First Shock Of The Season, What’s Next Audinate?

This story features AUDINATE GROUP LIMITED. For more info SHARE ANALYSIS: AD8

Audinate Group’s disappointing FY25 outlook came as a shock to many, but what about that long-term growth prospect?

-Audinate Group’s FY24 pre-release included FY25 outlook shock
-FY25 impacted by software transition and backlog
-Earnings forecasts and valuations significantly reduced
-Morningstar outlines the (ongoing) market opportunity

By Mark Woodruff

Following the pre-release of FY24 results, shares of audio-visual company Audinate Group ((AD8)) received a reality check as analysts reset the company’s growth trajectory following significantly weaker-than-expected FY25 guidance.

The business is experiencing a contraction in demand after a heightened FY23/24 growth period that proved unsustainable, but there are positive signs for the gross margin.

Making forecasting difficult, management has only two-to-three months of visibility on the order pipeline, explains Shaw and Partners.

Audinate now expects FY25 gross profits will be “marginally lower” than the US$44.5m achieved in FY24, which jars badly when set against Morgan Stanley’s prior expectation for around 22% growth.

While the outlook may get worse before it gets better, Macquarie suggests the current share price represents an attractive entry level for the long-term Audinate story and upgrades its rating to Outperform from Neutral.

This broker stresses the key driver of a weaker FY25 outlook was over-earning in FY24, not a fundamental impairment of the core business, plus management has already articulated plans to remedy known issues.

Despite some dramatic reductions in 12-month target prices, other brokers also remain generally supportive, including Overweight-rated Morgan Stanley and Morningstar. The latter has a fair value estimate of $18 while shares flounder below $9.00 having peaked at $23.51 in mid-March.

Morningstar regards Audinate shares as materially undervalued as FY25 is likely a transition year, after which growth will reaccelerate and margins will expand again.

Audinate’s Dante platform distributes digital audio and video signals over computer networks and is designed to bring the benefits of IT networking to the professional Audio-Visual (AV) industry.

Dante is the world’s most widely used protocol for digital audio networking, with more than ten times the number of products (enabled with the protocol) than the nearest competitor, Ravenna.

The Ravenna protocol is not owned by a single entity but was developed and is promoted by ALC NetworX GmbH, a German company based in Munich.

End users of Dante include universities, corporates, convention centres, theatres, stadiums, theme parks and recording studios.

Over 400 original equipment manufacturers (OEMs), including Bosch, Bose, and Yamaha, license the Dante protocol to enable digital delivery and management of audio for over 4,000 products, such as microphones, mixers, and speakers. These OEMs on-sell Pro-AV products (speakers, amplifiers, and mixers) to system integrators.

Explaining the FY25 slowdown

FY24 benefited from over-ordering by OEMs, catch-up benefits with the return of chip supply, and an unwinding of the backlog, explains UBS. Also, AVIO adaptor promotions are thought to have contributed to the overall positive performance.

Unfortunately, management’s FY25 guidance points to a dramatic slowdown, which Morningstar attributes to a transition of the business to software-based sales from hardware-based sales (cannibalising some of the existing revenue base) and a resolved backlog of hardware products. While both causes were expected, the magnitude was much greater than expected.

In particular, there was a large customer over-order on high value Brooklyn 3, but subsequent below average end product sell through is a material (one-off) headwind into FY25, explains Morgan Stanley. Inventory de-stocking was then compounded by end-of-life products (e.g. the Viper board which added US$2.8m in FY24).

A positive margin outlook

More positively, based on the preliminary results, gross margins for the second half of FY24 are expected to be 500%points (5%) higher than in the first half, while guidance for fiscal 2025 implies another 300%points (3%) increase in gross profit margins over the second half.

As a result, Morningstar’s gross margin expectation for FY25 has now been exceeded by 7% reflecting the shift to higher-margin (though lower-priced) software sales.

Audinate is still adding around 1m Dante devices to the field each year, which is supported by a lower average selling price (ASP) in embedded software, explains Macquarie.

As gross margins are expanding with a shift to software, there is a smaller impact to gross profit than to sales.

Shaw forecasts FY25 margins of circa 78% and gross profit of around US$43m.

This broker expects the company will likely burn some cash, but also notes Audinate has ample liquidity with more than $110m cash on the balance sheet.

The opportunity for Audinate explained

Morningstar believes Audinate has around 10% market share in audio devices, which leaves a large and highly winnable market opportunity as the industry digitises. Also, the analyst anticipates the company will gain significant pricing power (especially in the software segment) as network effects continue to strengthen.

The opportunity in digital video networking is more uncertain and likely less profitable, plus there is an impediment to establishing network effects, notes Morningstar, due to varying compression technologies (needed for the larger data intensity) that are usually not compatible with each other.

While Audinate is demonstrating strong momentum on all relevant metrics for its video networking business, this is from a small base, and the analysts consider this market is still up for grabs.

Despite this difficulty, Morningstar believes network effects from Dante’s audio solutions will help pull in AV professionals, who are already familiar with the Dante protocol. Because OEM’s need to cater to the preferences of AV professionals, the analysts note they are increasingly choosing to enable their products with Dante.

Ultimately, what matters for longer-term growth is industry adoption and competitive position, and Morgan Stanley doesn’t consider the latter has changed.

This broker points out cycle/revenue sequencing concerns also materially weighed on the stock price during the pandemic, but Audinate’s structural growth profile triumphed.

Focus on gross profit and a bullish revenue forecast

While revenue remains the key metric the Audinate share price trades to, according to Morgan Stanley, the gross profit is becoming increasingly important.

As per guidance, the broker’s FY25 gross profit forecast now trails slightly behind FY24, but the new FY26 forecast show a return to 18% gross profit growth.

Morningstar forecasts revenue will grow at an organic compound annual growth rate (CAGR) of 17% over the next decade, driven primarily by Audinate expanding the market for digital audio networking. Earnings (EBIT) margins are expected to widen to 40% by FY33, compared with 1% in FY23.

Overall Outlook

While reducing its 12-month target price to $10 from $22, Morgan Stanley still believes end-market demand is stable, Audinate’s structural growth story remains intact, and the company’s competitive position is not under threat.

Upcoming FY25 results on August 19 will provide more details, explains the broker, including commentary on end market demand, OEM/product trends (particularly in Video), and long-term incentive which may be a pointer to FY26 growth prospects.

Also awaiting greater clarity around video momentum, UBS removes -$2.01/share from its valuation of Audinate to reflect a potential 2% share of the digital video networking opportunity, which still has large upside potential. Despite slashing the overall target to $10.90 from $22.80, this broker still believes in the long-term structural shift to digital from analogue, Audinate’s strong leadership position, and a deep moat which is superior to anything under UBS’s Emerging Companies coverage.

There are five covering brokers in the FNArena database with four Buy or equivalent ratings and one Hold (Shaw and Partners). The average target price ex-Ord Minnet is $10.18. This amended target price suggests around 15% upside to the $8.87 share price at the time of writing.

As previously noted, Morningstar (not monitored by FNArena) has a fair value estimate for Audinate Group of $18.50. Ord Minnett previously whitelabeled Morningstar research.

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