Audinate Scaling Up Despite Headwinds

This story features AUDINATE GROUP LIMITED. For more info SHARE ANALYSIS: AD8

Despite the headwinds, brokers anticipate digital audio provider Audinate will continue to scale up earnings and ensure longer-term profitability.

-Second half outlook infers sales growth below historical ranges
-Lack of information regarding the impact on the supply chain of OEMs
-Potential for increased digital audio adoption and large Audinate share

By Eva Brocklehurst

The tentacles of coronavirus continue to spread, with audio technology provider Audinate Group ((AD8)) opting for a cautious outlook and citing a potential impact. Still, further growth in revenue is expected, albeit below the historical rate.

Structural tailwinds should ensure above-trend revenue growth and higher margins but, for the short term, a weakening Chinese economy and reduced AVIO adapter sales, following previous upfront channel purchases, are the main headwinds.

Shaw and Partners, not one of the seven stockbrokers monitored daily on the FNArena database, considers the slump in the share price overdone, despite the second half outlook inferring sales growth below the historical ranges.

Shaw assesses the business is driven by volume, not margin, and the main issue is reducing marginal costs. The business is now profitable on all metrics and the scaling up of earnings is likely to ensure longer-term profitability. The broker describes the gross margin of 77% as a "ripper".

Canaccord Genuity, not one of the seven, expects gross margin expansion will continue. Gross profit margins benefited from an increased shift to software sales in the first half.

Cost Investment

Still, rising costs will likely exceed revenue growth in the short term as the company doubles the size of its engineering/R&D personnel. Audinate has indicated it will continue to invest in the medium-term despite the headwinds.

Yet, there is also a lack of information as to the impact on the supply chain of OEM (original equipment manufacturer) partners from coronavirus, and the broader industry slowdown stemming from reduced economic growth.

Credit Suisse points out Sony indicated earlier this month that the impact of coronavirus could be large enough to eliminate the entire amount of its upward revision to sales guidance for FY20.

Audinate has no indication yet of the impact on demand outside of China, noting inventory stockpiles and shipments transported from Hong Kong have enabled orders to still be met. This is partially because of the timing of the Chinese New Year, when factory shutdowns are typical. Morgan Stanley observes growth for Audinate ex Asia still appears robust albeit supported by FX tailwinds.

Dante AV

Canaccord Genuity notes the quantum of Dante-enabled products has increased, with 179 OEMs yet to ship their first product. The industry is increasingly accepting that Dante AV will become the challenger to the incumbent solution, HDBaseT, following a positive experience.

UBS believes it is important the product mix is taken into account. Software grew materially compared with Modules in the first half and Dante-enabled devices and live OEMs were much stronger than expected. The bringing of Yamaha and Bolin on board for Dante AV are also positive developments, in the broker's view.

Canaccord Genuity accepts limited revenue benefits are likely in 2020-21 but positive operating leverage should ensue with from FY22, retaining a Buy rating and $7.20 target.

Credit Suisse acknowledges the share price outlook is attractive but retains a Neutral rating and awaits further visibility on the macro background. The broker would become more confident if is sure that the revenue slowdown can indeed be fully accounted for by the external environment.

The stock remains a key pick for Shaw and Partners, which has a Buy rating and $8.50 target. The broker points out the company has a record of surpassing expectations and there is no reason why this should not continue, especially given Dante Domain Manager and video are yet to meaningfully contribute to the future earnings trajectory.

Moreover, digital audio market adoption has only penetrated at a low 7-8% and there is potential to reach a 30-40% share in a few years. Digital Dante is no longer just for commercial integrators and OEMs but is increasingly used by manufacturers of residential audio equipment.

Shaw believes Audinate should be included in the "A-team" of impressive Australian technology companies, given a significant addressable market and its position as a global standard in digital audio networking.

FNArena's database has two Buy ratings and one Hold (Credit Suisse). The consensus target is $8.57, suggesting 29.2% upside to the last share price.

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