Chubb Limited: Undervalued, But Facing Some Serious Headwinds (NYSE:CB)


Chubb Limited (NYSE:CB) reported its second-quarter earnings earlier this month, and the company had a mixed bag of results.

The company saw growth in the revenues, which was offset by issues regarding catastrophe losses related to weather-related events and the ongoing COVID-19 pandemic.

Chubb appears undervalued on an intrinsic basis and has great liquidity with a growing dividend. Like most insurance companies, this year has been trying like no other in recent history.

Let’s take a look under the cover and see how Chubb performed.

Overview

Chubb Limited, an insurer that specializes in property and casualty and reinsurance products, recently released its second-quarter earnings.

A few highlights from the quarter, before diving into the nitty-gritty of the company’s second-quarter performance.

  • COVID-19 impacted net written premiums in the quarter by adjustments for the quarter of $184 million, from both the North American P&C Insurance and Overseas General Insurance segments to the tune of 2.3 and 2.5 percent points, respectively.
  • Chubb reported net catastrophe losses, including a COVID-19 charge of $1,365 million pre-tax, with $723 million in short-tail, and $642 million in long-tail insurance lines.
  • Chubb also saw negative impacts on net investment income resulting in lower reinvestment rates and lower floating rate obligations from COVID-19.
  • The company reported net losses of $331 million, which included $1,157 million after-tax of COVID-19 related losses.
  • Chubb reported consolidated net premiums were up 0.1 percent for $8.4 billion, with P&C premiums down 0.7 percent or $7.7 billion.
  • The combined ratio for the P&C lines was 112.3 percent compared to 90.1 percent, which includes the catastrophe losses of 23.9 percent factored into the ratio.
  • Excluding catastrophe losses, the P&C combined ratio for the accident year is 87.4 percent compared to 88.9 percent from the year-ago.
  • Operating cash flow for Chubb was $1,985 million for the quarter, compared to $1,386 million from the prior-year quarter.

Chubb operates the company in six segments; let’s next discuss the results of each segment.

North America Commercial P&C Insurance

The segment offers P&C insurance to large, middle, and small businesses in the U.S., Canada, and Bermuda.

Net premiums written increased for the segment by 5.3 percent, which indicates a positive rate increase, renewal retention rates, and new business. Along with the growth in net premiums written, the company also saw an increase in net premiums earned by 6.1 percent, as a result of growth in written premiums, all of which offsets $95 million in COVID-19 related adjustments.

The combined ratio for the segment increased by 32 percent because of higher catastrophe losses as a result of COVID-19, riots in the U.S., and higher natural catastrophes. The claims include $973 million from COVID-19, $118 million from riots, and the tornado in Nashville, TN, and other weather-related incidents.

North American Personal P&C Insurance

The segment includes offerings for high net worth personal line products, such as homeowners, excess liability, auto, and recreational marine services in Canada and the U.S.

Net premiums written for the quarter improved 1.4 percent or $18 million. The company attributes the increases to rate increases and improved retention of customers. Net premiums earned increased by 2.1 percent, or $24 million, closely related to the improvements in written premiums.

The loss and loss expense ratio decreased by 0.2 percent because of lower catastrophe losses for the quarter.

North America Agricultural Insurance

The agricultural segment offers crop insurance, as well as related catastrophe insurance lines including items such as hail damage and rain.

Net premiums written declined in the quarter by 1.1 percent, while net premiums earned declined 0.5 percent. It was primarily related to commodity price declines over the quarter.

The loss and loss expense ratio increased 1.2 percent for the quarter, due to higher catastrophe losses, and the year over year impact from crop derivative losses.

Overseas General Insurance

The segment includes Chubb International that specializes in P&C insurance for large corporations, middle-market, and small businesses.

The segment reported 10.5 percent decrease in net written premiums and a decline of 1.5 percent in net premiums earned. The company attributes the struggles to COVID-19 related issues, mainly in the personal lines from lower travel and lower exposures.

The combined ratio for the segment was 16.3 percent higher for 107.1 percent. The main culprit was the loss and loss expense ratio, which was higher due to higher catastrophe losses related to storms in Australia, wildfires in Australia, and other Mother Nature related events.

