Ubiquiti Networks (UBNT) reported another quarter of earnings growth. The company easily beat expectations for EPS, though posted a slight miss on revenue. The company’s shares have collapsed more than 20% following the report over tariff fears which shouldn’t harm business much in the long term. The company had a large outflow of cash during the nine months ending with the third quarter, though this should be less extreme over the coming quarters. The company still seems to be able to continue its buyback and dividend without much trouble.
Earnings and Balance Sheet
The company reported non-GAAP earnings per share growth of 13.8% YOY. GAAP earnings growth was negative with earnings decreasing slightly YOY. This discrepancy is largely due to the repatriation tax of over $100 million that was paid over several quarters in 2018 and included in the non-GAAP earnings, but not the GAAP earnings.
The quarter displayed an increase in gross margin of 1% from last quarter and 0.9% YOY to 46.6%. The company also displayed revenue growth of 13.8% YOY, though a decrease of 7.3% from the previous quarter. Management attributed this quarter over quarter decrease in revenue to distributor ordering patterns; likely impacted by the threat of tariffs. Revenues decreased across every geographic region from the last quarter, except South America.
Third Quarter Revenues
Second Quarter Revenues
This region showed strong growth quarter over quarter of nearly 9.9% from the second quarter. I think this area could continue to find future growth as its needs fit well within the company’s mission and range of products. Income from operations increased sequentially from last quarter and YOY showing continued strength. The largest reason for lower GAAP income YOY was income tax, the company received an over 20 million benefit in the third quarter of 2018 and paid nearly $10 million during this quarter.
Overall, the company continued to show its ability to increase its net income, even on lower revenue and uncertain business conditions. Net margin for the quarter was 30.99% based on GAAP net income which displays the company’s high profitability.
The company’s balance sheet improved significantly from last quarter. Total assets decreased slightly from the previous quarter by $6 million, but total liabilities decreased by more than ten times that amount. The company continued to pay down long term debt, which they’ve consistently for the past few quarters, by $10 million. They also decreased accounts payable by $45 million and other current liabilities by $27 million. In total, the company’s liabilities decreased by $68.5 million, or 8.45% of total liabilities. I’m glad to see the company paying down this debt as it should help free up money in the future for spending on other purposes such as increasing the dividend and will decrease their interest expense, though this isn’t very large at present.
Dividend, Buyback, and Cash Flow
The company announced its fourth 25 cent quarterly dividend and is going ex-dividend on May 17th. The company’s dividend yield is not a compelling reason to buy the stock and only stands at 0.67%. The dividend is currently safe, with a payout ratio of 22.47% and the company’s strong profitability giving the company little trouble of paying the dividend. As I’ve mentioned before the company is likely to continue to increase the dividend in the future as the large insider ownership, mostly by the CEO/Founder Robert Pera, leads to an interest in distributing earnings to shareholders. The dividend was announced last year and was announced through the end of FY 2019. I expect management to announce another quarterly dividend for FY 2020 and maybe even raise it, but this is by no means guaranteed.
High insider ownership means that the company’s buyback program isn’t going to be the easiest to execute, with only $9 million in shares being repurchased in the third quarter, due to 80% insider ownership and the unlikeliness that many of those shares are sold. The buyback is slowly purchasing back shares and has over $178 million left of the original $200 million allocated to repurchase. At current share prices, the buyback could, theoretically, repurchase 1.9% of the company’s outstanding shares.
The company did burn through quite a bit of cash in the 9 months leading up to the end of the third quarter. This may raise questions as to the safety of the company’s dividend and buyback. They saw a net decrease in cash of $356 million, whereas, for the same period a year ago, the company saw a net increase in cash of around $86 million. This difference can be accounted for by the debt issuance in FY 2018, as well as the $180 million inventory expense this year. The inventory buildup should slow down now that tariffs have already gone into effect, removing the incentive to purchase inventory in advance.
The largest expense, by far, is the company’s share repurchases which account for $328 million on the company’s most recent report. The second largest reason for a decrease in cash was the company’s $200 million purchase of investments, which was partially offset by the $69.6 million proceeds from the sale of investments, though there was still $113 million in cash used in investing activities for the period. Adding to this the $180 million in inventory purchased in anticipation of future import tariffs and increasing sales, we have a large outflow of cash.
The company should, going forward, have more than enough cash flow to cover its dividend and buyback program. Net income for the period doubled from the year before to $251 million for the nine months and the company’s $40 million in long term investments during this period show a confidence to put money aside and still have enough to cover expenses and shareholder remuneration.
Following the sell-off, Ubiquiti once again trading at around 24.12 times price to earnings, near where it was valued following its spectacular second quarter. The company seems to remain valued reasonably when considering their long-term growth prospects. They are valued at a slight premium to the industry median PE of 19.68, but I believe that their consistent outperformance in earnings has warranted this. The recent selloff makes an attractive entry point for long-term investors, but I would be cautious given the market’s skittish behaviour regarding the tariff issue.
Tariffs, in the short term, could pose a threat to the company’s margins and directly impact sales in their North America segment, their largest area by revenue. Their inventory buildup should help some to mitigate the impact of tariffs in the short term, but there will be an adverse effect in the next couple of years if the tariffs remain in place. The company has stated that, in the long term, they will be able to mitigate the impact of tariffs. I believe that, should tariffs stay for the near term, they are likely to be reversed in the long run, that the company is well positioned to continue to prosper and grow, though we may see costs related to adjusting its supply chain to avoid US tariffs and direct more sales to other markets.
The company showed another quarter of growth despite a decrease in revenue from last quarter. The company remains financially healthy and able to support its dividend and buyback. The tariff issue will continue to weigh on the stock and there is a chance for another sharp reaction to the fourth quarter in August if there is any evidence of impact from the tariffs. Even though tariffs shouldn’t prove a huge obstacle to long term growth, it nevertheless has scared investors significantly. Management expects to meet the high end of guidance for FY 2018 ending June 30. This would be hard to miss given the outperformance in the first three quarters. The company’s guidance for FY 2020 will be much more revealing of the company’s expectations regarding the impact of tariffs and future growth. The selloff provides an attractive entry point for long term investors in this high-quality company, but the next couple of months could prove tumultuous for the company as the trade war plays out.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.
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