NetComm (NTC) has upgraded FY15 earnings guidance to revenue of $73 million and an earnings before interest, tax, depreciation and amortisation (EBITDA) of approximately $7m – above analyst consensus expectations of $5.8m and also above our prior forecast of $6.6m.
The prior guidance at the half year result was above last year’s EBITDA of $5.2m. The driver of the increased guidance is a more rapid deployment of the NBN (rural broadband). In further encouraging news the NBN rollout rate is expected to continue increasing into FY16 and FY17.
The share price ($0.73) is up over 60 per cent since our “buy” recommendation after the half year result, driven by the recent earnings upgrade as well as new partner agreements.
In March this year a partner agreement was announced with Singtel. In May Hitachi selected NTC to deliver the ICT component of their smart energy project.
The guidance is especially positive considering there was an additional $1.8m investing cost that would benefit the future year’s earnings.
Although the results for this year are encouraging, it is the FY16 and FY17 growth that is critical to the valuation and share price of NTC. There will be significant margin expansion over the next two years as further revenues with a 30 per cent gross margin can be achieved without a further increase in fixed costs.
Management is of the view that the Ericsson-NBN Rural Broadband will be a greater opportunity than just the initial four year rollout, with expectations of a greater take-up rate down the track as well as ongoing work from technology upgrades.
As well as the strong growth in Australia, the company is positioning for overseas Machine-to-Machine (M2M) contracts and further Rural Broadband opportunities. The developer of innovative broadband products is leveraging its engineering capabilities in an attempt sell globally to major telecommunications carriers, core network providers and system integrators.
Chief executive David Stewart commented, “The rollout of the NBN in Australia is gathering pace providing us with increased volumes in the Ericsson-NBN Rural Broadband contract and we expect those volumes to ramp again significantly in the coming year. Combined with a strong Australian and NZ broadband business, we expect to generate improved revenues and earnings in FY16.”
Further, “We will continue to progress discussions and trials with our international M2M partners and in addition have several exciting Rural Broadband growth opportunities in the pipeline. Should any of these translate into orders, they will be very significant for NetComm Wireless.”
NBN rural broadband
Due to the size of our country there are up to one million Australian homes and businesses that are located beyond the reach of the NBN’s fibre roll-out. These homes and businesses will be offered access to the world’s first rural wireless broadband network. It is being built and operated by Ericsson, and NetComm has the exclusive contract to supply the 3G and 4G devices for this rollout.
The pace of the rollout is gaining momentum and its size has recently doubled, presenting a large growth opportunity for NetComm over coming years.
Although the company’s growth from the Australian rural NBN is secure, a more uncertain opportunity is the chance to win overseas rural broadband contracts. Many other developed nations have been watching Australia’s NBN progress with interest.
It has been generally accepted for most developed nations that the standard replacement is fibre in “built up areas” which covers around 90 per cent of customers. For the remaining 10 per cent, being regional and rural customers, it has been generally accepted that fixed wireless is the best solution.
There are US rural broadband contracts with Verizon and AT&T likely to be announced by the end of the year. Although NTC has the advantage of doing the work before, they are up against many larger competitors. Our view is that the US contracts should be viewed as a free option with significant upside if they are won.
With 50 billion devices expected to be connected by 2020 the M2M industry is experiencing rapid growth and M2M applications are forecast to grow to approximately $150bn by 2020.
The network connectivity enables the capability to:
- Monitor the environment
- Report their status
- Automate processes
- Receive instructions
- Take action
Networked assets allow businesses to be more aware of operational progress with a faster ability to react with increased productivity.
The improved connectivity of devices is affecting just about all industries, with some of the key verticals NetComm are targeting listed below.
- Smart metering
- E-health – in-house devices
- Industrial automation
- Business services – point of sale, vending machines, digital display
- Rural NBN – leverage into other developed countries
As well as Australia the company now has offices in the US, UK, New Zealand, the Middle East and Japan. This means they have exposure in all the key M2M regions.
As a small $95m market cap Australian company, Netcomm is up against significantly larger hardware providers. As such it is important they stick to niche areas where they can provide a point of difference.
The way management is attempting to differentiate themselves is by having capabilities for high performance customised devices that deliver long-term contracts and higher margins.
This means avoiding the high volume, low margin one-size fits all market segments that will generally attract more competition from larger suppliers.
Although NetComm is relatively small, they do have 32 years of engineering experience and low cost purpose built manufacturing capabilities in Asia.
With this strategy, even if they can win $5-10m worth of specialised M2M work in each of the offices it will have a material impact on the company valuation.
Another key to the strategy is to partner with relevant telco carriers and other partners to leverage the sales of the companies innovative products and custom solutions.
Traditional fixed broadband
With the shift to M2M, the traditional fixed broadband devices have become less than 50 per cent of revenues. Despite this the first half was stronger than expected due to VDSL and powerline demand.
NetComm is a high risk investment despite its 32 years of engineering experience with electronic communication devices. The nature of the emerging M2M industry provides risk related to the fast rate of change, and large amount of hardware providers with competing technologies.
Earnings currently lack diversification and therefore the company is very sensitive to a change in the rollout rate from customers, particularly with the rural NBN.
The slight upgrades to FY15 earnings have a relatively non-material impact on the company valuation. But the increased NBN rollout rate does reduce earnings risk for FY16 and FY17.
We are not assuming any major overseas contract wins, and most of our FY16 growth is from a ramp up in Vodafone and NBN revenues.
Our 5.4 cent earnings per share forecast for FY16 equates to a price-earnings (PE) multiple of 13.5 times. We expect an above market PE to be sustained due to very strong growth again for FY17. This growth again is mainly factoring in currently contracted work.
With more certainty around medium term earnings our DCF valuation has increased to 85 cents and we maintain our “buy” recommendation.
To see NetComm's forecasts and financial summary, click here.