Global Reinsurance

The segment reported an increase in net premiums written of 4.6 percent, for $207 million. And net premiums earned also increased by 2.9 percent, for $163 million. The increases in written and earned premiums were resulting from positive rate increases and new business written in the quarter.

The combined ratio improved to 76.6 percent, an increase of 11.1 percent, with the majority of the improvement coming from the loss and loss expense ratio, resulting from improvements in the prior period development.

Life Insurance

The life insurance segment improved 7 percent for the quarter in net premiums written for a total of $619 million, and the net premiums earned improved likewise by 6.5 percent. The increases were a result of growth in Latin America, with an expanded presence in Chile.

The life insurance underwriting income decreased $16 million for the quarter, primarily because of COVID-19 related catastrophe losses.

Corporate

The corporate segment results include non-insurance companies. Loss and loss expenses increased by $242 million related to U.S. child molestation claims, which are primarily reviver statute-related. The company reported a net loss of $570 million for the quarter, up 1.4 percent compared to the prior year.

Investments

Overall the investment portfolio grew from $109,234 million to $110,877 million, with equity securities improving as a result of more favorable market conditions in the second quarter versus the first quarter.

The company recorded net income from investments of $827 million, down 3.7 percent from the prior-year quarter.

Overall, on a revenue and activity quarter, it was more of the same for Chubb, they improved across the board, but mother nature smacked them hard in relation to weather-related events and COVID-19.

Let’s look at the growth story for Chubb going forward.

Growth Story

The continued growth for Chubb starts and ends with the performance regarding premiums. The company saw an increase in the combined ratio for the quarter, which eats into the profitability of the company.

Most of those losses were related to increases in reserves for COVID-19 losses, and effects from mother nature wreaking her havoc. The combined ratio, excluding the effects of these two results in a P&C combined ratio of 87.4 percent. Which yields profitability for Chubb as any combined ratio under 100 indicates profitability in regards to underwriting.

Historically, Chubb has exhibited strong combined ratios:

  • 2015 – 87.3%
  • 2016 – 88.3%
  • 2017 – 94.7%
  • 2018 – 90.6%
  • 2019 – 90.6%

The above-combined ratio indicates that Chubb has done a great job creating profit from its underwriting, and there is every indication that will continue. The likelihood of the losses continuing is unlikely unless mother nature has other plans.

Another bonus for investors is the strong dividend that Chubb pays. The company announced the suspension of share repurchases and has stated that will continue.

But the dividend is continuing, and with an annual payout of $3.12, and yield 2.52 percent, Chubb has grown the dividend by an astounding 27.34 percent over the last five years. The dividend looks strong, too, when considering the payout ratio of 43.8 percent.

The liquidity for Chubb remains strong, with operating cash flows of $3.697 million for the quarter and a $1 billion credit facility at its disposal.

The key for Chubb, as we advance, is to limit the losses that have grown over the last few years and to continue on the excellence in driving premium growth and underwriting profits.

Let’s next move onto the risks Chubb faces.

Risks

The first risk that Chubb faces is the whims of mother nature, with catastrophe losses mounting as the year progresses. Losses from COVID-19 related events have grown over the last two quarters as the pandemic has continued raging around the world.

Along with those losses, the company has also incurred losses from weather related ranging from the tornado in Nashville, TN, and other severe weather that has seemingly been everywhere this year.

Additionally, the company has sustained further losses from the wildfires in Australia, and the riot related civil unrest in the U.S., all of which comes with the territory of being a large insurer in catastrophe insurance.

The company in the first quarter expected these losses and set aside $1.6 billion in anticipation; it will be interesting to see how those losses affect pricing in the future.

Another risk the company faces is the ongoing threat of a legal nature. The company is facing numerous COVID-19 related litigations, which the company claims it is not responsible for as their policies do not cover those claims. If you would like more color on those legal issues, check out the fantastic article outlining those issues far better than I could:

Chubb Limited vs. COVID-19 Risks

Chubb has a lot of good things going for them, but the losses from COVID-19 will continue to mount as the pandemic continues, even though the company has set aside reserves, who knows how long this pandemic continues and that gives Chubb continuing liability now and into the future, possibly leading to further losses.

Valuation

Let’s move on to the valuation of Chubb, my favorite part.

According to Seeking Alpha authors, Chubb has a bullish rating of 4.0, while Wall Street is also bullish with a 3.5, and the quant rating is more subdued with a neutral rating of 2.86.

