internal and external financial reporting, as well as supervision of the company’s accounting functions. She was named CFO in September 2012.

Both the CEO, Kurtenbach, and CFO, Anderson made open market purchases in shares of Daktronics on December 6, 2021. We see this as a positive for the stock. A summary of key shareholders is shown in Exhibit 2.

Company Ownership

Company Filings

Q2:22 Financial Results

DAKT’s second quarter results for FY2022 showed a net sales increase of 29.1% to $164.5 million. This compared to second quarter fiscal sales in 2021 of $127.4 million. The increase was due to the result of strong demand and an increase in the conversions from orders to sales in Q2. The company during the call admitted that the conversion rate was still tempered by constraints in the supply of components, freight and labor availability. Gross profits for the quarter as a percentage of sales was 19.6% as compared to last year’s 26.2%. The decrease in gross profit was related to an increase of costs in inputs and higher personnel costs. They have experienced inflation in the costs including raw materials, labor and shipping and based on this are adjusting their pricing for future orders. Also, they had many larger projects during the quarter which can produce a lower gross profit.

Operating expenses for the second quarter were $27.9 million compared to $26.7 million or an increase of 4.5%.

They commented that their backlog was at an all-time high. This was due to the record number of orders and also due to the increase in lead times and the extending time in converting some order to sales.

EPS Guidance and Estimates

While the company does not typically provide guidance, they did comment that they do expect sales for the third quarter to increase over last year’s third quarter ($94 million) due to the record-breaking backlog. We believe this was an extremely conservative prediction. Typically, the third quarter is the company’s weakest quarter due to the seasonality of the business in sports and due to the decline of outdoor construction during the winter months. The third quarter also has two major holidays reducing the number or workdays available. We still believe since the backlog is so large, that sales should be at least as high as the third quarter of FY2020 which was $127 million.

Based on the backlog, and strong demand for the product, we expect DAKT to have a strong second half of FY2022. We expect sales to be up 40% in the third quarter versus the previous year which would only be a slight increase in sales from the third quarter of FY2020. We also expect sales to be up 30% in the fourth quarter of FY2022. We expect improvement in supply chain issues in the back half of FY2023 and reflect this in our revenue and gross margin calculations. We forecast $11 million in net income for the FY2022 year and $23 million in net income for the FY2023 year. These forecasts result in net earnings per share in 2022 and 2023 of 0.25 and 0.52, respectively.

Investment Risks

Supply chain issues could be worse than our expectations. Just like many companies, supply chain issues have impacted DAKT. They have been impacting the supply of components, freight and labor availability. They have also experienced inflation in their input costs including raw materials, labor and shipping. They expect these factors to cause some volatility in their revenue cycles and production costs for the remaining of the fiscal year and into fiscal year 2023. Even with these issues, they saw an increase in the conversion into sales in Q2. We expect an improvement in the conversions to continue and we are modeling gross profit to improve from the usually low 19.6% to between 21.5% and 23.6% over the next few quarters. This remains lower than historical gross margins but higher than the first half of FY2022. Supply chain issues and inflation remains a risk for the company.

COVID-19 restrictions could return. The reduction of COVID-19 restrictions has improved economic outlooks and provided the customers of DAKT with more confidence. Based on their confidence that the worst we are moving in the direction of a more normal environment, a record number of orders were placed. Of course, if restrictions were to return, our assumptions would be overly optimistic.

Valuation

Daktronics, Inc. trades at 20.3 times our 2022 EPS estimate of $0.25 and 9.77 times our 2023 EPS estimate of 0.52. While it is difficult to find companies which do exactly what Daktronics does, we show a list of other electronic companies which are considered competitors by Refinitiv in Exhibit 3. While many of these companies are larger and more diversified companies than Daktronics, it is still interesting to look at them and their ratios.

We value Daktronics using a blended valuation methodology where we blend 50% of DAKT’s price target to relative P/E ratios and the other 50% to DAKT’s DCF model displayed on page 14.

In our relative valuation, we assume a reasonable but still conservative PE ratio of 15 using our FY2023 earnings expectations which is $0.52. This conservative valuation leads us to a price target of $7.80.

In our DCF model, we estimate the firm would earn a return on capital of 5.4% (which is the average ROC over the last 12 months) reinvesting 20% of this return into their business and growing after-tax operating income by a conservative 1.0% over the next seven years. We believe these assumptions are conservative especially with DAKT’s backlog and potential for growth. These assumptions lead to a DCF price target of $8.50.

We then equally blend the relative valuation price target, $7.80 and the DCF valuation price target, 8.50 to come up with a final price target of about $8.

Exhibit 3: Peer Multiples

Peer Multiples

Refinitiv Eikon and Singular Research Estimates

Disclosure: I/we have a beneficial long position in the shares of DAKT 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. I have no business relationship with any company whose stock is mentioned in this article.