Ituran Location: Recurrent Revenue And Recent Acceleration Of Subscribers (ITRN)

Ituran Location and Control Ltd. (NASDAQ:ITRN) recently noted the highest subscription growth in the history of the business. It also notes recurrent subscription fees. In my view, if the acquisition of Road Track Holding is successful, and optimism expressed in quarterly reports continue, ITRN’s stock price could trend north. Even taking account of the risks from goodwill impairments or third-party patents, in my opinion, the company is undervalued.

Ituran

When we think about the social logic of the future and the business possibilities that both technology and digitization will offer in various areas of industries, the connectivity of devices and vehicles is taking more and more forms, and is appearing in all kinds of activities. In this sense and with less than 30 years since its foundation in 1995, we find Ituran as a company that currently has international operations in Canada, the United States, Brazil, Argentina, and other Latin American countries.

It began as a company dedicated to the manufacture of telecommunications devices as well as defense systems, established in Israel, mainly oriented to take technologies from the military services and develop them to adapt them and provide them to all citizens. Its functions and strategic orientations were changing, to the point that in 2016 it stopped participating in the Tel Aviv Stock Exchange, and began to list only on Nasdaq. The breaking and expansion point for Ituran was the purchase of Road Track Holding, a telematics company with a position in Latin America.

We paid the shareholders of Road Track Holding S.L $91.7 million for 81.3% of the company valuing the company at approximately $113 million. Of this, $75.7 million was paid in cash, through a debt facility provided by Ituran’s lending bank. Source: 20-F

Its current business is focused on telematics services, mainly at the location of stolen cars, and vehicle fleet management services, through technologies that were initially developed for the location of pilots of the Israeli military. Its model is based on the circulation of the graph that we see below, with an estimated customer plant of two million and growing year after year.

To access the services, customers first pay a single subscription fee, and through their experience, they are offered improvements and benefits that complete the entire service, which generates a subscription later.

Statistics show that since 2004 Ituran has been adding subscribers year after year, and this number is always higher than the previous year. We can see that some of its subscriptions come through direct contact with its clients and others with “aftermarket” subscriptions which are given through third parties. In the case of the car location service, the largest number of clients are insurers of different types, and in the case of the management of transport fleets, the clients are from different industries ranging from supermarkets to telephone companies or manufacturers of cars.

To the services of a single subscription that are the locator and the management system, other services are added, such as the installation of smart devices in vehicles, which serve to optimize and increase connectivity between them. In my view, the name of Ituran, due to the solidity of its knowledge and its research base coming from Israel as well as the annual success and growth of its business model, has gained international recognition, which is demonstrated in some of its contracting brands.

Balance Sheet

As of September 30, 2022, Ituran reported cash worth $30 million, accounts receivable of $44.552 million, and other current assets of $45.883 million. In addition to inventories worth $32.494 million, total current assets stand at $153 million, so the ratio of inventories/current assets stands at more than 1.2x. I believe that Ituran reports a decent amount of liquidity.

Non-current assets included deferred income tax of $10.746 million, funds in respect of employee rights of $14.728 million, and property and equipment worth $40.809 million. Besides, with operating lease rights of use assets of $9.629 million, intangible assets of $13.491 million, and goodwill worth $39.485 million, total assets stand at $288.335 million, close to 2x the total amount of liabilities.

The list of liabilities included credit from banking institutions of $15.974 million, accounts payable of $22.749 million, deferred revenue of around $20.832 million, and other current liabilities of $37.086 million. Total current liabilities stand at only $96.641 million.

Regarding the non-current liabilities, I would highlight a long term loan of $21.153 million, deferred revenues of $12.692 million, operating lease liabilities of $6.773 million, and total non-current liabilities of $44.432 million.

Ituran Reports Positive Free Cash Flow

Estimates include 2023 net sales of $311 million, with an EBITDA of $88.5 million, operating profit of $66.8 million, and an operating margin of 21.40%. 2023 Pretax profit would stand at $63.9 million. I believe that Ituran is a good read because the net income is expected to grow from $16 million in 2020 to around $45.9 million in 2023.

I couldn’t find forecasts about Ituran’s future free cash flow, so I carefully studied the previous cash flows to understand what we could see in the future.

The results for the nine months ended September 30, 2022 include a net income of $29.408 million in addition to depreciation and amortization of $14.871 million, a decrease in receivable accounts of $4 million, a decrease in other current assets of $10 million, and an increase in inventories of $8.810 million. Finally, the net cash provided by operating activities stood at $29.204 million, which, with capital expenditures of $18.758 million, would imply FCF close to $10 million. I wanted to include the cash flow statement because my FCF numbers from 2023 to 2030 are aligned with recent figures delivered by Ituran.

