DKosig
For those with freedom to invest in microcaps, AstroNova (NASDAQ:ALOT) is a sneaky good setup that has incrementally gotten more recognition as they’ve started to post improving results over the past few quarters. But despite the stock growing 12% year-to-date and 50% over the past year, there’s still room for it to be justifiably higher over the next 24-48 months.
At ~12x free-cash-flow today, the risk/reward looks particularly attractive. Over the coming years, there are a few mechanical items that are likely to favorably shift over the coming years, which will result in improved earnings/FCF. As these items – normalized hardware/supplies mix, acquisition royalty rolling off, and operating leverage – do improve, this should naturally result in increased investor interest as a more normalized profile of the business becomes evident.
Product Identification: Temporal Sales Pressure
Product Identification (PI) sales were down 5% in Q4 to $26.6M. For those who may be unfamiliar with AstroNova’s business, their PI segment consists of label printers, selling both the hardware and supplies (ink, toners, media). They sell various “tabletop” printers, which are essentially smaller-sized product label printers with prices ranging from less than $5,000 to a couple hundred thousand dollars. Customers spread across a number of end-markets, but thanks to the label-heavy nature of food and beverage businesses, the F&B vertical comprises a good portion of sales (undisclosed precisely how much).
They didn’t confirm specifically, but as it was the case in Q3 when PI sales were down 11%, sales in Q4 likely reflected a mix of both hardware and supplies sales declines. From one angle, it’s directionally true that there are likely some macro impacts affecting their sales today. Sure, food & beverage and health & nutrition businesses are a sizable component of sales, so their general macro exposure seems fairly insulated – people still have to eat and clean after all – but just given the general direction of businesses on average, there are a few pockets of customers here and there that have maybe decided not to invest in a new printer to conserve cash, or have curtailed planned capacity growth. Management previously noted too that they sell to a lot of mom-and-pop businesses, so it’s reasonable to think that some have gone out of business lately.
And it’d make sense qualitatively, too. Their printers cost somewhere from $5K to $2M, but are generally somewhere around the $50K mark. So, in the same manner a consumer would defer a big purchase like a new vehicle unless necessary, I can imagine a business doing the same for printers.
But there are also idiosyncratic issues that PI is battling. For context, last quarter (Q3 2024), they noted how sales were negatively affected by an inkjet supplier issue which they continued to work through in Q4. Basically, they’re referencing an issue that started in early 2022 when one of their suppliers supplied faulty ink, which in turn damaged the printers they were selling to their customers. As such, since mid-2022, AstroNova had to go to each customer to repair/replace those printers akin to a vehicle recall.
Unless my mental model is wrong here, this really shouldn’t affect hardware sales given the replacement cycle nature of sales. This does affect their supply sales, though, of course. As they’ve noted, with the printers broken (partially or entirely), they’re consequently running less frequently or not at all, which means their associated supplies revenue declines. In other words, 2023 reflects a period in which they were underselling supplies relative to what a normalized year of customer printer production volumes would look like. And this still affected them in Q4 – per their comments here, they wouldn’t be complete with the repairs until the end of the fiscal year (confirmed by the charge taken in Q4 associated with the repair costs).
Looking ahead, then, there’s a natural uplift sales should benefit from going into calendar 2024 (FY25). That is, after they seemingly get past the repair issues in fiscal Q1, they’ll start selling a (higher) normalized level of supplies volumes. Concurrently, they’ll also be comping easier periods in the 2023 period when sales were depressed from this situation.
Hardware-wise, this side of the business could continue as normal. It’s unclear when the macro pressures abate, but per the broader set of business I track, we’re seemingly starting to reach a modest level of stabilization. They did launch 3 new printer products lately, however, and per their comments on the Q4 2024 call, they make it sound like sales could grow from production ramps in later 2025.
One broader angle with the PI business is that there’s a notable level of competitive risk. What’s historically been the case is that through continuous product improvements, AstroNova’s been able to take share from commercial printer vendors as clients realize increasing value from tabletop printers. To this end, then, I do worry whether this eventually engenders a response from those commercial players, which includes the likes of Epson and Canon.
