Aviat: Q2 Better Than Expected; Balance Sheet Risk From PASOLINK Acquisition (NASDAQ:AVNW)

SOPA Images/LightRocket via Getty Images Aviat Networks’ fiscal 2024 Q2 financial results (NASDAQ:AVNW) have been released. While consensus estimates indicated a YoY 33% decrease for Q2 and a further YoY drop of 48% in Q3 to come, the Q2 reports now released actually show a YoY 4.8% growth, significantly outperforming expectations. In general, there are positives for Aviat long term. The valuation of the shares at this time is particularly attractive, although risks related to the firm’s balance sheet related to its recent acquisition of NEC’s wireless transport business present some short-to-medium-term concerns. Operations & Q2 Earnings Aviat is a leader in the provision of microwave networking solutions. It offers secure wireless transport compatible with a range of applications, and it designs, manufactures, and sells advanced digital microwave systems that are used in IP networks. Aviat’s services are particularly useful in providing efficient transmissions to remote areas where wired infrastructure is unavailable. The firm’s microwave radio systems are fundamental to many telecommunication networks worldwide. Aviat also offers network management services, including software solutions, which help its customers maintain their wireless networks. Its clients include private network operators, wireless and wireline carriers, and government agencies in industries including transport, utilities, and public safety. Emergency services, for example, are particularly well served by Aviat’s services. In January 2024, Aviat announced its collaboration with Indonesia’s Smartfren Telecom, providing it with microwave transport. The agreement should capture further market opportunities in the region. In addition, Aviat acquired NEC’s wireless transport business in November 2023. Aviat expects the business to contribute about $150 million in annual revenue. Particular value is contributed by NEC’s (OTCPK:NIPNF) PASOLINK, a wireless transport solutions brand that is recognized around the world for its quality. Q2 earnings showed a 4.8% YoY increase in total revenues, up to $95 million for the quarter. There was a notable increase in international revenue of 13.1%, primarily driven by Latin America and Asia Pacific markets. However, there was a slight decrease in United States revenue. The firm’s gross margin grew from 35.5% in the previous year to 38.8%, with higher software sales. However, operating expenses increased by 35.2% as a result of the NEC wireless transport business acquisition. Net income per share GAAP is $0.24, which is a significant decrease from Q2 2023 when the company reported net income per share GAAP of $0.51. Notably, Aviat’s debt rose $49.7 million following the NEC wireless business acquisition, but the balance sheet was strengthened by $45.9 million in cash as opposed to $22.2 million as of June 30, 2023. It also raised its full-year fiscal 2024 guidance to revenue of between $425 and $432 million. Financials Aviat has particularly strong growth, with YoY revenue growth at 13.46%. This is a 178.76% lead on the sector median of 4.83%. Its forward revenue growth goes up to an even higher 19.82%, a 195.19% lead on the sector median of 6.71%. Its YoY diluted EPS growth is 29.5%, a 934.86% lead on the sector median of just 2.85%. However, its forward diluted EPS growth is expected to be around 13%, which is still much higher than the future expected sector median of 6.36%. Seeking AlphaAuthor, Using Seeking Alpha Aviat has less strong profitability than growth, particularly with its TTM gross margin, which is 35.86%, 27.06% less than the sector median of 49.17%. However, its TTM net income margin of 5.18% is 172.58% higher than the sector median of 1.9%. Compared to a set of its major industry peers, Aviat has the second highest net income margin, second only to Gilat Satellite Networks (GILT): Seeking Alpha As mentioned above, the balance sheet has become weaker since the recent report due to Aviat’s acquisition of NEC’s wireless business. At present, the company’s total liabilities are 49% of total assets, significantly higher than in June 2023 when the company’s total liabilities were just 40% of total assets: Seeking Alpha The TTM cash acquisitions cost reported by the firm is $32.2 million, which was used in funding Aviat’s $65.5 million NEC wireless business acquisition, consisting of $42.1 million in cash and $23.4 million in stock: Seeking Alpha Market Outlook & Growth Drivers The most significant growth driver for Aviat Networks at this time is its acquisition of the NEC wireless business. This acquisition will considerably improve the firm’s exposure to 5G, rural broadband, and private network markets. These emerging technologies are high-growth areas and should contribute to strong growth for Aviat in general over the next decade. 