Axon Enterprise (NASDAQ:AAXN) has been one of the hottest stocks in the market so far in 2018. Investors have poured into shares after the company increased guidance and launched new products that could keep it growing for the next decade.
Given all that's going on at Axon and its newly heightened valuation, let's look at whether or not the stock is still a buy.
Why investors are excited about Axon in 2018
The biggest factor that has driven shares higher in 2018 was management increasing annual revenue growth guidance from 16%-18% to 18%-20%. Executives also reiterated that operating margin is expected to expand 300 to 400 basis points, which should bring the company back to sustainable profitability by the end of the year.
You can see above that operating margin has struggled the last few years, primarily because of investment in research and development and sales staff in order to grow revenue. Investors are pleased that this year margin will begin turning around and profitability will be increasing as the company grows.
What could supercharge Axon Enterprise
The beauty of Axon's business model is that most of its new products are based on a recurring revenue business model that will likely lock law enforcement agencies into the company's products for the foreseeable future. For example, an unlimited Axon camera bundle gives each officer a body camera, unlimited HD storage of Axon camera uploads on Evidence.com, and a camera upgrade every 2.5 years for $79 per month per user. Most customers sign up for multiyear contracts, ensuring revenue and profits for Axon.
This pricing is similar to the pricing model of Axon's new Fleet in-car camera system, and Tasers are also being sold on a recurring-revenue model. Building this high-margin recurring revenue is what could supercharge Axon's stock.
In the last two years, contracted future revenue backlog has increased from $202.3 million to $570 million, and annualized recurring revenue has grown from $18.1 million to $83.3 million. The backlog is great for long-term profitability because the gross margin for service sales, which is most of the recurring revenue, is extremely high. In the first quarter of 2018, services gross margin was 78.7%, so recurring revenue is something Axon would love to grow.
The positive trends in the past may just be scratching the surface of Axon's coming growth trends. Sales reps are no longer just selling a body camera and Evidence.com cloud storage of data. They have a fleet offering, records management, and a holster that senses when a weapon is drawn and automatically turns on nearby cameras, all added to the product lineup this year. These should help grow backlog and recurring revenue in the long term.
Can Axon keep up its growing ways?
The question of whether or not Axon's stock continues to rise will come down to its growth. I think the company's expanding portfolio of products will keep bringing in customers, and there's still a lot of untapped potential in the market.
Axon has a total of 226,900 cumulative seats booked for Evidence.com and $366 million of revenue in the past year. But that's just scratching the surface of the company's potential. Management thinks its total addressable market is $6.5 billion and could expand in the future as the product line grows. Before Axon introduced records, Axon Fleet, and enhanced services for tasers, the total addressable market was only expected to be $2.9 billion, so just the past year of new products is growing the company's potential.
There's no doubt Axon's stock is expensive by traditional metrics, trading for 10 times sales and an astronomical P/E ratio given very little in profits today. But this is a company that I think will revolutionize law enforcement and continue to grow into its $6.5 billion addressable market. Given the high margin of existing products, if management can keep operating costs down it could drive substantial earnings growth for the foreseeable future, which is worth paying a premium for.