Daktronics stock is a buy on potential future growth (DAKT)

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With stable operating cash flow, Daktronics (NASDAQ:DAKT) is a leader in its industry. In my opinion, if the management opens new offices abroad and signs more agreements with resellers, the revenues would be directed to the north. I’m pretty optimistic about the new automation and improved manufacturing processes announced recently. With ample cash to fund these initiatives, Daktronics appears somewhat undervalued. My DCF pattern showed a target price near $9.3, while the current market price is near $4.1-$5.7. So I’m a buyer.

Daktronics: diversified business model, international sales and growing order book

Founded in 1968, Daktronics, Inc. is the worldwide industry leader in the design and manufacture of electronic scoreboards, display systems and on-screen video displays.

Readers may have seen the company’s display systems while driving, watching a basketball game, or ordering food at a restaurant:

Investor Presentation

Investor Presentation

I believe that the activities of the company are well diversified. The management derives most of its revenue from live events, commercials and transportation.

Interestingly, the company’s international sales represent only 13% of the total amount of revenue. In my opinion, there is a lot of room for improvement outside of the United States. With the know-how accumulated in the United States, I think the company will most likely see a steady increase in international sales in the years to come:

Investor Presentation

Investor Presentation

There is another clear fact that indicates future sales growth. According to the most recent 10-K, the order backlog has increased significantly in 2021. We are talking about more than $300 million in orders for integrated electronic display systems, which management expects to recognize in net sales to the future :

Our backlog as of May 1, 2021 was $304 million, compared to $268 million as of May 2, 2020. We expect to fill the backlog as of May 1, 2021 over the next 24 months. Source: 10-K

With previous FCF growth, more resellers and process automation, I expect a target price of $9.3

For those unfamiliar with Daktronics’ financials, let me mention that over the past five years, the company has averaged -2% sales growth, 4% EBITDA margin, operating margin close to 1% to 2%, and an average tax close to 37%. The company’s EPS remained almost positive and close to $0.05 to $0.23:

My numbers

My numbers

The company’s CFO was also positive and grew from $20 million in 2012 to $67 million in 2021. D&A has always been close to $14-17 million:

Investor Presentation

Investor Presentation

In my opinion, if the management successfully signs agreements with more resellers in Europe, Asia and Latin America, the revenues will most likely be shifted north. If the company makes acquisitions abroad or opens new offices abroad, direct contact with customers can generate even more revenue:

We use resellers outside of North America for large integrated system sales where we do not have a direct sales presence. The majority of our products sold by resellers in North America are standard catalog products. We support our dealers through direct mail/e-mail advertising, social media campaigns, advertisements in trade journals, product and installation training, trade shows and accessibility to our regional sales or service teams and our demonstration equipment. Source: 10-K

I would also expect significant growth in FCF through increased standardization and uniformity of parts, other lean manufacturing techniques, and process automation. The company highlighted these practices in its latest annual report and in investor presentations:

One of our key strategies is to increase standardization and commonality of parts and manufacturing processes across all product lines through the use of product platforms to increase efficiency. Other strategies include supplier management programs and lean manufacturing techniques. Source: 10-K

Investor Presentation

Investor Presentation

I tried to make very conservative assumptions about the future. I included sales growth of 2.6%, EBITDA margin of 7% to 3%, effective tax of 22.7% and investments/sales of 1.6%. Results include FCF from $45 million to $61 million:

My numbers

My numbers

Like other investment advisors, I think a WACC of 7.5% seems fair enough. I used cost of equity of 12%, cost of debt of 4.25% and a beta of 1.8-1.9x. If we also used a conservative exit multiple of 9x EBITDA, the IRR would be 24% to 25% and the target price would be close to $9.3:

My numbers

My numbers

Daktronics Announces Free Cash to Fund Company’s International Expansion

With an asset/liability ratio of 1.9x and cash of $59 million, I believe the company’s financial position is stable. In my opinion, management has enough cash to design new products and advance control systems:

10-Q

10-Q

The company’s obligations do not seem significant. As of October 30, 2021, the company reported $15 million of long-term warranty obligations and $10 million of long-term contract liabilities. I wouldn’t expect most investors to be afraid of the company’s contractual obligations:

10-Q

10-Q

Supply chain risks, miscalculation of future spending in new deals and competition imply target price of $4.7

Daktronics can suffer from competitors if the company does not invest enough in improvements and innovations. I also believe that management may experience FCF margin deteriorations if competitors lower their prices. This risk was disclosed in the most recent annual report:

The electronic signage industry is characterized by continuous product improvement, innovation and development. We compete with products made in foreign countries and in the United States. Our competitors may develop lower cost or less functional products, be willing to charge lower prices to increase market share, or market new and unique product, service and controller offerings. Source: 10-K

Supply chain risks and component shortages can be very detrimental to the business. Customers may not receive the Company’s products or component prices may increase. In this detrimental scenario, management may experience decreased FCF margins, which may decrease demand for the stock. As a result, the WACC could increase, and the intrinsic valuation decrease:

The electronic components used in our products are sometimes in short supply, which may affect our ability to meet customer demand. If we experience shortages or increases in the price of raw materials and components and we are unable to pass these increases on to our customers or are unable to manufacture our products at all or in a timely manner, it could adversely affect our business, financial condition, or results of operations. In addition to increased costs, these factors could delay the delivery of products, which could lead to the imposition of liquidated damages or other contractual damages that could negatively impact our profits. Source: 10-K

In this detrimental case scenario, I would also include some errors when calculating project costs. As a result, the company may not predict the amount of free cash flow to be obtained. In this case, the company could report less EBITDA and FCF than expected:

Unforeseen costs that exceed our initial estimates may not be recoverable under fixed price contracts. Unforeseen cost increases may occur due to several factors, including, but not limited to: cost increases, shortages or unavailability of materials or labor; unforeseen technical problems; required project changes not initiated by the customer; non-performance or delay in performance of their obligations by suppliers or subcontractors; logistical interruptions or delays; and capacity constraints. Source: 10-K

In the previous conditions, I used -2% sales growth from 2022 to 2032, so 2032 sales would be $335 million. If we also use 5% EBITDA margin, $10-20M D&A and 3% working capital/sales changes, FCF would be close to $45-30M:

My numbers

My numbers

Finally, with 45 million shares outstanding, a WACC of 10% and an exit multiple of 5x, I got an IRR of 10% and a target price of $4.7. Traders are currently buying shares at $4.1 – $5.9, so I don’t think there is significant downside risk.

My numbers

My numbers

My takeaways

Daktronics reports stable operating cash flow. In my opinion, the management has accumulated significant know-how. If the company opens overseas offices or signs more reseller agreements, I would expect a significant increase in international FCF growth. Management also implements lean manufacturing and tries to find new efficiencies in the manufacturing process. Putting it all together, I got a target price of $9.3 and limited downside risk. Given the current price, I buy shares.

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