Zebra Technologies Stock: Great Business, Cheap Valuation (NASDAQ:ZBRA)

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Thesis

Zebra Technologies (NASDAQ:ZBRA) is a buy after a significant drawdown from its ATH. The company is the market leader in a growing industry with a good moat and capital allocation strategy. Warehouses will play an increasingly important part of our supply chain and Zebra is here to profit from it.

Quality Checklist

I will run Zebra Technologies through my quality checklist to find out if it is a high-quality company worth investing in. My checklist will run through the following criteria:

  • Are they a market leader in a growing market?
  • Is Free Cash Flow per share growing?
  • What do the margins look like?
  • Do they have a wide economic moat and is it widening?
  • Is the company led by an owner-operator?
  • How is the capital allocation strategy?

Macro Tailwinds

Zebra is operating in a variety of different markets with a wide variety of products and services. The best fits for their markets are Warehouse automation and Machine vision.

According to thelogisticsiq, the warehouse automation market is expected to grow to $41 billion by 2027, a compound annual growth rate (CAGR) of 15% in the next 5 years. According to grandviewresearch, the machine vision market is expected to grow to $26 billion by 2030, with a CAGR of 7.7% over the next 8 years.

As we can see, Zebra is operating in markets growing at an attractive pace. They are also the market leader in their different segments. Besides Data capture, where the competition is fierce, Zebra is by far the biggest player in its segments. Honeywell (HON), an American conglomerate, is the main competitor in all segments. Being a conglomerate though, Honeywell lacks focus and can in no way be considered a pure-play into these segments. Zebra being the Market leader in a growing market means a check on the list.

Zebra Technologies market share

Zebra Technologies market share (UBS)

Free Cash Flow

Zebra generates considerable free cash flows, which are rising over time. It isn’t the most smooth upwards trend, largely due to the M&A part of the business, but the long-term direction is good and I expect them to grow FCF/share in the low teens given the markets they are in and that they are well run with sticky products. Another check for the list.

Zebra Technologies Free Cash Flow

Zebra Technologies Free Cash Flow (koyfin)

Margins

Zebra Technologies’ margins have been largely consistent over the last 15 years. They aren’t the most stable, especially due to the company’s M&A track record with often large deals that need to get integrated into the company. In recent years Zebra has shifted focus from hardware offerings to software offerings, which should help margins increase over the next decade. Zebra now employs more software engineers than hardware engineers.

Zebra Technologies margins

Zebra Technologies margins (Koyfin)

Economic Moat

Zebra operates in a lot of different industries, ranging from retail and warehousing to healthcare and hospitality. The solutions get integrated vertically into the workflows of the customer, offering a very sticky business which then gets expanded with software and analytics services. They also have a unique go-to-market strategy, leveraging distributors with a long-term incentive structure to sell Zebra’s products to the customer. The distribution also offers a risk though, as 50% of this distribution comes from just three distributors. I don’t see this as a big risk though, considering it’s a long-term business relationship with incentives in place.

Owner Operator

The lack of insider ownership is my biggest complaint about Zebra Technologies. Fortunately, the company has a large institutional ownership to compensate for it.

Zebra Technologies ownership structure

Zebra Technologies ownership structure (Seeking Alpha)

Capital Allocation Strategy

Zebra has a good capital allocation strategy. The top priority is an internal investment. If good opportunities arise they are open to doing acquisitions if they align with the hurdle rate. Long term the company aims for a leverage ratio between 1.5-2.5 times debt to adjusted EBITDA, currently, this ratio is around 0.8, so there is more than enough room for new acquisitions. If the price is right, they will also look into doing large acquisitions, potentially paying in stock as well if the opportunity is too large to debt finance it as we can see in the transcript I added below.

Zebra about capital allocation

Zebra about capital allocation (koyfin)

Acquisitions

Generally, these acquisitions are bolt-on acquisitions or Value-added capabilities to increase their ecosystem of products and services and underpin the moat of the company. I really like that Zebra often does angel investments into promising acquisition targets and observes them for a while before full out buying them. M&A is a risky business because often synergies and integration don’t work as well as intended. The way they do angel investments reduces the risk considerably in my opinion. Over the last decade they allocated over $5 billion into acquisitions and I expect them to continue doing so into the future.

Zebra Technologies Acquisition history

Zebra Technologies acquisition history (Aggregated by the author with data from Zebra IR)

Buybacks

Zebra opportunistically buys back shares from its cash flow if no better reinvestment is available. As we can see in the graphic below, they don’t just buyback at any price, which I like. They also recently authorized another billion for buybacks.

Zebra Technologies returned capital

Zebra Technologies returned capital (Koyfin)

High Returns on Capital Indicate Good Allocation

Zebra manages to generate high returns on equity, assets and capital, with the general trend going upwards. Once again, it’s not a straight line up with periods of large M&A dragging down the metrics in the short term.

Zebra Technologies return metrics

Zebra Technologies return metrics (koyfin)

Valuation

Zebra Technologies shed off all of the premium valuation it gained during the pandemic. Shares are trading back in line with historical multiples of mid-teens for forward earnings and low teens for EV/EBITDA. The FCF yield of 4.5% also is in line with historical levels.

Zebra Technologies valuation

Zebra Technologies valuation (Koyfin)

Conclusion

Zebra Technologies checks all my points besides insider ownership. It is a high-quality business with a great track record of effectively allocating capital in a growing industry with increasing relevance. Shares are trading at a fair value and I initiated a small position in my personal portfolio after writing this article.