Seeking Alpha also gives Chubb a value factor rating of D-, with the company posting negative earnings for the quarter, as we referenced above. The company’s TTM P/E is 26.1, which is well above the sector median of 11.48.

And the TTM price to book of 1.04 is slightly above the sector median of 0.86, but below the company’s five-year average of 1.24 by 16.34 percent.

All in all, Chubb appears overvalued on a relative basis, according to both the TTM for both the P/E and P/B ratios.

The intrinsic valuation tells another story. Because the earnings for the quarter were negative, I normalized the earnings over the last five years, including the TTM, which gave me the starting point to begin the intrinsic valuation.

After the calculations are complete, Chubb looks undervalued from an intrinsic viewpoint. Based on some pretty conservative numbers, i.e., the cost of equity and expected growth rates, which are below the historical numbers, the company looks undervalued, with a margin of safety of approximately 19 percent in case my assumptions are off-target.

Final Thoughts

Chubb had a challenging second quarter with the ongoing catastrophe losses from both the weather and COVID-19 related issues. The company is still doing a great job creating growing revenue from its focus on growing net written premiums.

The company is undervalued on an intrinsic basis and will continue as long as the COVID-19 related losses continue to mount, probably at least until the end of the year.

Chubb has the advantage of continuing strength in growing revenues, strong liquidity, and a great balance sheet to sustain itself until COVID-19 is in the rearview mirror.

The uncertainty, both now and into the future, gives me pause to pounce on this company, and I would recommend holding until gaining more clarity on the COVID-19 related losses.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.





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SPX Dividends Face Major Long-Term Headwinds


Over the past 10 years, S&P 500 companies have grown per share dividends at the fastest pace on record, expanding them at an average rate in excess of 10%, far in excess of nominal GDP growth. Even over the past few months, as equity indices around the world have seen dividends collapse, S&P 500 dividends have remained at record highs. Dividend growth has accounted for almost all of the returns in the S&P 500 over the past decade, and even if the dividend yield remains at the current historically low level of around 2%, falling dividend payments suggest that the S&P 500 is likely to decline over the next decade.

Dividend Growth Accounts For Almost All The S&P 500 Gains Over Past Decade

The annual total return on the S&P 500 over the past 10 years has averaged around 14%. This can be broken down into an average dividend yield of 2%, 11% growth in dividends per share, a 1% gain from net buybacks, and a marginal decline in the dividend yield. In other words, growth in dividends per share has been the major driver of stocks during the last decade of the bull market.

Source: Bloomberg

The 11% annual growth in dividends per share over the past decade compares to a historical average rate of 4%. In real terms, the figure is even more of an outlier from a historical perspective, as the chart below shows. The rapid dividend growth amid a disinflationary backdrop has not been seen since the roaring 1920s boom.

Source: Robert Schiller

Amid a collapse in the economy in Q2, total U.S. corporate dividend payments hit a new record high of 7% of GDP, double the long-term average. This exceeds the previous peaks seen in 2008 and 1929 by a full percentage point, and suggests that dividend growth will be much slower going forward than it has been over the past decade.

Source: FRED

One-Off Factors Have Driven The Dividend Boom

The rise in per share dividend payments has been driven by a number of one-off factors which have allowed dividends to grow at a faster pace than any other fundamental variable. We can break down dividend per share growth into four component parts: sales, profit margins, the dividend payout ratio, and net share buybacks.

Sales: Rising sales per share have contributed just over 4 percentage points to dividend per share growth since 2010, growing broadly in line with nominal GDP growth.

Profit Margins: Despite sales rising by just over 4% per year, earnings per share have managed to grow by 8% annually, with profit margins expanding by roughly 4% per year. The expansion in profit margins over this period has been entirely driven by declines in interest and tax payments, which have fallen to record lows of just 1% of sales.

Source: Bloomberg, Author’s calculations

Dividend Payout Ratio: Companies have managed to grow dividends even faster than profits over the past decade, with the payout ratio rising from 30% in 2010 to 46% currently. This means that the payout ratio has contributed just over 2pp to the growth in dividends.

