Shares in Zebra Technologies (NASDAQ:ZBRA) fell 11.9% in September, according to data provided by S&P Global Market Intelligence. The fall came after the market digested the company's second-quarter earnings released at the end of August.
To be fair, the market's skepticism is probably about the third-quarter guidance rather than the second-quarter numbers. Management guided toward a year-over-year net sales decline of 3% to 7% in the third quarter, but analysts were left surprised by the guidance for adjusted earnings before interest, tax, depreciation and amortization (EBITDA) margin of just 19%.
The number is surprising because the midpoint of guidance calls for revenue of around $1.07 billion representing a 12.2% sequential increase compared to the second quarter. However, adjusted EBITDA margin is only expected to rise from 18.3% in the second quarter to 19% in the third quarter.
Management discussed the issue on the earnings call and noted that the company will face $9 million of premium freight expenses in the quarter. In addition, gross margin is also expected to decline due to the "mainly higher level of large deals in the quarter," according to CFO Olivier Leonetti on the earnings call.
The shift toward large deals, as opposed to deals with small and medium-sized businesses (SMBs), seems to be implying a negative impact on gross margin. Indeed, CEO Anders Gustafsson explained that the "SMB segment was harder hit by the shutdown," as many of them were not deemed essential businesses.
In addition, Gustafsson pointed out that some large orders from retailers had been pushed out, including radio-frequency identification (RFID) orders which require "in-store activities, and also focus more on apparel or fashion retailers," according to Gustafsson.
In short, the guidance is a salutary reminder that Zebra's customers include businesses that remain challenged by the ongoing impact of the COVID-19 pandemic. Areas like e-commerce and healthcare are doing fine, and two thirds of Zebra's retail business goes to "mass merchants, grocers and e-tailers," many of which have been stepping up investment. However, Zebra also sells into sectors of retail that have been hit hard, and to manufacturers with exposure to industries that have been significantly impacted by the pandemic, such as automobiles and aviation.
On balance, investors should be aware of the potential for some near-term disappointment, but over the long term, the evolution of end-market demand looks assured. Moreover, Zebra's key rival, Honeywell's productivity-solutions business, is expecting its sales to return to growth in the second half. A good sign for the industry.
Moreover, the recovery in Zebra's overall end markets is expected to lead to a double-digit recovery in sales in 2021, leaving the company trading on around 18 times its 2021 earnings expectation. That looks like a good value for a stock with attractive long-term prospects.