Vaisala Oyj: Is The Global Leader In Weather Observations Too Expensive?

seekingalpha06-17

Vaisala Oyj has an asset-light business model that supports revenue growth without significant capital investments and is benefiting from global megatrends like renewable energy, AI, and health ...

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Vaisala has a wonderful asset-light business model that allows the company to grow revenue without making large incremental investments. It is also well-positioned to benefit from several global megatrends, including growth in the renewable energy sector (ICLN), artificial intelligence and process optimization, and an increased focus on health and well-being. The company likes to say that \"the weather\" is renewable energy's fuel, and as such, making better predictions improves yield and utilization of these assets. Vaisala can, therefore, contribute to solving climate change and pave the path forward for the energy transition and decarbonization of the economy. Its data and forecasts have other high-tech applications, including autonomous driving, where accurate weather information is critical for the proper functioning of these vehicles. The company has some cyclicality, as it is exposed to the capital expenditure cycle, but if we zoom out over the past decade, it has significantly outperformed major European stocks, as we can see when we compare its performance to the SPDR EURO STOXX 50 ETF (FEZ). Data by YCharts Company Overview Vaisala is in the business of helping customers make critical decisions based on the environment and the weather. Some of its end-markets include the electricity generation and transmission sector, the aviation and transportation sector, and the logistics sector. The company has a nice geographic revenue diversification, with a 2023 geographical net sales split of 37% in the Americas, 30% in the APAC region, and 33% in the EMEA region. Some of its legacy use cases include using weather data and forecasts to optimize de-icing on airplanes, and helping secure and protect the electricity grid. More recent examples include using wind forecast to help reduce the environmental impact of shipping. This last example is the result of work with customer Norsepower, which optimizes wind-assisted propulsion with accurate wind data to reduce fuel consumption by roughly 5% to 25%. Vaisala Investor Presentation Competitive Moat Despite the company being a technology and product leader in the environment and weather forecasting industry, we see limited evidence of a strong competitive moat. Its operating margins are decent, but not particularly impressive, and in many cases customers can switch to a competitor without major issues. It is only in some of the more advanced products and services that the company appears to have a stronger competitive position. On average, we would say the company has a narrow competitive moat. Vaisala has shared that it maintains a high R&D investment budget as a strategic choice to remain the technology leader in its industry, and they also want to be a one-stop shop for weather customers. So far, research and development investments appear to have helped the company remain an industry leader, but have not resulted in anything close to impressive revenue or profit growth. Financials Despite some cyclicality, the company has been able to increase revenue in the mid-single digits on average, and earnings per share in the high-single digits. For example, in 2023 it delivered earnings per share of €1.35, an almost 9% increase when compared to 2022, while net sales were up a more modest 5%. Vaisala Investor Presentation As the company has been able to grow earnings without having to make significant capital investments, its return on equity (ROE) has improved. Currently around 18%, its ROE is significantly above that of the average company and reflects the benefits of the asset-light and highly scalable business model. Data by YCharts The most recent quarters show growth stalling, which is not that surprising considering the effect that higher interest rates are having on capital expenditures around the world. The decline in net sales in the first quarter of fiscal year 2024 had a very significant impact on profitability, but this cyclicality in sales and profits has been common throughout the company's history. Vaisala Investor Presentation As can be seen in the graph below, while quarterly growth rates have been very volatile, in the end they have historically averaged around 5%, and the company usually comes out of each cycle with higher revenue and profits. We are a bit disappointed with its net profit margin, which can be considered quite decent in the high-single digits, but it is far from those delivered by companies with strong competitive moats and significant pricing power. The company has a very strong balance sheet with a net cash balance, given that it holds cash and cash equivalents of €105.0 million, while its interest-bearing liabilities are only €61.4 million. Data by YCharts Growth Opportunities Perhaps the largest growth opportunity for the company is found in the renewable energy sector. Vaisala likes to say that \"weather is the fuel of renewables\", which is not wrong, and highlights the importance of accurate weather forecasts for the industry. They can have an impact at different stages, from selecting the optimal place for a solar plant or wind farm, to helping plan and manage their construction, to optimizing their energy yield. In some cases, this means detecting wind conditions minutes before the wind currents arrive, giving time for operators to orient the wind turbines' blade pitch to increase yield. Vaisala Investor Presentation One offering from Vaisala that we find particularly promising is its subscription-based Vaisala Xweather data and software