Net Buybacks: An additional tailwind in terms of per share growth in dividends over recent years has been the decline in share count owing to the surge in net buybacks. This has contributed almost a full percentage point to per share growth in fundamentals, compared to a historical drag of 1-2% per year. Buybacks have been aided by the rise in debt issuance, and as a result, leverage ratios in the non-financial sector have risen to multi-year highs.

Source: Bloomberg

Dividend Payments Have Come At The Expense Of The Future

Going forward, we expect sales to continue to growth in line with nominal GDP, which is likely to average less than 1% over the long term for reasons previously explained here. Furthermore, the prospect for continued gains in profit margins seems very slim given the limited potential for tax and interest payments to fall. Meanwhile, we see little scope for rising dividend payout ratios given the current elevated level.

We believe that in a best-case scenario, dividends will follow the path of sales growth over the coming years as profit margins and payout ratios remain elevated, which would imply nominal dividend growth of roughly 3-4% assuming inflation comes in line with recent trends. Much more likely, however, is that dividends mean-revert downwards as a share of sales and GDP, thanks to a combination of declining profit margins and payout ratios. If we assume that dividends as a share of sales and GDP revert to their long-term average over the next decade, then this would mean per share dividend declines in the order of 3-4%. With the current dividend yield of under 2%, this would translate into negative total returns even if the trailing dividend yield remains at its current historically low level.

Disclosure: I am/we are short SPX. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.





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Asian Stocks Up After Boost from Positive U.S. Data, But Headwinds Remain By Investing.com


© Reuters.

By Gina Lee

Investing.com – Asian stocks were mostly up on Tuesday morning, buoyed by strong American economic data released overnight. But a stalemate in the U.S. Congress over the latest stimulus measures, as well as ever-increasing global COVID-19 case numbers, remain a challenge.

The reported a better-than-expected expansion, which boosted U.S. markets.

“It has been an upbeat U.S. trading session and Asia will absorb the leads accordingly,” Chris Weston, head of research at Pepperstone, said in a note.

Meanwhile, some investors were optimistic that the U.S. Congress would reach an agreement soon.

“Momentum begets more momentum, and the markets have been overbought we believe, but the demand to buy has been there,” Bob Phillips, managing principal at Spectrum Management Group, told Bloomberg.

“There’s a big desire from both parties to get some kind of stimulus passed. The way the market is reacting, I think the market is expecting that.”

U.S. House Speaker Nancy Pelosi is due to meet with Treasury Secretary Steven Mnuchin and White House Chief of Staff Mark Meadows later in the day to continue negotiations, raising hopes for a breakthrough sometime soon.

The “only good thing we can say on the political impasse in Washington is that negotiations remain ongoing,” National Australia Bank (OTC:) said in a note.

Japan’s rose 1.34% by 11:37 PM ET (4:37 AM GMT) and South Korea’s gained 1.11%.

Down Under, the jumped 1.65%. Investors will be watching the Reserve Bank of Australia’s announcement of its policy decision later in the day, after Melbourne imposed extended and tightened lockdown measures over the weekend.

Hong Kong’s inched up 0.80%.

Meanwhile, U.S.-China tensions are also up heating up after U.S. President Donald Trump ordered Chinese company TikTok to sell its U.S. operations to a U.S. company or close them by mid-September.

China’s was up 0.09%, reversing some earlier losses. The was down 0.38%.

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Fusion Media or anyone involved with Fusion Media will not accept any liability for loss or damage as a result of reliance on the information including data, quotes, charts and buy/sell signals contained within this website. Please be fully informed regarding the risks and costs associated with trading the financial markets, it is one of the riskiest investment forms possible.





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Ford: Built Tough Against Near-Term Headwinds (NYSE:F)


Like most car companies, Ford (NYSE:F) has been having a tough time during the coronavirus pandemic. The lockdown and subsequent stay-at-home orders have dampened consumer confidence and halted automobile sales. However, the company is an American icon with a fantastic product and a loyal following. Despite the current short-term difficulty, I believe the company still has a solid, long-term future.

The company is facing some serious short-term headwinds because of the capital and fixed-cost-intensive nature of the business. Ford reported Q1 2020 net loss of $2.0 billion. Even more concerning is this net loss corresponded with a first-quarter free cash flow of negative $2.2 billion. In order to raise cash, the company tapped around $15 billion from its credit lines, issued an additional $8 billion in debt, and suspended its dividend. The company ended Q1 with $35 billion in cash.

