On Jan 17, Zacks Investment Research downgraded security and protection services provider The ADT Corporation (ADT) to a Zacks Rank #3 (Hold) from a Zacks Rank #2 (Buy) largely on the back of shrinking profitability owing to tough competitive pressure and economic woes. Despite the relative weakness, the stock is currently trading at a forward P/E of 16.1x with long-term earnings growth expectation of 6.2%.
Why the Downgrade?
ADT is facing significant pricing pressure and competition as the security alarm industry is highly fragmented due to low barriers to entry. These include competitive pricing pressures on installation, monitoring and service fees.
In addition, cable and telecommunications companies are also eroding ADT’s 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 other value drivers that act as a hedge against tough competition. This has increased its operating costs and reduced its profitability to some extent.
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.
In addition, 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.
In addition, ADT’s business strategy hinges on acquiring companies and making investments that complement its existing businesses. These acquisitions entail huge integration costs, which often become a drag on the profitability of the company.
Furthermore, ADT incurs significant upfront investments for expanding its customer base, including direct material and labor costs to install security and home/business automation systems, indirect sales costs, marketing costs and administrative costs related to installation activities. The economics of the installation business also varies depending on the customer acquisition channel. Consequently, ADT’s long-term profitability is dependent on long customer tenure and minimal customer attrition.
Other Stocks to Consider
Some other stocks in the industry that look promising include CoreLogic, Inc. (CLGX), Corporate Executive Board Co. (CEB) and IHS Inc. (IHS), each carrying a Zacks Rank #2 (Buy).
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