Of course, there’s not a technological or capital barrier to entry preventing them from doing so, but seemingly a barrier of interest. It’s still a relatively small market, and one angle that management has uncovered is that those commercial vendors don’t want to have to build out a direct salesforce but would rather go through distributors, as evidenced by their current model. In effect, this limits their ability to sell a full suite of products – from printers to ink to media to toners – and it also limits their service capabilities.
Ultimately then, to the extent the competitive risk doesn’t materialize, I’m expecting sales to improve a little over the coming quarters as the supplies revenue improves, and the macro situation doesn’t increasingly hurt their sales. They posted $26.6M of sales in Q4 and $104M in 2023 – I don’t think it’d be all that unreasonable to expect low-to-mid-single-digit growth on top of their Q4 results to get a rough run rate of something like $27.5M in quarterly sales. Seasonality isn’t huge, but sales can be modestly lumpy here and there given the higher-dollar nature of sales, so on a full-year basis, $110M in PI sales looks reasonable to me.
Test & Measurement: Long-term Robust, Near-Term Uncertainty
AstroNova’s Test & Measurement (T&M) sales are largely comprised of airplane printers (and related supplies like thermal paper) sold essentially through 3 levels throughout the supply chain – i.e., directly to airliners, to the OEMs like Boeing (BA) or Airbus, or to Tier 1 suppliers who supply the OEMs. The printers are installed in both the cockpit and the back of the plane, so there’s generally 2 per narrow body plane. Pilots utilize the cockpit printers to print various information including weather, passenger data, air traffic control data, etc. Then there’s a small percentage of the segment consisting of data acquisition tools used in various transportation areas – auto, rail – primarily utilized for testing purposes.
Q4 2024 sales increased ~11% to $13M, part of which benefited from price as the note in their 8-K. Sales have understandably increased by an improved backdrop for airplane production. And for context, volumes are essentially tied to orders rather than deliveries of OEMs as the printers are ordered (selected by airlines) before production (there is some replacement demand). To this end, we can see that BA’s orders were 611 in Q4 (1,576 in 2023) compared to 376 (808) in the prior year, and Airbus reported 2,319 orders in 2023 versus 820 net in the prior year. Of course, they service other OEMs too – think Gulfstream and Embraer – but the broader data I’ve found suggests orders were up all around.
Recent Boeing issues (that seemingly keep popping up in growing numbers) could very well result in some near term impact to production rates in 2024 or 2025. So far, I’m not aware of any public comments from them suggesting this is going to be the case, but a la the 737 MAX issues pre-COVID, it’s not an inconceivable scenario. As for AstroNova, however, for one, Boeing is not all of their sales within this segment, but two and more broadly, AstroNova sells to both Airbus and Boeing. In other words, at least on a long-term basis, to the extent that Boeing production issues materialize and industry demand needs to be fulfilled by Airbus, AstroNova should capture that demand growth.
To this end, it’s hard to think that annual commercial aircraft production doesn’t grow from here. Per this third-party report, 2023 deliveries across the industry were around the 2013-level (about 25% below 2018 levels) while backlogs continue to grow. In other words, we’re going to need to speed up production as, evidently, annual demand is outpacing annual capacity. Also, there’s about a 10-year backlog of planes needing to be delivered based on present annual production rates. So, for the foreseeable future, AstroNova’s printer demand is not going away for market reasons.
Outside of the near-term Boeing risk, the bigger long-term risk is that their printers get disintermediated. And I agree – they probably will go away down the line absent product iterations/improvements as airlines incorporate more digital technology like iPads/other tablets into the system, and this is a notable risk that I worry about. But in the meantime – and I mean the next decade plus – I think this risk is tempered as not only is there a literal pilot preference for printers, but apparently there’s safety value too as, per Greg, pilots can’t fly certain routes for safety reasons unless they have this in-cabin printer. So, between these variables plus the slow-moving nature of the airline industry given the regulatory requirements of getting things approved, etc., I’m not worried about this angle reducing demand for the foreseeable future.
