Eroad (ASX: ERD) is a telematics company that I own shares in and have covered extensively. Unfortunately, the thesis has gone awry, starting from late last year. In November, I announced my decision to start selling my Eroad stock, and then in January I indicated I would sell even more.
In the former article, I wrote:
…the fact that the company has missed its guidance, then blamed it on the pandemic, in the face of evidence that the slower growth comes from competitive pressure, means that management is on thin ice. If they miss guidance again or make other errors in communicating with shareholders, they could find that investors flee the the stock. This would break down the thesis that they can win more fans over time, by being honest and competent management with high integrity.
Clearly, then, my thesis today sits in tatters. First, we saw the CFO Alex Ball resign in February, though he gave considerable notice; and is scheduled to have his final day on May 13. Before he is even out the door, the CEO and founder, Steven Newman, has announced he too will step down. Apparently, succession planning began in 2020, so this news might not surprise some people.
Newman could have made some sort of comment assuring other shareholders that he remained committed to the business and plans to remain invested, but he did not. Given he and entities associated with him are the largest shareholder, the lack of reassurance may cause jitters. While we don’t know about his intentions, there is clearly a possibility he will sell. We clearly lack understanding of this move, but it’s also possible that Newman continues to support the company and plans to hold on to his shares for years to come.
In any event, my actual thesis is broken, so I am planning on selling at least some (more) of my shareholding.
The question for me becomes; when, and at what price?
Right now as we speak, in the worst obviously possible scenario, Eroad is a low growth business that lacks a coherent strategy and path to profit growth. The share price is bouncing around today, but at the time of writing its market capitalisation is about NZ$425m (at a share price of around AUD$3.40).
In FY 2021 Eroad made an EBIT of NZ$4.4m and had positive free cash flow, so you could argue it is extremely expensive based on current profit before tax. The financial result shareholders are looking for is operating leverage, which essentially requires organic growth. And that’s been hard to come by.
My guess is that given Eroad’s ability to borrow, and ability to breakeven, it will be able to achieve organic growth (though whether the return on investment in sales, marketing and product development pays off, is less clear). However, the sociological side of the argument; that through good performance this aligned founder CEO led management team would grow in esteem, seems to have failed.
CFO resigned, CEO resigned, guidance downgraded, and share price at long term lows.
Now, the other way to look at is that this is just a blip in the longer term growth journey. In New Zealand dollars, Eroad has just about tripled annual revenue from $32.8m in the year to March 2017 to $93.8m in the twelve months to September 2021. In the same period, weighted average shares increased from about 60 million to about 83m at the latter date, dilution of just 38% compared to 185% revenue growth. That looks like genuine value creation to me.
This more optimistic point of view would acknowledge that growth has since flatlined, but argue this may prove to be temporary. And should growth kick off again in earnest, it’s easy enough to imagine Eroad earning 10% EBIT margins on revenue of $160m in just a couple of years, especially since Coretex takes its pro forma revenue to over $140m, and it has already achieved EBIT margins of over 4%, before ever focussing on profit, and even at lower scale.
$16m EBIT might not make the company look cheap immediately, but if it were combined with a narrative of increasing margins, the market might start extrapolating 20% EBIT margins down the track; and I would have thought that possible with this kind of business. Personally, I still think that might well happen, but I can’t ignore that the sociological side of the thesis is in tatters.
Therefore, I will definitely look to keep selling Eroad shares until I can gain confidence in new management. If the share price rebounds from here, I’ll probably sell all my shares. If the price languishes around these levels, I might hold at least some of my shares into the next results, and assess the situation at that point.
According to CapIQ, the average analyst expectation is for $22m in EBIT by FY 2024. I suspect the result will come in below that, but it’s possible, and if achieved the company would arguably be quite cheap today.
And so, all things considered, I’m just going to wait and see if the share price rebounds at all. If it does, I’ll probably sell out completely. If it doesn’t I’ll probably just sell slowly. I do feel quite angry at myself for not realising that the CEO was not going to stick around, though I’m not sure if there is any way I could have known that. There probably was.
Please remember that these are personal reflections about a stock by a diarist. I own shares in Eroad may sell some of them tomorrow or at a later date, or not at all. This article should not form the basis of an investment decision. It is an investment diary valuable only for the cognitive process it demonstrates. We do not provide financial advice, and any commentary is general in nature. Please read our disclaimer.