We suggest investors stay invested in security and protection services provider The ADT Corporation (ADT) based on a relatively balanced view. The stock at present neither calls for a bullish take nor a hurried sell-off. A brief discussion of the underlying factors would further explain our middle-of-the-road stance.
The Positives
With a wide array of products catering to a broad spectrum of customer needs, ADT has a strong footprint in the large and growing residential and small business security market. The company’s product portfolio includes some of the most respected, trusted and well-known brands in the industry. As reputation and reliability serve as the two key elements in the decision-making process while purchasing home and small business security and automation services, ADT has a distinct advantage over rivals with its well-recognized and reliable brands. The depth in product portfolio, strong brand identity and a well-diversified customer base offer an unrivalled competitive advantage to ADT.
The company believes monitored security and home/business automation services are still under-penetrated in North American households. In addition, rising concerns about crime and security issues (particularly for the aging population), increasing customer interest in lifestyle and business productivity, and technology advancements are likely to support the higher penetration of interactive services and home/business automation. The company envisions significant growth potential and is all set to capitalize on this opportunity by leveraging its efficient operating model and cutting technology costs over time. These efforts would enable the company to considerably reduce the cost of basic installation and services, thereby making it affordable for more and more households and businesses. As it looks now, we find the inherent growth prospects of ADT very encouraging.
In fact, a bulk of monitoring and home/business automation services and a large portion of maintenance services are governed by multi-year contracts with automatic renewal provisions, which generate significant recurring revenues for ADT. This insulates the company from market volatility and enables it to invest in healthy organic and inorganic growth. Mergers and acquisitions have also played a pivotal role in ADT’s growth story over the years. Periodic investments in the direct sales force and complementary distribution channels should also enable ADT to retain and capture additional market share to fuel its growth engine.
The Concerns
On the flip side, ADT faces significant pricing pressure and competition as the security alarm industry is highly fragmented due to low barriers to entry. The company witnesses stiff competitive pricing pressure on installation, monitoring and service fees. In addition, cable and telecommunications companies are also eroding its market share by expanding into the monitored security alarm industry and bundling their existing offerings with monitored security services. As such, ADT has to continually invest in R&D and similar value drivers to stave off competition. This inevitably increases its operating costs and reduces profitability to some extent.
In addition, the operations of the company are subject to various federal, state, provincial and local laws and regulations in the U.S. and Canada in areas such as consumer protection, occupational licensing, environmental protection, labor and employment, tax and other laws and regulations. Most states and provinces in which ADT operates have licensing laws directed specifically toward the security services industry. Increased government regulation escalates costs and restricts operations, somewhat impairing the long-term growth of its business.
ADT’s first quarter fiscal 2014 results also failed to impress. GAAP net income declined to $77 million or 39 cents per share from $105 million or 44 cents per share in the year-ago quarter. The year-over-year decrease in earnings was primarily attributable to high operating costs and interest expense stemming from its status as a standalone public company.
Moving Forward
With a mix of both positive and negative factors, we currently maintain our Neutral recommendation on the stock. ADT holds a Zacks Rank #3 (Hold). Stocks in the industry that look promising now include Nielsen Holdings N.V. (NLSN), Verisk Analytics, Inc. (VRSK) and McGraw Hill Financial, Inc. (MHFI), each carrying a Zacks Rank #2 (Buy).
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