The preliminary results for Q2 do not look promising either as total vehicle sales were down 33.3%. This is really bad news for the company as, like all automobile manufacturers, Ford’s margins are incredibly tight. Despite having $155.9 billion in sales, the company only has a 13.6% gross margin. Given the high fixed costs, a small decrease in sales would lead to a large decrease in the bottom line.

A possible silver lining though is that retail sales were only down 14.3% and retail sales for trucks were practically flat. The bulk of the loss can be attributed to the lack of industrial fleet sales. This is not surprising given that companies were conserving cash due to the pandemic and a lot of these purchases may have been pushed back or canceled. Basically this means that the Q2 2020 results will most likely look much worse than Q1 2020.

Investor presentation

Investor presentation

Ford’s future prospects look a lot better

Despite the present challenges, Ford is prepared to fire on all cylinders through 2020-2022. First and foremost, a new Ford Bronco is set to launch sometime in 2021 (with the unveiling in a few days’ time). The Bronco is a classic brand last seen in 1996. Ford is intending to tap on the nostalgia for the brand by highlighting its classic design such as its iconic horizontal grill. Similar to the Jeep Wrangler, an SUV Ford dedicated to taking on, the Bronco is an off-road-focused SUV. It will be mid-sized 4×4 and be a body-on-frame designed for rough roads. The Bronco will be offered in two- and four-door configurations along with a smaller variant called Bronco Sport.

2021 Ford Bronco: What We Know So Far

2021 Ford Bronco: What We Know So Far

Ford has been very clever in building hype for the reveal of the Bronco by partnering with Disney to get the message across all of its platforms. In fact, the Ford Bronco is among the most anticipated cars in 2020 according to Google search trends. Hype for the Bronco has been building up since this study was done and is close to the highest it’s been in anticipation of the launch. The company seems to have learned its lesson from the failed launch of the Explorer, so I do not expect any issues from this launch.

These Are The Most Googled Upcoming Cars Per State In America | Carscoops

Google Trends

Brian Moody, executive editor at Autotrader.com, said, “Jeep has been capitalizing on their heritage for decades, and not in name only. Jeep has proven that a genuinely capable adventure/utility vehicle with a nod to the past is what many people want. And that’s what the Bronco promises, if they can deliver an authentic product and, more importantly, communicate that authenticity laced with nostalgia, it will be a winner.”

Ford declares war with all-new Bronco as Jeep Wrangler demand spikes

Apart from the upcoming Bronco, Ford has hedged its future in the electric vehicle market. Threatened by upstarts like Tesla (NASDAQ:TSLA) and its Cybertruck, Ford has dedicated itself to building its own electric vehicle using its ever-popular F-150 as the base. The F-150 is the best-selling vehicle in America, and it’s quite clever that Ford used this as a way to introduce its entire EV line-up. This means that for the average truck driver, the design and feel of the electric vehicle version F-150 is far more comfortable than the somewhat weird-looking Cybertruck. Ford is targeting to have this car out by 2022.

Pick-up trucks are the company’s differentiator and its bread and butter. Ford and Lincoln both ranked in the top 5 in J.D. Power 2019 US Initial Quality. Ford pick-up trucks have a brand history built over the years when it comes to power and reliability. Given Tesla’s Model Y production quality issues, I do not view the company as a threat to Ford’s long-term dominance of the market.

The other potential threat to Ford from the EV side is the upcoming Rivian truck which is set to launch sometime in late 2020. However, Ford has hedged being displaced by a possible disruptor by investing $500 million into the car manufacturing start-up. Ford’s Lincoln brand continues to closely work with Rivian using its electric vehicle platform. This partnership allows Ford to have a sort of “hedge” should Rivian become the dominant EV technology.

Watch Ford F-150 all-electric pickup prototype tow over 1 million lbs of train carts – Electrek

Valuation

I feel that Ford is undervalued as the company’s price to book value is close to the lowest it’s been in five years. The current price to book ratio is 0.83x. Automobile manufacturing is a mature industry that is incredibly capital intensive. This deters new entrants from entering the industry and ensuring the incumbents’ dominance in the long term. While the stock has recovered from the lows quite a bit, it has not yet fully recovered from its price of $9.16 at the beginning of the year.

