Times have become tricky for investors. On the one hand, there is the high-inflation concern which is gradually turning into a macro-economic risk plus the uncertainty facing the stock market as a result of the Fed hiking rates. On the other, there is the geopolitical uncertainty caused by Russia's invasion of Ukraine which is now weighing on supply chains across the world. To make matters worse, there has been a surge in COVID in China which has impacted the port city of Shenzhen from where most of the world's electronic components originate including those of Apple (AAPL).
In the meanwhile, under-the-radar companies which have good fundamentals are being ignored and one of these is Nasdaq-listed Ituran Location and Control (NASDAQ:ITRN). Its stock as shown in the deep-blue chart below has decoupled with and outperformed the Invesco QQQ Trust (QQQ) since the beginning of March, but still, trail Apple's.
My objective with this thesis is to assess whether Ituran's outperforming of the tech sector can continue for the rest of 2022 and for this purpose, I will go through the financial results, but, first, I provide investors with some insights about the business.
Ituran provides advanced location and protection services for vehicles and drivers by using GPS (Global Positioning through Satellites) and RF (radio frequency) communications. Its solutions are used for vehicle and merchandise location which ultimately help to achieve theft prevention. The company also provides fleet management, road assistance services, and connected car services.
Now, using satellites to locate cars is not something new as the technology has been commoditized and already forms parts of smartphones. Also, with so many satellites orbiting in the sky above our heads and commercialization of services built around the transmission of data using the mobile phone ecosystem, people can buy professional GPS kits for less than $700. This is enough to securely provide data on the position of vehicles and their status. Together with the GPS locator purchased, many service providers also provide value-added services in the form of integrated e-mail or SMS message notifications.
However, what distinguishes the Ituran system from others is that it works via technology originally developed to locate military pilots in distress, which was later converted to civilian use. Thus, the Israeli-based company can be considered as a provider of military-grade gear, one example being its anti-jamming devices which can be used as a solution against GPS-jamming devices used by sophisticated thieves trying to steal big truckloads traveling through the vast remote territories of Brazil.
The company has also benefited from the fact that the underlying technology which drives its solutions has been getting cheaper over the years, especially since 2003, when mobile internet and broadband connectivity became more widespread. However, many locations around the world where Ituran's kits are used for receiving alarm signals if a truck deviates from the planned route remain underserved in terms of mobile coverage. Still, by using a blend of communication tools, the company's location kits are operational and have become critical in informing security agents of potential incidents, for example when a theft is in progress.
Thus, the company has been steadily growing its subscriber base, with the growth also persisting through the 2008-2009 financial crisis, only to be paused by the 2020 COVID pandemic. In this case, rather than financial reasons, the stagnation in subscriber numbers (chart below) was due to social distancing and shelter-at-home mandates issued by authorities throughout the world.
Now, the above presentation was made at the beginning of 2021 and one year later, I assess whether there has been a resumption in growth and how it has translated into revenues.
First, 2021 has been a recovery year after revenues stagnated in 2020. Now, given that Q4-2020 was a low quarter due to COVID, I compared Q4-2021's sales of $70.4 million with Q4-2019 (a normal quarter), when it amounted to $65.5 million. Here, the fact that Q4 sales for 2021 not only beat those of 2020 but also 2019's figures indeed points to a full recovery.
This performance was driven by the subscriber base growing at a record pace, with 44,000 net adds, resulting in a total of almost 1.9 million subscribers at the end of 2021. This growth was achieved across a wide geographical area covering the company's Usage-Based Insurance ("UBI") business in Israel as well as the car financial and rental activities in Brazil and Mexico, and the U.S.
Moving into the bottom line, there was a double-digit EBITDA growth of 14.2% for Q4. For the full year, the company reported revenues of $271 million and EBITDA of $73 million, signifying a margin of 27% (73/271), a level which has only been surpassed once in Ituran's history.
Looking into the reasons for these high EBITDA margins, I noted that the company had enjoyed gross margins of 47.51% in Q4 which was about 1% more than in the same period of 2020 despite the fact that there were supply chain issues which are normally synonymous with higher costs. According to the management, the company did manage to deal with the problem in an efficient way.
As a matter of fact, the component shortage all over the world is getting worse with major parts of China now under COVID lockdown. For this purpose, according to one of Ituran's SEC filings, its products are manufactured both in China and Israel. This means that it should be adversely impacted, but, on a positive note, the company also adds that its supply chain excludes dependency on a single manufacturer.
Investigating further, Ituran did see some adverse effects due to higher supply chain-related expenses in the first quarter of 2022 and going forward, there should be some effect of an industry-wide component shortage on its forthcoming financial results. However, this should be confined only to the hardware (telematics products) segment as shown in the statement of income extract below.
In this respect, 70% of the company's revenues come from the other or service segment. Furthermore, as per my calculation, this segment generated 55.3% of gross margins compared to only 26.6% for the products segment during fiscal 2021. Also, the shortage of components should not be expected to impact production itself and sale volumes, as, Ituran's strategy has also consisted of increasing inventory levels.
This said I would do not exclude some impact on the gross margins due to additional shipping and freight charges in the first half of 2022, but, deriving revenues primarily from its service business and having shown an ability to control General and Administrative costs (income extract above), the overall impact on Ituran's operating income is likely to be limited.
Factors that can also help to mitigate lower product gross margins are expansion in other countries around the globe for its fleet management services. This expansion is being carried out through local representatives as well as sharing the distribution channel with Mobileye, an Israeli subsidiary of Intel (NASDAQ:INTC) that develops self-driving cars.
These are synonymous with more profitable growth and, also by using local sales staff, there are more chances of mitigating the effects of a rise in COVID cases around the world.
Another avenue for growth is the new segment dedicated to banks and financing companies. Here, Ituran is addressing a problem commonly faced by banks when they issue car loans to individuals. Some borrowers fail to effect the monthly repayments and in big countries like Brazil, Mexico, and the U.S., it can become difficult to trace them. In this case, Ituran's vehicle tracking capabilities which go to the extent of sending a buzzer-based notification to the customer to advise him of payment moratoriums have proved highly successful in some pilot studies in Brazil.
As for valuations, the company remains undervalued considering different metrics as evidenced in the Valuation Grade table below. Specifically considering the trailing Price to Sales ratio of 1.69x, this remains highly undervalued with respect to the IT sector, by nearly 48%. Adjusting accordingly, I obtain a target of $33 based on the current share price of $22.6.
Now, this is a company whose cash flow from operation for 2021 was $55.8 million, which translates to a lower or better trailing Price to Cash Flow metric of $8.37 per share when compared to peers. This means that investors pay $8.37 for every dollar in cash flow that Ituran earns. This figure is also much better than cash-rich Apple's $22.55.
Furthermore, as of the end of last year, the company had cash and marketable securities of $54.7 million. Negating the debt of $31.4 million results in net positive cash of $23.3 million. Additionally, just for Q4, an amount of $3 million was returned back to shareholders as dividends and there were 5.4 million dollars of share buy-backs.
Consequently, with recurrent subscription revenues, a good cash position, no debt, and a policy of rewarding shareholders, Ituran is a buy. Due to its small size with a $455 million market cap, and investors focusing mostly on the big Nasdaq names, the Israeli company seems to have been ignored by the market. This said, there are supply chain risks in 2022, but its strong fundamentals and ability to exhibit profitable growth should help it navigate the highly uncertain economic environment lying ahead.
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Disclosure: I/we have a beneficial long position in the shares of ITRN 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.
Additional disclosure: This is an investment thesis and is intended for informational purposes. Investors are kindly requested to do additional research before investing.