Shares of Axon Enterprise Inc (NASDAQ:AAXN) fell 6.4% on Thursday after an analyst downgrade. But for obvious reasons, there’s no need to panic when it comes to Axon stock.
Analyst Mark Strouse simply wrote that the stock needed a “breather” from a valuation standpoint, and Strouse has a case. Even after Thursday’s decline, AAXN has gained 140% this year alone, and has tripled from November lows.
Of nearly 1,900 stocks with a market capitalization over $2 billion, only Intelsat SA (NYSE:I), Madrigal Pharmaceuticals Inc (NASDAQ:MDGL), and Crispr Therapeutics AG (NASDAQ:CRSP) have performed better in 2018.
With AAXN at 80x next year’s earnings even backing out its net cash, valuation does look a bit stretched. But that alone doesn’t negate Axon’s long-term potential.
An Impressive Growth Story
The AAXN growth story has a number of pillars. Revenue in the legacy TASER business rose from $90 million in 2011 to $234.5 million last year. Body cameras provide another growth opportunity, and May’s acquisition of VIEVU cements its leadership in that space.
Axon also is building out its software business, along with other services. As a result, the company estimated at its November Investor Day that its addressable market had more than doubled from $2.9 billion to $6.5 billion.
About 40% of that TAM comes from overseas, where sales have risen from $18 million in 2011 to $60 million last year.
Certainly, there’s a good, if not great, story underlying Axon stock. Competition exists, but as Axon has said, it only really loses when customers are focused solely on price.
Body cameras have a notable effect on police and citizen actions. Tasers can save lives if used properly.
It’s always dangerous for a business to rely on state and local funding but the value proposition of Axon’s hardware, along with software efforts like Evidence.com, should keep it protected from budgetary vagaries.
Meanwhile, the high earnings multiples are in part due to the fact that margins are at a trough. The Software and Sensors business is running at a loss, in part due to upfront costs for revenue to be recognized over several years.
A free trial period for hardware last year also contributed to enormous margin compression: operating margins dropped from nearly 12% to under 4%.
But those investments are driving revenue growth, and Axon expects those margins to recover 150-250 bps each year for years to come.
Is Axon Stock Too Expensive?
As is common with growth stocks, the question is whether the valuation matches the story. And that’s a legitimate concern. Axon’s own 5-7 year targets are for 16-18% revenue growth annually, along with the aforementioned margin expansion.
Even at the high end of sales targets, that would suggest something like $1.3 billion in revenue in 2024, at maybe 20% margins. $260 million in EBIT at a 25% tax rate would probably lead to about $3.50 in EPS.
A 30x out-year multiple, discounted back at 8%, values the stock at $67 right now. That’s only modestly above the current price – and a dollar above JP Morgan’s target.
And so there’s a real case that maybe the parabolic run of late has gone too far. Axon stock rose almost 150% just between late February and Wednesday’s high of $69.09.
The only possible ways toward upside seem to be if the company outperforms its own expectations (which certainly is possible) or if it becomes an M&A target.
Axon would add much needed growth, and a larger owner could accelerate international adoption as well.
The problem is that at the moment, there’s no sign Axon is an acquisition target or is looking to sell. And while AAXN stock could outperform if it exceeds expectations, that’s true of pretty much every stock.
The long-term case remains intact, and I can see why shareholders might want to stick with AAXN after this year’s bull run. But JP Morgan makes a pretty good argument: AAXN does look pretty close to fully valued.
As of this writing, Vince Martin has no positions in any securities mentioned.