5G Infrastructure Market Revenues Worldwide 2020-2030 (Next Move Strategy Consulting, Statista) In addition to 5G growth, governments, including the US and EU members, are providing funding to extend broadband coverage to rural areas. The US government’s Infrastructure Investment and Jobs Act, for example, allocates billions of dollars towards improving broadband connectivity in an effort to improve digital access. The COVID-19 pandemic also pushed forward the demand for improved wireless access by stressing the importance of digital communication. This has been instrumental in helping to improve certain companies’ efficiency through lower overhead costs. However, it doesn’t work for all organizations and management styles, and some reversion to the mean is currently underway, which might reduce the emphasis on wireless communications over the next decade. Additionally, the United Nations has made specific efforts related to its Sustainable Development Goals to achieve universal internet access, falling under Goal 9. Also, market research firms such as McKinsey & Company and Deloitte often release reports stressing the digital adoption in emerging economies, where high growth is likely. However, it must be noted that there is significant competition in the area, including from SpaceX’s Starlink, and the probability of new disruptive technologies emerging that could compete with Aviat’s operations is high enough to reduce my future growth forecasts for risk-mitigation purposes. Aviat also competes with Huawei, Ericsson (ERIC), Nokia (NOK) and ZTE (OTCPK:ZTCOF). A lot of these companies have offerings that directly overlap with Aviat’s and could result in market share loss for Aviat moving forward. Valuation One of Aviat’s strongest points at this time is its valuation, with a TTM P/E GAAP ratio of 26, a -9.58% lead on the sector median of 28.75. Additionally, its forward P/E GAAP ratio is 16.79, which is a -38.97% lead on the sector median of 27.51. Over the last 5 years, the company’s earnings per share without non-recurring items has grown at 69.5% per year on average, and over the last three years, it has grown at 124.9% per year on average. While Aviat’s earnings growth over the next decade is likely to be strong, it is unlikely to remain at such high levels. Over the last year, the growth rate for earnings per share without non-recurring items has come down to 25.2%. I think it is not unreasonable to estimate EPS without NRI growth of around 15% per year on average over the next 10 years; this is conservative but also facilitates the expected high growth from exposure to growing and new markets outlined above. For my DCF analysis, I also used a 4% terminal-stage growth rate and an 11% discount rate. My result supposes a 28% margin of safety with a fair value estimate of around $45 compared to a present stock price of around $33: Author, Using GuruFocus Risks There is a considerable chance that my discounted cash flow analysis could be too optimistic if Aviat fails to achieve 15% growth in EPS without NRI over the next 10 years. The company had a net loss until 2017 for over a decade, and while it is showing promise with high growth at this early stage of profitability, whether its earnings growth will continue is highly dependent on how it manages its operational strategy, including its acquisitions, in the future. Additionally, the balance sheet remains my largest risk for investing in the stock when considering potential issues in the short-to-medium term, which could arise in weak economic environments where lower spending requires more debt financing. The company does have a very high cash and short-term investments balance of $45.9 million and large total receivables of $236.4 million; however, the fact that its balance sheet has about 9% more leverage than usual is a moderate risk for investors to consider. I don’t think it detracts much from the investment potential, but some weakness is inherent in the post-NEC wireless business acquisition financial health of Aviat. Conclusion I think Aviat is a good business to own right now. All things considered, I believe the risks to an investment are minimal and the operations are run well, with significant room for growth and all-round good financials. While the net income from its Q2 results was a YoY decrease by GAAP standards, its non-GAAP net income saw a considerable gain. The valuation of the shares is highly compelling to me, and as such, my analyst rating for Aviat stock is a Buy.

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