Zebra Technologies: Workflow Optimization; Start by Buying (NASDAQ:ZBRA)

Zebra Technologies (NASDAQ:ZBRA) is a global leader in the Automatic Identification and Data Capture (“AIDC”) industry. Zebra has a wide range of products and solutions to optimize the workflow for their customers, serving sectors such as retail and e-commerce, transportation, logistics and digital. production. Digitization and automation are long-term growth factors for the company. I initiate a “Buy” rating with a one-year price target of $360 per share.

Solutions to optimize customer workflow

Zebra’s major growth driver can be summarized as follows:

• As outlined in the slide below, there are several megatrends that support Zebra’s long-term growth. Zebra offers a wide range of products, including real-time location (“RTLS”) and radio frequency identification (“RFID”) systems, for capturing location data. These products are widely used in digital manufacturing, logistics, industrial automation, IoT and data analytics markets. As such, Zebra has grown with these megatrends in recent years.

• Zebra uses custom hardware and software solutions to optimize the workflow for their customers. These solutions can analyze data from operational workflows and take action on that data in real time. For example, their software can provide clients with workforce management, workflow executions, and pricing optimizations. Additionally, their purpose-built hardware can provide valuable data insights to these software solutions.
• Finally, Zebra offers portable mobile computers for retail/e-commerce, logistics and manufacturing facilities. This custom equipment is designed to operate in harsh environments, helping customers manage inventory and improve supply chains. Apparently, Zebra has benefited from the growth of e-commerce and the massive accumulation of distribution centers over the past few years.

Acquisition strategy

Zebra has spent more than $2 billion on acquisitions over the past five years. On June 3, 2022, Zebra acquired Matrox Electronic Systems for $881 million. Matrox is a leading player in the machine vision and software markets. I agree with this understanding because machine vision is a rapidly growing market driven by the expansion of digital manufacturing and industrial automation. The integration of Matrox vision technology has enhanced Zebra’s hardware and software solutions in the industrial automation space.

In October 2021, Zebra acquired Antuit, a provider of demand sensing and price optimization software solutions, for $145 million. The SaaS solution has expanded Zebra’s customer base among retail and consumer products companies. In addition, Zebra has focused on their software offerings in recent years to achieve higher recurring revenue.

In August 2021, Zebra acquired Fetch Robotics for $301 million to improve its on-demand automation technology. As revealed in the release, Fetch’s autonomous mobile robots are being used wildly for optimized picking in fulfillment centers and distribution centers. The acquisition helped Zebra strengthen its workflow optimization solutions.

In general, Zebra has effectively used mergers and acquisitions to expand its product offering and expand into adjacent business areas. Thanks to organic growth and M&A, Zebra has seen solid revenue and net income growth over the past few years, despite some weakness in FY23 due to weak capital spending from retailers.

Recent Result and Outlook

Zebra released its Q2 FY24 result on July 30, reporting a 0.2% increase in revenue and a 2.8% decrease in adjusted net income, as shown in the chart below.

It is encouraging to see that business growth is starting to pick up this quarter, having been down more than 30% in recent quarters. I believe the growth reflected early signs of recovery in demand, led by the mobile computing, retail and e-commerce businesses. During the earnings call, management anticipated that the market will continue to recover in the second half of FY24, while maintaining a cautious view on spending behavior from their large customers.

For FY24, they are guiding revenue growth of 4%-7% with an adjusted EBITDA margin of 20%-21%, as detailed below.

I consider the following factors for their short-term growth:

• According to recent quarterly results from Walmart ( WMT ), Dollar General ( DG ), Home Depot ( HD ), and Costco ( COST ), retail consumption remains quite weak in the US market due to high interest rates. It’s quite understandable that retailers are starting to reduce their capital expenditures and reduce overheads to improve margins. As a result, I anticipate headwinds to Zebra’s growth to persist in the near term. However, when the economy starts to improve, retailers will need to invest in their omnichannel and distribution centers to support e-commerce.
• Weak retail sales are also reflected in overall retail sales data provided by the US Commerce Department, as shown in the chart below. Total retail sales were very weak in the first half of 2024. Given the current high interest rates, the retail market is unlikely to recover anytime soon in my view.

As such, we forecast Zebra to grow its revenue by 6.5% in FY24, supported by 2% growth in custom equipment, 2% in software and 2.5% in services. Starting in FY25, I project that the company will recover to 7% organic revenue growth, driven by long-term megatrends such as industrial automation, digitization and IoT. Additionally, we estimate that the company will allocate 10% of revenue to M&A, contributing an additional 2.5% to top line growth.

DCF rating

As discussed, I model total revenue growth of 6.5% in FY24 and 9.5% from FY25 onwards. I model 30 bps annual margin expansion for Zebra, assuming 10 bps from new product offerings with higher ASP, 10 bps from mix to software and services, and 10 bps from SG&A operating leverage. With these assumptions, the DCF can be summarized as follows:

The cost of equity capital is calculated to be 13.1%, as follows:

Discounting all free cash flow from equity (FCFE) at a rate of 13.1%, the one-year price target is calculated at $360 per share.

Key risks

• CAPEX Cycle: Zebra Technologies’ business is tied to some degree to customer capital expenditure cycles. In challenging economic environments, Zebra Technologies’ growth is more likely to be slow, as it is now experiencing.
• The company sources many important components from China; therefore, geopolitical turmoil, particularly between the US and China, could increase cost pressures for Zebra and disrupt their global supply chain.
• Zebra exited Q2 FY24 with a net debt leverage level of 2.4x, which is relatively high compared to other technology companies. The company prioritized debt repayment and committed to reducing leverage and improving cash flow balances.

Final note

Zebra Technologies is well positioned to capture the growing demand for industrial automation and digitization. Purpose-built hardware, software and cloud analytics can provide real-time actionable insights to their customers. I initiate a “Buy” rating with a one-year price target of $360 per share.