sankai
Overview
Trimble (NASDAQ:TRMB) stock, in my opinion, is poised to capitalize on the widespread adoption/interest in digital transformation in several important end markets. Earnings should become less cyclical as the company shifts its business model to focus on software and subscriptions rather than hardware and perpetual licenses. I also think that the company has grown faster than its competitors in the hardware industry and that the company's transition to a subscription model for its software is still in its early stages, which will greatly increase the TAM and fuel growth potential over the next several years.
Earnings update
4Q22 EPS for TRMB came in at $0.60, which was below expectations. While ARR increased by 14% to $1.60 billion, revenue was down 8% year over year to $857 million (the consensus was $876 million). Operating margin dropped 20bps in the 4Q, ending at 21.9%. For FY23, management has guided for EPS of $2.66 to $2.86 on revenue of $3.70 billion to $3.80 billion, with organic ARR growth in the mid-teens percent range. Expectations for operating margin are 23% to 24%, with gross margin coming in at 62% to 62.5%.
Organic and ARR growth
Due to destocking trends and moderating demand, management guided organic growth to decline in the near term but inflect up in 2H23 (mid to high % range). Despite the fact that the Transportation sector is forecast to experience high churn in 1Q, ARR growth is expected to improve through FY23 with mid-teens % growth. While it appears to be a mixed bag, the good news is that all segments are likely going to see organic growth other than Geospatial in FY23. Meanwhile, in FY23, organic sales of hardware plus perpetual software are anticipated to decline.
In particular, the slowdown in the Geospatial and Heavy Civil engineering sectors indicates that the supply of machinery has caught up with demand. The slowing cyclical demand, especially in the Geospatial surveying market, was a major factor in the 13% drop in organic hardware revenue in 4Q22. According to management estimates, the reduction in dealer inventory accounted for -9% of the headwind in organic sales, which translated to a 4% drop in sales to the end user.
Inventory issue
The negative effects of dealers reducing their inventory levels will continue in the short term. This reduction in inventory caused a 400bps decline in organic sales growth in 4Q22 and was made worse by a slowdown in end-market demand. Hardware organic sales were also down by 13% during the same period. Sadly, management believes that this trend of inventory reduction will continue for the next two quarters due to an improvement in supply and dealers' caution due to ongoing uncertainty. This is likely to have a significant impact on the Geospatial segment, which has a high concentration of hardware sales. It is also important to note that hardware and related software sales are still much higher compared to pre-COVID levels in industries like civil construction and surveying. As a result, this situation could potentially have a negative impact on performance, and if not handled properly, it could determine whether the company outperforms or underperforms expectations.
Change in GTM strategy
The company made a shift in its go-to-market strategy for its agriculture aftermarket business. Direct marketing and independent TRMB dealers will be the primary distribution channels going forward. In my opinion, this strategy has some advantages because it raises brand awareness among consumers. I also think this shift presents an opportunity for TRMB to broaden the range of products available through its distribution channel, which I believe was being constrained by dealers. Moreover, management remains confident that the company is increasing its share of the wallet among its customers in Europe and SA as a result of its proficiency in the management of mixed fleets.
Margin
In 4Q22, TRMB gross margin expanded due to a shift in the proportion of revenue generated from hardware to software, but this was partially offset by investments. Although it is expected that the gross margin will grow in the future, the operating profit margin will remain under pressure due to increased reinvestments in digital transformation.
Guidance
Midpoint guidance for FY23 adjusted EPS was $2.76, which is below the consensus estimate of $2.90. Midpoint revenue guidance was set at $3.75 billion, which is also below the consensus estimate of $3.88 billion. Most importantly, management is no longer counting on a repeal of Section 174, so FCF conversion is anticipated to be 100% (1x from net income). That said, the potential elimination of Section 174 would add $150 million to FCF in FY23.
Conclusion
TRMB's 4Q22 earnings were below expectations, with revenue of $857 million and a decline in operating margin to 21.9%. Despite the headwinds from dealer destocking and a slowdown in demand, management is guiding for organic growth to improve in 2H23. In my opinion, TRMB is positioned to benefit from the growing interest in digital transformation across a variety of strategic end markets. By shifting its business model to one that emphasizes software and subscriptions rather than hardware and perpetual licenses, the company should see less cyclical fluctuations in its earnings.