And it’s also unlikely they lose market share too. Honeywell used to be their main aerospace competitor, but AstroNova went ahead and acquired their printer business in 2017. They talked about having the “majority” of wide body market share in 2017 while noting that Honeywell is the “leader” for the narrow body planes.
Adding it all up, 11% isn’t a sustainable growth rate as pricing should end up slowing, and they also had a stronger Q4 for their data acquisition products, which tend to be lumpy. And indeed, the $13M posted is higher than the ~$10M posted in Q1-Q3. So, something slightly less than $13M – call it ~$12M is a fine run rate, implying that something around ~$45M is appropriate on an annualized basis.
Margins: Positive Outlook
By segment, PI posted segment EBIT margins of ~12%, compared to 7% in the prior year. This comes despite reduced operating leverage given the lower volumes, but you have to sort of break this out. Yes, sales were down – specifically, lower hardware and supplies volumes – which naturally results in operating deleverage. And as you might expect, there are various fixed manufacturing and distribution costs that they can’t just remove if volumes are 5% lower or whatever.
On the other hand, they’ve made some changes to their model following the acquisition of Astro Machine. Noted here, but since the acquisition, they’ve exited duplicate product lines – although not a huge impact to sales – consolidated facilities, moved manufacturing from Rhode Island and Asia to Astro Machine’s Illinois plant, and also closed a showroom. As such, while unit volume declines created deleverage, this was offset by a reduced cost base. Still, though, this was only apparently a $2.4M annualized benefit, or ~$600K benefit per quarter, which isn’t enough to fully explain the better margins today.
They did call out a positive mix to account for the residual, but admittedly, I’m not sure what this refers to. Software, which has higher margin, didn’t seem to grow as a percentage of total sales, so that wasn’t it. We know that Astro Machine has higher operating margins (lower gross margins) and they’ve exited lower-margin products, but (a) the Astro Machine business was already in last year’s results and didn’t seemingly outperform, and (b) as noted earlier, the lower margin product revenue wasn’t huge. TrojanLabel, however, has higher margin than QuickLabel, so there may be some positive mix shift there.
One item that pressured margins in Q4 was an inventory adjustment, which should go away… at least for now. For comparison, despite flat revenues with the prior quarter (Q3), margins went from over 18% last quarter to ~12% today, and they claimed it had a lot to do with the inventory adjustment.
Looking ahead, their pricing seems fairly stable today, but as we get into 2024, even if sales marginally grow in 2024, which only results in a marginal operating leverage, two things should help. First, they’re finished with their restructuring, so they’ll see reduced expenses from this. Two, they recognized $162K in Q4 related to the ink-issue/printer repairs, which should go away too. Three, the inventory adjustment should go away as well. And fourthly, the expectation is for the supplies business to outpace the hardware business, so this’ll be a mix tailwind. So, all in all, consistent with their mid-teens margin expectations, something like 14% is more reasonable in 2024 at today’s sales volumes.
On the T&M side, they posted ~28% segment EBIT margins versus ~27% in the prior year. They did raise their prices, although I’m not entirely sure to what degree this offset cost inflation, so I can’t tell how much it contributed to the margin growth. Still, as a business who does the manufacturing of the printers and related supplies, the higher volumes were a natural operating leverage tailwind.
Like PI, mix is important here too as the more supplies revenue they have, the better the margins. I think, however, their mix here is fairly normalized – I don’t see a performance dichotomy. In Q3, they noted the segment margin increase to 23% resulted from “higher revenue from high-margin product lines,” so that’s a mix benefit last quarter. But in Q4 they noted that margin growth came from “reflecting higher revenues, increased manufacturing efficiencies and favorable pricing actions,” so mix evidently wasn’t material.