ChartData by YCharts
ChartData by YCharts

Among the big three car manufacturers, Ford also consistently has the highest gross margins. In a capital-intensive industry, having the highest gross profit margin gives you a substantial edge over your competition. However, there is room for improvement as Asian competitors like Toyota (NYSE:TM) and Honda (NYSE:HMC) have gross margins above 15%. Ford’s margin has been declining over the past five years. I feel confident that the company can improve its margins as it is undergoing an $11 billion restructuring plan in order to bring costs down and be more efficient. With the various possible tailwinds the company could have in the future, I believe the company is oversold and a reversion to a price to book value of 1 is probable. The company has a book value per share of $7.46 (which is my near-term target price as well). This implies a 25% upside from the current price levels.

ChartData by YCharts

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in F over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Caveat emptor! (Buyer beware.) Please do your own proper due diligence on any stock directly or indirectly mentioned in this article. You probably should seek advice from a broker or financial adviser before making any investment decisions. I don’t know you or your specific circumstances, therefore, your tolerance and suitability to take risk may differ. This article should be considered general information, and not relied on as a formal investment recommendation.





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Duos Faces Some COVID-19 Headwinds (NASDAQ:DUOT)


Duos Technologies (DUOT) is an innovative company that has developed some interesting solutions for a whole series of problems, based on AI. Most prominent among these is their RIP (Intelligent Rail Inspection Portal) for the automated inspection of railcars while in motion.

While the company is experiencing headwinds as customers face logistical problems due to the pandemic, we believe these headwinds are temporary and the company continues to improve its capabilities and expanding these to new segments, which is the main reason we are bullish on the shares.

We described their capabilities at some length in our previous article, so we’re not going to repeat that here. While the Q1 figures were bad, with revenues plunging 77%, we think things really aren’t nearly as bad as that figure suggests.

Growth

Here is a summary of the last five years:

ChartData by YCharts

Revenue is stagnating and operationally things are taking a turn for the worse, but we think this reflects some temporary headwinds and investment in growth.

But there are nevertheless several contract wins:

  • CSX: A RIP was implemented in record time and is featured in a CSX promotional video. In the coming months, a set of 20 AI models will be added to the project.
  • CSX awarded the company another RIP order and management is optimistic that won’t be the last this year.
  • A RIP was nearly completed for another customer in Mexico.
  • Management expects a couple of follow on orders from a Canadian customer, which should be forthcoming “very-very soon.” (Q1CC). Indeed, after the close of Q1, the company was awarded a $1.8M contract for a RIP, to be completed by the end of Q3 (this was a delayed deal that was expected to close in Q1 but it got over the line in the end).
  • After Q1 closed, the company was awarded a $945K follow-on contract for Monroe County Sheriffs Office in Florida to provide an ICAS, the company’s Intelligent Correctional Automation System.

While the pandemic has had an undeniable negative impact on customers’logistics, there might be a silver lining given that the manual and labor-intensive inspections the RIP system replaces are complicated by the pandemic as well; from the Q1CC:

I think that there will be a continuous pressure on them to replace manual processes with technology. So we feel quite bullish that our process won’t go away. It may be slowed down because of prudent capital allocation among those larger customers but we don’t see any risk, downside risk when we lose this revenue.

The company can now install these RIP projects in a month, instead of the two months it used to take.

These carry the promise of the company addressing other segments besides railcar inspections, like:

  • ICAS
  • Track safety
  • Bank safety

With respect to the first (Q1CC):

Our ICAS system provides all digital video, intercom, detention door control and access control and is integrated into a singular command and control platforms known as centraco. The completely integrated system provides superior monitoring and control, is substantially more cost-effective and integrates all aspects of control into a single intuitive user interface. ICAS was specifically designed to replace legacy jail and correctional facility automation systems based upon the all programmable logic controller technology and human-machine interfaces.

One of the advantages is not only that it requires less labor to operate, it can be implemented in parallel, that is, without having to vacate the jail, which seems a pretty compelling selling point to us.

Nevertheless, management is actually warning against too much optimism for this segment (Q1CC):

We haven’t included in our projections any income for additional jails at this point. So that would be the prudent thing to do to postpone hiring dedicated team. But as long as we don’t hire a dedicated team, the business development obviously is not going to come by itself. But that’s one of the things I don’t want to [mislead] you and thinking that we said we’re going to have 5 to 10 jails a year because we don’t have the infrastructure and the staffing to do that right now.

