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The latest update from Frontier Smart Technologies, out this morning, implies a worsening balance of risk reward for the shares. With Science Group ruling out a statutory merger, and material uncertainty arising over the Q4 order book, the group’s cash position and covenants, we reiterate our sell recommendation.
Frontier Smart Technologies Group
Frontier Smart has released a trading update and revised full year outlook. While the group’s long term strategic plan remains in place, near term competitive pressures in Digital Radio, combined with delays in the ramp-up of the new Smart IoT Licencing business, is now likely to impact full year revenue and profitability. As a result, the group now expects to be loss making in the current financial year. The Board is confident however that the combination of actions already taken to improve Digital Radio market share, new product launches, and positive indications on Smart IoT Licencing will result in a return to EBITDA profitability in H2’19 and for FY’20 as a whole. Today’s update is clearly disappointing but we remain confident in the group’s well invested, market leading IP and see multiple routes to leveraging this IP to deliver on management’s medium term objectives.
Frontier Smart has released its FY’18 results showing group revenues down 21% versus a strong comparative. FY’18 contains two contrasting halves: H1 sales were adversely impacted by Norwegian DSO overstocking issues, whilst H2 saw strong recovery. The group delivered FY’18 trading EBITDA of $0.8m, having posted a $2.1m EBITDA loss in H1. Outlook looks more positive, with modest growth expected in DAB (regulatory-driven) and Smart IoT (licencing and non-audio). Valuation remains attractive at 0.4x FY’19 EV/sales, with our SOTP implying an intrinsic value range of 73p – 103p.
FY18 results offer no surprises for FST, following their pre-close trading update in January which gave guidance on revenues, EBITDA, and net debt and to which we realigned forecasts. The Group edged ahead on revenue with $41.8m for the year against our forecast of $41.3m. EBITDA of $0.8m was in line, with net debt of $2.5m slightly under our revised $2.1m, yet ahead of our original forecast of $3.0m for the year. Notably, the trading outlook confirms early successes in non-Audio IoT and progress in licensing; suggesting a cautious, yet positive view to 2019. On FY19E forecasts of $42.5m we retain our PT of 62p to put the shares on an un-ambitious 0.8x EV/Sales. Buy.
We release FY19E forecasts for FST and align FY18E numbers with guidance issued in their trading update last month. Whilst we downgrade our FY18E revenue from $46.6m to $41.3m, EBITDA was broadly in-line, and Net Debt beat with $2.1m vs expected $3.0m. Looking ahead, we highlight early enjoyment of licensing revenues (NRE at this stage) in FY19E and expect maiden revenues from the Company’s exploration of non-voice IoT applications. Continued price weakness since summer 2018 is in our view unwarranted, with the shares currently trading on just 0.4x FY19E revenues. We believe this materially undervalues a company with exposure to a healthy midterm pipeline of opportunity and re-iterate our PT of 62p. Buy.
Frontier Smart Technologies has announced its selection by KOHLER, a global leader in kitchen and bathroom products, to help launch its new Verdera Voice Smart Mirror with integrated Google Assistant. Whilst not expected to deliver material unit quantum as a niche, high-end product, the announcement represents a potentially significant milestone in successfully broadening Frontier’s revenue base into non-audio IoT. Frontier Smart trades on <0.4x FY’19 EV/Sales, which materially undervalues the strong core DAB business and Smart IP in our view. With the product launching in Q4 19, this announcement has limited impact on our forecasts and we leave our FY’19E numbers unchanged.
Frontier Smart’s trading update shows delivery of the expected H2 recovery following a challenging first half. FY18E revenues are in-line (‘not less than $41.0m’ versus N+1: $41.6m) despite overstocking of digital radios post-FM shutdown in Norway impacting H1. Full-year trading EBITDA expectations are also in-line at $0.8m, with H2 showing strong improvement (H2: +$2.9m; H1: Loss of -$2.1m) resulting from implemented R&D cost control and H2 sales recovery. FY19 guidance targets further improvements in EBITDA, driven by Smart Audio and non-audio IoT licenses, and normalisation of DAB revenues following the Norway DSO. We re-introduce FY19 numbers, forecasting group revenue growth of +5% y/y and EBITDA margins of 3% (+100bps y/y); yet we see scope for upgrades to forecasts should traction with IOT partners continue and cost reduction programmes implemented in 2018 exceed expectations.