My FCF Expectations

Ituran offers rental of its services, specifically in Mexico and Brazil, locating second-hand car financing companies, and companies in turn lease fleets for transportation. Besides, in Brazil, where Ituran owns 50% of the operator’s shares, the company offers the telematic connectivity service for cars, locating transport fleets and business cars. Under this scenario, I assumed that the difficulty of buying new cars and growth in the sharing economy will likely represent growth drivers for Ituran. The company disclosed some of these catalysts in a recent presentation.

Considering recent commentaries delivered in the recent quarterly report, Ituran after-market subscribers appear to grow at a faster rate than ever. In my view, if management continues to deliver better expectations in 2023, the demand for the stock will likely trend north.

In only three quarters of 2022, we added 140,000 new subscribers, putting us well ahead of our annual target of between 140,000 and 160,000. As we move into 2023, it is clear that we are growing our after-market subscribers at a faster rate than we have historically. Based on the recent run-rate, we are happy to increase our expectations for the growth rate of our global after-market subscriber base ahead, now expecting 180,000 to 200,000, net new subscribers-adds annually. Source: Quarterly Release

Besides, I believe that the ongoing stock buyback program will most likely enhance the demand for the stock. As a result, Ituran could experience less cost of equity, which would lead to a higher fair price.

Under the current buy-back program, 79,816 shares amounting to $2.0 million was purchased in the third quarter of 2022 and approximately $6 million remains under the current program. Source: Quarterly Release

My forecasts include 2030 net sales of $455.4 million together with a sales growth of 5.60%, EBITDA of $130 million, and an EBITDA margin close to 28.53%. 2030 FCF would be $20 million with 2030 FCF/sales of 4.38%.

If we include a WACC of 9.7% and an exit multiple of EV/EBITDA 9.1x, the terminal value would be $1.182 billion, and the NPV would be of $564 million. The resulting enterprise value would stand at $650 million. Besides, if we include cash of $30 million and a debt close to $36 million, the equity valuation would be $644 million, and the fair price would be around $31.79 per share with an internal rate of return of 4.28%.

In My View, Competitors Don’t Seem To Represent A Large Risk

For each regional market, the list of competitors changes, since there is no company positioned internationally in this sense. In Israel, we can name Pointer and Skylock. In the United States, which is the most competitive regional market, LoJack, Onpoint, and Sarekon GPS stand out, while in Latin America, some names that have achieved positioning on the continent include Prosegur and Lojack. Ituran has an advantage in terms of the development, speed, and efficiency of its technology, which generates a more expensive service than that of some of its competitors.

Ituran Could Suffer Due To Lack Of New Technological Developments, And Goodwill Impairments

In my view, Ituran is still integrating the Road Track business model into its operating segments, not yet achieving operational comfort at the commercial level in Latin America, although it does maintain the previous operations of the acquired company. This, together with the factor that new technological developments could displace and render Ituran’s product obsolete, represents risk at the operational level.

Considering the total amount of accumulated goodwill and the acquisition of Road Track, I believe that goodwill impairments could occur. Let’s keep in mind that in the past, Ituran did report declines in goodwill, which, in my view, could lead to reductions in book value per share and stock price declines.

During 2021 no intangible assets impairment loss was recorded. During 2020 the company recorded an intangible assets impairment loss in the amount of approximately US$ 3.7 million, respectively. The impairment was recorded in the consolidated statement of income under Impairment of intangible assets and other expenses. Source: 20-F

On the other hand, Ituran does not own 100% of the intellectual property of its products, since many of these are supported by third-party patents. A breach of one of these agreements could be a difficult position for the company. In the worst case scenario, Ituran’s FCF margins would decline.

In relation to its clients, in the last year, a single client represented 10% of Ituran’s annual income, which is a risk in its diversification. In my view, if clients decide to leave the company, the decline in net sales could bring significant price volatility.

Under the previous conditions, I expect net sales close to $322 million accompanied by net sales growth of 0.50%, EBITDA of $92 million, and an EBITDA margin of 28.53%. FCF would be $14 million with FCF/sales of 4.38%.

If we assume a WACC of 9.7%, the NPV of future FCF would be $67 million. Besides, if we use an EV/EBITDA close to 6.9x, the terminal value would be $637 million with a NPV of $304 million. Finally, I obtained an enterprise value of $370 million, equity of $364 million, a fair price of around $17.98 per share, and an internal rate of return of -3.39%.

My Takeaway

Ituran delivers both recurring subscription fees and significant subscriber growth. Besides, management proved recently that Ituran intends to also grow inorganically, which, in my view, multiplies the business possibilities for the company. Finally, considering the recent optimism delivered in recent quarterly reports, I would be expecting a lot from Ituran. Even considering risks from lack of new technological developments, goodwill impairments, or third-party patents, in my opinion, the company appears undervalued.