But from that quote, the obvious take-away is that this segment has a lot of potential. Then, there is track safety, where the company is working with the MTA and New York transit (Q1CC):

we have matured our product and it’s now branded as [tracker wheel] where we are using artificial intelligence not only to detect objects of people falling on the track but we also can now classify what the objects are. For instance we can classify if someone’s wearing a hard hat and safety vest and we can then decide this is an allowed intrusion.

Management is in talks with various prospective customers, like the Florida DOT. This technology can be applied in other situations, like railroad crossings. Bank safety is another promising segment (Q1CC):

So with the banks, particularly a big customer, Texas Capital Bank in the last year we provided a security infrastructure to 36 subsidiaries.. We expect that the bank who is in the process of merging and adding hundreds additional branches we expect some business flow.

There are quite a few other applications already, described on the company website.

AI

In essence, all their applications are driven by AI, most notably their image recognizing capabilities, which depend on machine learning. The company is four-folding the capacity of image labeling, increasing the throughput to 700K images a month.

They have a library of 4M images, so they’ll have to keep at it for another 6 months or so to get through that. Why is this important? From Q1CC:

The increase throughput of image labeling will significantly impact our application quality as we will be able to present images to our AI engine in an order of magnitude greater than where we were before.

There is also progress with their AI platform truevue360, which offers bespoke AIaaS services, from the company website:

truevue360 offers an “Artificial Intelligence as a Service” (AIaaS) solution that can be hosted in the cloud, on premise or on the edge. All that you need to provide are business requirements and a data stream. truevue360 will do the rest.truevue360 will review your business needs to determine the best AI approach, develop a model that accurately produces your required results and train the model with your supplied data stream.

Truevue360 already announced its first $1M contract in Q3 last year, and there is likely more to come Q1CC:

we are making a great progress in developing the AI applications and models for our existing customers. On average, we are retraining seven models a week until we reach 95% accuracy at which point these models are deployed for live validation with the customers environments. We also experimenting with novel AI applications using drone video footage processing and high-speed rail car analysis looking for car separation.

The thing to notice here is that truevue360 produces recurring revenues, these are not just one-off projects.

Q1 figures and guidance

These are not pretty, revenue declined 77% to just $0.99M and EPS came in at -$0.80, missing by $0.23. But management argues that most of the decline is due to delays as a result of business interruptions of various customers (Q1CC):

The current pandemic related to the coronavirus COVID-19 outbreak has temporarily impacted expected receipt of awards and caused delays in execution due to travel and other restrictions.

Management feels good about the outstanding $25-30M bookings and there are no cancellations. Management did retract their 2020 revenue guidance (which stood at $20M) but still affirmed revenue growth in 2020, which means that revenues will come in above the $13.6M the company produced last year.

Finances

It’s no surprise GAAP margins took a dive on the soft revenue:

ChartData by YCharts

But it’s also clear that the company earns between 45% and 60% gross margins in normal times, and if truevue360 becomes a larger part of their revenues, that could increase further.

ChartData by YCharts

The company loses $4M in cash a year but this is pretty much its worst level in five years. The company did a financing in February (and the over allotment) selling 1.54M shares at $6 for a proceeds of roughly $9M.

It ended Q3 with $6.6M on the books, management argues this will last until break-even. The market cap is still tiny at $17.6M.

ChartData by YCharts

Valuation

ChartData by YCharts

For what it’s worth, two analysts average at an EPS estimate of -$1.15, and the one analyst taking on board next year sees an EPS of $0.73. Needless to say, we don’t see much in the way of valuation holding the shares back.

Conclusion

We think this is an attractive company in the making, the core capability is generic and applicable in many different markets, and on top of that, it functions as a generic AIaaS platform generating recurring revenues.

While there are undeniable headwinds from the pandemic which could last quite a bit longer as the situation in the US is worsening by the day, the company isn’t necessarily limited to the US market, and the pandemic also highlights advantages of the company’s application, most notably saving labor which not only brings cost advantages but also makes social distancing less complicated.

The shares are far from expensive, and the company has cash for at least another year, should the COVID-19 headwind persist.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in DUOT over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.





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