Verra Mobility: Valuation Got Cheaper And Fundamentals Remain Sound (Rating Upgrade)

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Verra Mobility delivered solid 3Q24 results, driven by strong growth in its core segments, Commercial Services and Government Solutions.The company's growth prospects remain strong, supported by the ...

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(NASDAQ:VRRM) previously (July 2024) with a hold rating as the valuation was expensive, albeit I thought the business model was very attractive. I upgraded my rating from hold to buy as valuation has become cheaper today. The fundamentals remain solid, in my view, wherein the largest segments of VRRM (CS and GS) should continue to perform in the near term. 3Q24 earnings (announced on 31st October) In the 3Q24 quarter, total revenue saw $225.6 million, with $217.3 million from service revenue and the rest from product revenue. By end market type, commercial services [CS] revenue saw $109.1 million; government solutions [GS] saw $90.3 million, and parking solutions saw $21.5 million. This represented a total revenue y/y growth of 7.5%. Gross margin came slightly below expectations at 95.12% vs. 95.33%, which led to the minor miss in EBITDA expectations ($104.69 million vs. $106.5 million). By end market, CS and GS segments continue to be the main profit drivers, as CS contributed $72.87 million in EBITDA and GS contributed $28.09 million. CS revenue growth outlook remains steady The growth outlook remains attractive as the underlying demand for domestic travel is still strong. While management guidance for the CS segment is to grow FY25 revenue at the low end of the 6-8% range, I believe this should serve as a baseline to think of FY25 growth and beyond. For what it’s worth, I think management is guiding safely for FY25, as the Transportation Security Administration [TSA] did estimate that FY25 passenger volume growth to be 4.5%, which represents a moderation back to normalized level (the average of pre-covid period 2014-2019). The reason I remain optimistic is because I expect travel growth to be stronger than expected, as inferred from the comments from several domestic airlines that demand remains sound. Translating this to revenue growth for the segment, if travel demand comes in stronger than expected (i.e., on the back of recovering consumer spending confidence, which is still low today), VRRM could report stronger-than-expected growth.  As we prepare for 2025, we are focused on producing capacity that is in-line with our expectation of demand growth. While capacity planning for the year ahead is ongoing, we currently expect our 2025 capacity to grow low-single-digits year-over-year. First off, as we take a look at the fourth quarter, I do see strong demand overall. But it's a quarter in which a strong October, and I think a strong December, it has some noise in it in terms of expected softness in demand around the election around Halloween. American Airlines Group 3Q24 earnings Corporate demand acceleration was nice to see in September across all regions and is expected to continue into Q4. Contracted corporate revenues were up 13% in September at 95% of 2019 revenues, which is 13 points higher than July and August. United is centered in the largest business markets as corporate demand expands, we expect a material tailwind. United Airlines 3Q24 earnings Looking forward, demand for travel on Delta remains healthy, with continued preference for our premium offerings. Our recent corporate survey indicates a positive outlook for business demand, with 85% of respondents indicating they expect their travel spend to grow in 2025. Delta Air Lines 3Q24 earnings  Outside the US, VRRM is also gaining momentum in Europe (a key growth driver for the segment). Just a few weeks ago, VRRM announced they had managed to clinch the major deal with two major global rental car companies to offer its services in Italy. This lends credence that VRRM can actually continue to win contracts (note they have previously won contracts in Ireland and Spain).   VRRM Outlook for GS segment remains healthy too There were no signs of growth slowdown in the GS segment as VRRM continues to expand programs with existing clients and win new deals, wherein new contracts drove around $22 million of incremental ARR (annual recurring revenue) (including a large deal with Hayden AI that was worth $8 million in ARR). Looking ahead, I think the most important growth driver to note is further expansion in California. For reference, the current 6-city pilot phase is worth ~$125 million, and management estimate is for this TAM to double if more cities are to be included. If that happens, which I believe it will because of the value proposition that speed cameras can reduce traffic accidents (related to speeding), VRRM will be well positioned to win more deals given its history with working with the US government. The fact that VRRM won the contract in San Francisco (California’s first automated speed safety program) is a testament that VRRM is a very strong candidate. There is also another visible growth catalyst that should materialize in 2025—the RFP results in New York City, which is expected to come to a conclusion in 2025 (per the earnings transcript). Management currently guides for flat y/y revenue growth for New York City (as they await the outcome), which means any renewal of contract (supposedly with new pricing terms) would mean upside to guidance. Moreover, the NY Governor had also recently signed legislation to increase its red-light program to 450 intersections, which, if VRRM gets to renew the contract, should mean that VRRM gets to implement this red-light program (a new source of revenue). We're also excited that New York's Red Light expansion Bill was signed into law earlier last week, allowing for the expansion of cameras at 450 additional intersections in the city of New York. Company 3Q24 earnings   Bloomberg Valuation   May Investing Ideas Management largely reiterated their FY24 guidance, and I did not make any changes to my FY24 estimates. However, to be conservative, I did revise my FY25 growth estimates down to 6% to reflect management’s guidance for the CS segment (albeit I see upside to it, depending on how strong domestic travel is). My view of earnings margins has not changed as well; in that, I still expect margins to gradually recover to pre-covid levels over time. The key update to my model is that I have included the value of the FCF generated in FY25/26 into my target share price calculation. I have previously overlooked the cash generation ability of VRRM. Using consensus FCF estimates and my assumption that VRRM will keep this cash on the balance sheet (since leverage is going to stay at 2x and VRRM is already near this target level, which means no major cash outflow to pay down debt), this should result in another $2.75 of value. Although there are catalysts that may drive upside to growth, assuming that VRRM trades at its historical average of 18x forward PE, I see an upside of 22%.   VRRM Risk Domestic travel may be much poorer than I believed if the consumer spending environment sees more headwind from the macro environment. The growth catalysts mentioned above are largely independent of how well VRRM can execute, given that the government is the one making the decisions. There is no guarantee that the government will act according to my or management’s timeline, which may result in growth being pushed back. Conclusion  I give a buy rating for VRRM as I am positive on both the CS segment (due to the domestic travel demand strength) and the GS segment (VRRM continues to win/renew contracts). In particular for the GS segment, VRRM won a key contract in San Francisco, which bodes well for it to win other contracts. Notably, VRRM valuation has also become slightly more attractive, and if I include the value of the expected FCF in FY25/26, the upside is quite attractive.","kind":null,"is_publish_news":true,"is_publish_highlight":false,"is_publish_live":false,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"0","news_tag":"analysis","news_rank":0,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.29.1","shortVersion":"4.29.1","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2480260578"}