According to most big-name players on the Street, a recession is pretty much a fait accompli.
Those steeling themselves for such an event point to the U.S. Federal Reserve’s hawkish efforts to bring down inflation as the prime reason. Each interest rate move is being closely tracked on their radar, yet they differ in their view of the Fed’s skill in attempting to steer the economic plane. Will the landing be soft, bumpy or devastating? Jeff Bezos recently advised stockpiling cash, just in case it is Scenario No. 3: a strong economic contraction and a big increase in unemployment. Pile it high and deep, says the Amazon king.
So, in a period of declining GDP growth, can an investor take cover? If so, it makes sense to look for a sector where projects tend to be long-term in nature, and therefore, less prone to cyclical effects. A place where the tailwinds are noteworthy and recession-resistant. Well, according to the current chief executive of Quarterhill Inc. (QTRH-T), a small Canadian tech company, which does much of its business in the United States, intelligent transportation systems (ITS) are the ticket. Quarterhill provides products and services, such as red light and speed-enforcement systems, automated truck-weighing stations, toll-road systems and equipment, traffic management and safety systems. The opportunities are there, especially now that Congress has passed President Joe Biden’s Infrastructure Investment and Jobs Act.
The company’s market cap is a tickle under $200-million. We purchased the shares in December, 2016, at $1.95 and they currently trade around $1.50. This enterprise is in the process of transforming itself. It has a legacy business of patent licensing called WiLan that provides lumpy cash flow but is in strategic review – read: up for sale. Management wants to focus solely on its intelligent transportation segment. At the same time, Quarterhill is in the early innings of an M&A strategy. In 2021, it spent $150-million acquiring Electronic Transaction Consultants to join two other components – another ITS called International Road Dynamics, and WiLan.
The scale of the change should be a concern to an investor. One important aspect is Quarterhill’s management. There has been some churn, which makes the outfit’s future direction less certain. In May, it appointed a new chief executive for WiLan, a new chief financial officer for Quarterhill and a new board member – the third new board appointee this year. In December of 2021, Bret Kidd, the head of the newly acquired business, Electronic Transaction Consultants (ETC), was promoted to chief executive of Quarterhill, replacing Paul Hill, who had been in that job for a year and a half.
A 20-year-old company, Quarterhill provides tolling software to transportation agencies in Texas, California and Illinois. Its platform processes more than two billion transactions a year, worth more than $3-billion. Annual revenue estimates range between $95-million and $120-million, while adjusted EBITDA is forecast between $12.5-million and $15-million over the next 12 to 18 months. (EBITDA stands for earnings before interest, taxes, depreciation and amortization.)
Now that he’s been there a year, Mr. Kidd’s first real test is going to be the WiLan licensing unit. If sold at a decent valuation, it’s possible it could spur a rally in Quarterhill stock. The unit is performing well, and he is in no rush to sell. What helped pave the way for a possible deal was the resolution, earlier this year, of a patent dispute with Apple Inc.
In the third quarter, Quarterhill saw operational improvement in the ITS business, with sequential revenue growth of 8 per cent. The ITS backlog is robust, at $770-million. In the past 12 months, $235-million in new business was garnered, and since 2021 more than $500-million in contracts have been closed. In addition, this week, the company received a 10-year, $80-million contract in California. This deal with the Alameda County Transportation Commission also has the possibility of a four-year extension.
Though there are labour and supply chain delays, a busy bidding season is anticipated in 2023. The goal is to expand margins, leading to higher cash flow and a better bottom line in 2024. Yeah, not exactly a revelation.
International Road Dynamics (IRD) has performed well through prior recessionary environments throughout its 40-year history. Both ETC and IRD serve the public sector, which can be countercyclical, and some long-term U.S. stimulus money is now going into some of the states.
The company does have a good balance sheet with cash at $76-million and working capital of more than $110-million. It is paying down debt seriously. The $150-million price tag for ETC was half paid for in debt.
Quarterhill is a low beta stock, so theoretically less volatile than the market at large, but it is experiencing a downtrend. Shares began 2021 at $1.67 and closed the year at $2.56, including a brief fling above $3. However, starting right out of the gate in January, 2022, it has trended downward and recently hit a 52-week low of $1.47. The market sentiment for equities in 2022 has mostly been “risk off” and Quarterhill’s stock has felt the impact. The dividend yield has generally been better than 2 per cent and is now at more than 3 per cent.
The rating is currently a hold in the Contra the Heard President’s Portfolio. We have talked about adding more, but the purchase had a reasonably heavy weighting, so we’re just sitting tight. The initial sell target remains $4.84, which is a lot further away now than when the stock price was purchased. Still, we are sticking with it.
Benj Gallander and Ben Stadelmann are co-editors of Contra the Heard Investment Letter