Resolving Tolling Challenges And Advancing European Software Will Transform Operations

Key Takeaways

• Strategic focus on resolving legacy issues and software development aims to enhance margins and drive revenue growth through proprietary offerings.
  
• Expansion into the European market and AI-driven innovations are positioned to boost market reach and technological differentiation, supporting future revenue success.
  
• Financial volatility and revenue unpredictability, driven by tolling project reserves and quarterly fluctuations, could challenge Quarterhill's cash flow and earnings stability.

Catalysts

Operates in the intelligent transportation systems business in Canada and internationally.

• Quarterhill is focusing on resolving legacy tolling contract issues, which should lead to improved adjusted EBITDA margins once resolved, impacting overall earnings positively.
  
• The company's expanded focus on software development in the Tolling and Enforcement business is expected to drive higher margins by creating more defensible proprietary offerings, potentially impacting net margins and revenue.
  
• Efforts to penetrate the European tolling market, bolstered by the strategic acquisition of Red Fox, are anticipated to expand market reach and drive future revenue growth.
  
• New contract wins, such as the $40 million ACTC Alameda contract expansion with options to extend it for an additional $15 million, signal strong revenue potential and backlog growth.
  
• The emphasis on AI-driven innovations, including the AI vehicle classification system for traffic monitoring, is poised to enhance technological differentiation and future revenue streams, while also potentially improving net margins.

Quarterhill Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Quarterhill's revenue will grow by 7.2% annually over the next 3 years.
• Analysts are not forecasting that Quarterhill will become profitable in next 3 years. To represent the Analyst Price Target as a Future PE Valuation we will estimate Quarterhill's profit margin will increase from -7.2% to the average US Communications industry of 7.4% in 3 years.
• If Quarterhill's profit margin were to converge on the industry average, you could expect earnings to reach $14.0 million (and earnings per share of $0.12) by about April 2028, up from $-11.0 million today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 15.6x on those 2028 earnings, up from -10.2x today. This future PE is lower than the current PE for the US Communications industry at 22.1x.
• Analysts expect the number of shares outstanding to grow by 0.48% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 7.59%, as per the Simply Wall St company report.

Quarterhill Future Earnings Per Share Growth

Risks

• Reserves taken for certain tolling projects in Q3 2024 negatively impacted gross margins, indicating potential ongoing financial volatility that may affect net margins.
  
• The company is still negotiating resolutions for inherited tolling contracts with challenging implementations and economics, which may affect cash flow and create future liabilities.
  
• Seasonal fluctuations in cash flow, particularly in seasonally slower quarters like Q1, could impact cash from operations and earnings reliability throughout the year.
  
• Despite a positive cash position and backlog increase, the company's revenue is subject to quarterly fluctuations due to the timing of revenue received from ongoing projects, which introduces unpredictability into revenue expectations.
  
• The integration and optimization efforts, including the sale of non-core assets and focus on new markets, could introduce execution risks that impact revenue growth and net margins if not effectively managed.

Valuation

• The analysts have a consensus price target of CA$2.083 for Quarterhill based on their expectations of its future earnings growth, profit margins and other risk factors.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be $189.1 million, earnings will come to $14.0 million, and it would be trading on a PE ratio of 15.6x, assuming you use a discount rate of 7.6%.
• Given the current share price of CA$1.34, the analyst price target of CA$2.08 is 35.7% higher.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.