Frontier Smart’s interims reflect the tough trading conditions outlined at the July trading update. As previously reported, the group’s Digital Radio business suffered from a period of short term de-stocking in the first half. Additionally Smart Audio growth has been impacted by promotion of 1st party products, pushing out the expected demand increase for 3rd-party products. Order levels in Digital Radio have begun to recover however, and management expects a substantially stronger performance in H2, underpinning our FY’18 EBITDA forecast. With the group keeping a tight lid on costs, and the medium term outlook offering cause for optimism, we believe the current share price fails to reflect the underlying value of the business.
Frontier’s interims are in line with expectation, as set by earlier trading updates in May and July. H1’18 sales were down 32% to $17m due to Norwegian retailer overstocking in Q4’18, albeit we highlight the post-period trading update confirms recovery in both revenues and working capital. We maintain our forecast recovery to $46.6m sales in FY18E; on a current multiple of 0.5x EV/Sales FY1 we see significant upside in the valuation and maintain our PT of 62p (29% upside). Buy.
Frontier Smart has indicated that challenging trading conditions in Q2’18 have led to reduced expectations for FY’18. The group’s Digital Radio business is suffering from a period of short term de-stocking after weaker than expected retail sales in Norway in Q4’17. Additionally Smart Audio growth has been impacted by promotion of 1st party products, pushing out the expected demand increase for 3rd-party products. The combined effect is a 27% reduction in FY’18 revenue, resulting in EBITDA moving to £0.7m (from £2.0m). Today’s update is clearly disappointing, however we continue to believe Frontier has built a valuable position in two attractive markets, with Digital Radio providing a solid cash generation engine and backstop for valuation.
Frontier Smart’s FY’17 results show a strong year of growth with excellent cash generation, as flagged in January. Group revenue grew 28% to £41.0m while adj. EBITDA grew 171% to £1.9m (N+1Se: £1.8m). Both divisions performed well, with Digital Radio boosted by the FM switch-off in Norway and Smart Audio recording its first material revenues in the year. Strong free cash flow of £4.2m resulted in net cash at the year end of £3.0m (N+1Se: £1.7m). We make no material changes to our forecasts and continue to expect the group to benefit from rapid growth in the 3rd party Smart Audio market. Our intrinsic value range of 191p – 242p offers plenty of upside, with potential for further value creation as the Smart Home market establishes itself.
Frontier Smart’s FY’17 trading update confirms another strong year of execution, with revenue and EBITDA expected to be in-line with expectations and net cash stronger than forecast at £2.9m (N+1Se: £1.7m). The core Digital Radio business has enjoyed a strong year, boosted by the FM switch-off in Norway, and continues to generate positive cash flows. Initial sales of Smart Audio units have been achieved in the year and we believe the group is very well placed to secure a crucial place in the highly attractive emerging Smart Audio ecosystem. Execution remains key however we believe the shares remain attractive, despite the recent strong performance, with significant medium term value being created.
Frontier has announced that its Smart Audio platform has been chosen by HARMAN to power its new JBL Control Xstream wireless speakers. Frontier and HARMAN have collaborated on Digital Audio products since 2013 and this design win, with the world’s leading provider of wireless home audio devices, follows on from the group’s previous win to power the JBL Playlist speaker. We believe this continued collaboration is strong validation of the quality of Frontier’s solutions, supporting our view that the group is well placed to secure a significant slice of the attractive Smart Audio market. With the Digital Radio business delivering c.£10m+ EBITDA p.a. and the Smart Audio division expected to hit EBITDA break-even within our forecast period, we continue to believe Frontier is a compelling investment proposition.
Frontier has established itself as a world leading supplier of technology solutions to the audio market. It has built an 80% market share in the attractive Digital Radio market and is successfully leveraging that position to gain access to new growth markets. With the Digital Radio business delivering c.£10m+ EBITDA p.a. and the Smart Audio division expected to hit EBITDA break-even within our forecast period, we believe Frontier is a compelling investment proposition, which has largely gone under the radar to this point. Our intrinsic valuation produces a range of 162p to 213p, with the current market cap more than underpinned by the Digital Radio business alone.