Zooming out, something that’s easy to overlook is their transition from selling Honeywell printers to former Honeywell customers to selling them a ToughWriter printer. On the last call, they noted that 40% of printer sales are ToughWriter today, which they expect to reach 90% by FY28. Concurrently, there’s a margin benefit – outside of the minimum royalty paid to Honeywell in connection with the acquisition, there’s an additional royalty paid per unit sold. Thus, by converting customers to ToughWriter, they can capture higher margins by reducing Honeywell printer sales. Also, they acquired Honeywell in 2017 and have been paying part of the $15M minimum royalty each year. There’s about $5M left, which means then in FY28, there’s going to be $1.5M of annual opex that goes away, leading to natural margin uplift.
If we put it all together, to the extent that Boeing production declines, AstroNova will obviously be impacted margin-wise as they lose that operating leverage. But should our expectations pan out to be largely right – i.e., industry production grows – with their mix and price/cost decently normalized today, a 24% segment EBIT margin are reasonable at $45M in annual sales. Over time, the mix shift of ToughWriter printers and the elimination of the royalty could certainly push their margins close to 30%.
Valuation: Compelling
At today’s price of $17.8/share with 7.44M basic S/O, that’s a $133M market cap. Net of $4.5M of cash and $21.9M of total debt, that’s an EV of ~$150M.
On a present run rate basis, PI should post sales/segment EBIT of $105M/$14.7M (14% margin), and T&M should post sales/segment EBIT: $45M/$10.8M (24% margin). Corporate expense of $12M, D&A of 4.4M, interest expense of $2.6M, and a 25% tax rate is reasonable. And finally, 1% capex to sales is reasonable to me as well.
Added up, that gets me to $25.5M in total segment EBIT. Minus corporate expenses, interest expense, and taxes, that’s net income of $8.2M. Add in D&A and back out annual capex, I get ~$11.2M in FCF annually at today’s run rate (D&A is greater than capex thanks to acquisition amortization).
That then amounts to a 12x FCF multiple today, which I actually think is fairly reasonable on mature earnings. Despite the paper-orientation, neither business is really a secular decliner – businesses need labels and pilots still prefer printers – and with general GDP-like market growth, a low-single-digit growth multiple is warranted. I’d personally model them at 13-14x.
However, I’m not sure these are the mature earnings we should be valuing them on. To the extent that airline production does grow given the growing backlog, we could see T&M sales grow by ~5%+ for a few years barring any Boeing issues. Furthermore, they would then capture the margin benefit from not only operating leverage, but the ToughWriter conversions, and then royalty decline. I.e., At a mid-single-digit growth rate – say, 5% – 150 bps of margin uplift from operating leverage, 150 bps from the ToughWriter conversion, and $1.5M in reduced expenses from the royalty elimination, I think their run rate sales/EBIT of $45M/$10.8M would grow to $55M/$16.7M by FY28 (CY27).
Even assuming PI sales are flat in FY25 (CY24), they should grow low-single-digit thereafter until FY28 to post sales/EBIT of ~$115M/~$16M in FY28. That would then amount to consolidated segment EBIT of $32.7M. With most of this growth coming from increased sales per customer, mix shifts, and idiosyncratic acquisition expenses going away, corporate costs should remain more or less flat – back out interest expense, and taxes, and I get FCF of ~$16.3M. 13.5x that is a market cap of ~$220M.
Assuming cash generated in the interim of ~$40M – ~$10M annually – that amounts to an adjusted market cap of $260M, or an IRR of ~18%. That’s of course, very attractive considering that outside of the risk posed by possible Boeing production disruption, this outcome doesn’t really hinge on hard-to-execute items – e.g., royalty payments rolling off, mix normalized on the PI side.
Conclusion
I think AstroNova presents an attractive risk/reward at today’s prices. Essentially, there are internal opportunities for them to grow the earnings power of the business irrespective of end-market conditions. But concurrently, their end-markets should grow over the coming years, anyways, leading to what I think will be robust EBITDA growth.
This opportunity, of course, isn’t without certain risks. Most notably is the fact that Boeing’s issues could indeed proliferate and cause near-term headwinds, given that Boeing is a material amount of their sales. There’s also the probability that they will run into another operational issue similar to the supplier issue today, or that one of those aforementioned PI competitors decides to make a bigger push into their markets.