platform. Customers can subscribe to data sets and mapping APIs for lightning, maritime, renewable energy, road weather, and air quality. This is a great initiative to drive recurring revenue and offer data and solutions as-a-service. Unfortunately, the company has not shared much detail about this new segment, even though it shared a dedicated presentation in 2022. In it the company said that this platform grew by double-digits in 2022, had a +98% net revenue retention (NRR) rate, and that more than 95% of its revenue was recurring. Vaisala also shared that the platform already had more than 1,500 paying customers. In the 2023 report we could not find much information about how this business is doing other than a brief mention saying that it continues to deliver strong growth without specifying the growth rate or absolute revenue numbers. Another detail they shared is that they have added a self-serve option in the platform to expand its potential market to smaller customers. Vaisala Investor Presentation Dividends Given the benefits of its asset-light business model, the company is able to return most of its profits to shareholders in the form of dividends. Over the past five years, the average payout ratio has been roughly 65% of its earnings, and the company has grown the dividend at a similar pace as its earnings has grown. Still, given the high valuation at which shares currently trade, the dividend yield is only about 2%. Vaisala Investor Presentation Outlook In the short term, results are likely to remain weak, with the company recently guiding for full-year 2024 net sales to be in the range of €530 million to €570 million. Compared to 2023, that implies growth in the range of -2% to roughly 6%. For its operating result (EBIT) the company expects results to be in the range of €63 million to €78 million, which implies earnings growth ranging from roughly -5% to +17%. Given current conditions, we think results will likely come closer to the lower end of the ranges shared by the company. Companies have been reducing their capital expenditures as a result of the higher financing costs brought by the interest rates increases. Still, there are expectations that capital expenditure spending will tick up in the coming six months. Looking further ahead, we think the company can probably continue to deliver mid-single digit revenue growth, a high-single digit profit growth, over the cycle. In particular thanks to growth coming from the renewable energy end-market, and new applications like autonomous driving for which the data and forecasts Vaisala provides are critical. Data by YCharts Valuation With a Price/Earnings ratio above 30x, and relatively modest growth, shares do not look particularly attractive to us at the moment. Still, when compared to company's making advanced measurement or testing equipment, Vaisala actually looks like a bargain. This is true if we compared the Price/Earnings ratios or the Price/Sales ratios. Data by YCharts For example, KLA Corp (KLAC), which dominates the semiconductor metrology and inspection equipment industry, is trading at a Price/Sales multiple of more than 4x that of Vaisala. Still, we think this is more a result of several of these companies likely being overvalued, more than Vaisala being attractively priced. We also think that a company like KLA has a stronger competitive moat than Vaisala does, but it can be argued that both companies are leaders in their industries, even if Vaisala is a much smaller company operating in a niche industry. Data by YCharts Since we like to invest in stocks for at least a 10% return, we took our future earnings estimates and calculated their net present value. The result is about €30, which is considerably lower than the €40 at which shares are currently trading. We think the company deserves a place on our watch list, while we wait for them to trade closer to our fair value estimate.     EPS Discounted @ 10%   FY 24E €1.48 €1.35   FY 25E €1.62 €1.34   FY 26E €1.78 €1.34   FY 27E €1.96 €1.34   FY 28E €2.14 €1.33   FY 29E €2.35 €1.33   FY 30E €2.58 €1.32   FY 31E €2.83 €1.32   FY 32E €3.11 €1.32   FY 33E €3.41 €1.31   FY 34E €3.74 €1.31           Terminal Value @ 3% terminal growth €48.67 €15.51           NPV   €30.12   Click to enlarge Risks The biggest risk we see is that competitors from countries with low production costs might try to reverse engineer or copy their instruments and equipment, and sell them at a lower price. The risk is mitigated by the intellectual property that protects these products, including patents and trade secrets. The risk is also mitigated by the company's reputation and track record, and we think a large part of their customers would not risk purchasing a product that might be of inferior quality even if offered at a lower price, given the high impact that incorrect data can have on their decisions and operations. The company's sales are also very sensitive to economic conditions, which results in some cyclicality in its sales and profits. This is mitigated by relatively healthy profit margins, and a strong balance sheet with a net cash position. Conclusion Vaisala is an interesting company that is not receiving much investor attention, yet it is a business with many attractive qualities. It is benefiting from several megatrends, including the growth in the renewable energy sector, and its asset-light business model allows it to grow without having to invest significant incremental capital. As a result, it is able to grow while distributing most of its earnings to shareholders. Despite all these positive attributes, we cannot justify the current share price, but we will keep the company on the watch list in case shares trade closer to our fair value estimate.  Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. 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