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Company Update | Audinate (ASX: AD8) - Successfully Navigating Uncertainty

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Gareth Abernethy, Clime Asset Management's picture
Analyst: Gareth Abernethy, Analyst, Clime Asset Management
  • The tight market for chip related products pervades however individual companies such as AD8 are faring better than others.
  • Supply chain issues are adversely impacting smaller peers more, potentially reducing future competition.
  • AD8 continues to grow its install base gap versus the rest of the market.

It has been a tumultuous half so far for small cap industrials and tech, with the market remorselessly cutting price multiples across these sectors. Increasing expectations of interest rate rises and geopolitical uncertainty, combined with industry specific issues such as the chip shortage and some large cap US tech earnings misses, has shaken confidence across the board. One of our preferred names in the small cap tech space, AD8 has unfortunately been exposed to all these thematics. However, the most recent market update from AD8 shows the company is successfully traversing its difficult operating environment.

The chip supply issue has been an ongoing issue that has resulted in chip manufacturers and by proxy any ‘smart’ device manufacturers, being generally unable to meet the demand for their products. This was seen with Apple recently downgrading iPhone shipment guidance by 10 million units and Toyota reducing car production by another 20% last month.

Given this, AD8’s update was particularly pleasing – outlining that its chip supply issue appeared to peak in January and February, with a considerable inventory build of $3.7 million chips over the quarter. This has given management confidence that it can more effectively reduce its backlog of orders, particularly in the Brooklyn and Broadway modules. It also improves the outlook for supplying the next generation of Brooklyn chips expected in FY23. Another positive takeaway is that the company has managed to maintain gross margins at 75.8% despite the purchasing of inventory in tight markets. Management flagged that the full effect of these inventory purchases had not fully flowed through but should partially be offset by the 25% price increases pushing through for Brooklyn and Broadway products from March onwards. Further, the update mentioned an increase in orders off the back of Dante’s first video product, however, no numbers were provided. This division could eventually grow to match a similar size to the company’s audio business.

Despite making good headway on broadly building chip inventory, risks remain around its Ultimo chip supply – with the production factories currently locked down in China. Management had flagged this at previous updates, and discussions are taking place regarding finding additional geographies to manufacture in, such as South-East Asia. As such, some short-term pain could still present itself if lockdowns persist in China in the months ahead. A series of broker estimates suggest around 10% of Ultimo’s previous year’s units shipped could be affected. While not an ideal situation, the interoperability of Dante via physical chips and software services somewhat alleviates these supply pressures.

Ultimately, the worst of the issues that have plagued AD8 over the last two years look to have reached a trough. Whilst denting the company’s profitability and top line growth, the problems have been industry-wide. AD8’s decision in mid-2020 to undertake a $28 million capital raise now appears to have been pertinent, with several competitors (see figure 1 below) unable to secure meaningful chip supply.

Figure 1: Total audio products per protocol

Source: AD8 Company Presentation

 

AD8 now finds itself in a relatively competitive position, allowing it to provide certainty to its original equipment manufacturer (OEM) partners and continue to grow its market share. As we mentioned in a previous AD8 update, even as the overall revenues and growth have been challenged through the pandemic, the company’s market-leading position and ability to raise capital have shielded it from the worst that the industry has experienced. AD8 continues to successfully expand the gap with the rest of the market for pro-audio, and it is on track to become the ‘Intel’ of the industry in the years ahead.

Ownership Disclosures: 
Our fund partner Clime Asset Management (Clime) owns (AD8) on behalf of various mandates where it acts as an investment manager.

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