Gemalto is a Dutch-French digital security company which started its operations in 2006 after the combination of Axalto and Gemplus International. Right now, it’s one of the largest digital security companies in the world with multi-billion Euro revenue. The company has listings on Euronext Paris and Euronext Amsterdam, and it’s trading with ticker symbol GTO on the latter exchange. The average daily volume is in excess of 700,000 shares.



The FY 2016 results weren’t bad at all

Digital security is big business, and Gemalto was able to release pretty decent results in its financial year 2016. The revenue remained flat but due to a 5% reduction in the company’s cost of sales, the gross profit increased by in excess of 10% to 1.186B EUR.

On top of that, the other operating expenses remained stable as well and despite a push in the sales and marketing expenses, the total operating profit increased by approximately 70% due to a lower G&A expense. With an operating profit of 347M EUR (for an operating margin of 11.1%), Gemalto can be pretty happy as it’s a substantial increase compared to the operating margin of 6.5% in the previous financial year.

Source: annual report

Unfortunately the tax bill was also disproportionally higher, resulting in the bottom line showing a net income of 186.2M EUR (compared to 136.9M EUR in FY 2015). This resulted in an EPS of 2.09 EUR per share, which is roughly 33% higher than the 1.56 EUR per share in the previous full-year.

The sharp increase in Gemalto’s operating margin obviously is one of the reasons why the company has been a market darling lately, and the company’s cash flow results seem to confirm Gemalto’s capex-light business model, resulting in strong cash flows.
Source: financial statements

With an operating cash flow of 458M EUR, Gemalto’s accounting department probably was pretty happy. However, the total amount of taxes to be paid seems to be underrepresented (75M EUR in cash outflow related to taxes versus a total tax bill of 107.5M EUR), and after taking this into consideration, as well as the changes in its working capital position, the adjusted free cash flow is approximately 399M EUR. The capex remains quite low with a total of just $141M (of which the majority is related to the amortization of intangible assets), resulting in an adjusted free cash flow of approximately 258M EUR.

Even after deducting the 7M EUR in net financial expenses, the free cash flow is still 251M EUR, and yes, that’s approximately 35% higher than Gemalto’s net income.  

A profit alarm in March has upset a lot of people

Just a few weeks after releasing its full-year results, Gemalto released an update which was perceived as a very negative surprise.

Gemalto said it suddenly expected its Q1 revenue to be approximately 7 to 9% lower compared to the revenue in Q1 2016 due to the lower payment business revenue in the USA (as there seems to be a slower-than-expected pick up in the demand for payment cards with chips). In fact, the full-year revenue guidance of the payment business has been revised as well, and Gemalto now expects the total revenue to be 100M EUR lower than previously expected.
Source: company presentation

Even though this is bad news, it’s not disastrous. After all, it seems to be caused by a delay in the use of chip cards. But the market definitely blamed Gemalto for the late warning. Most investors were extremely ticked off the company didn’t even mention this when it announced its full-year results, literally just a few weeks before.

It’s impossible the decline in demand suddenly happened in March, so the lack of transparency and disclosure was the main reason for the 20% fall. Since the announcement, Gemalto’s share price has increased by approximately 10%, which indeed indicates the initial drop was overdone.

Investment thesis

Gemalto’s profit warning shocked the market, and the share price nosedived. However, even if the company wouldn’t see any increase in its operating and free cash flow, it still wouldn’t be trading expensive. After the recent 10% share price increase, the free cash flow yield (based on the 2016 results) is approximately 5.1%. Considering the balance sheet is very robust (the net debt is less than 70M EUR), this valuation is definitely warranted for a company of this size and with these returns.

Disclosure: the author has no position in Gemalto

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