Plant ADT Securely in Your 'Don't Be Tempted' List

ADT looks undervalued based on several measures, including its average analyst price target. But the earnings growth it needs for a share-price rebound is unlikely to be forthcoming.
By Richard Saintvilus ,

Based solely on its average analyst 12-month price target of $42.50, home security company The ADT Corporation (ADT) - Get Report looks like a bargain at current share price of around $33. The shares are down 7% on the year, and have fallen more than 10% in the past six months. Given all this, many investors may be wondering if it's time to buy ADT.

But ahead of the company's fourth-quarter earnings results, which are due out before the opening bell Wednesday, investors would be better served to ignore the cheap stock price and focus on the headwinds ADT still faces -- particularly in the realm of home automation. Owing to proliferation of Internet of Things devices, remote monitoring apps and various do-it-yourself home security tools like Canary, ADT's growth prospects are not as attractive as its stock price would suggest, and its earnings are still under pressure.

For the quarter that ended in September, analysts' average earnings estimate is for 48 cents a share on revenue of $906 million, translating to a 13% decline in earnings, while revenue is projected to rise about 3%. For the full year, earnings are projected to decline about 4% to $1.94 a share, while revenue of $3.58 billion would mark an increase of 5%.

If you've held ADT shares for the past year, three years or five years, you're down more than 7%, 20% and 7%, respectively. During those time periods, you would have had much a better result buying investing in a Dow Jones Industrial Average (DJI) or the S&P 500 (SPX) index fund.

It's true, the company is still growing both its subscriber base (up 262,000 in the third quarter) and operating cash flow (up 6% in the third quarter). Nonetheless, it's tough to recommend these shares, even with ADT stock trading some 22% below its 52-week high. Competitive threats are one thing, but ADT -- beyond its recent partnership with Alphabet (GOOGL) - Get Report (better known as Google) -- has not shown it can effectively respond to the changing landscape, and capitalize on the IoT and home automation trends.

What it's going to take to reverse the decline in the stock is simple: earnings growth. And the Florida-based company is projected to grow EPS at an average annual rate of 7% over the next five years. However, while that projected growth rate might sound good at first glance, compared to the 5% rate projected for the S&P 500, it also means ADT's projected 2016 earnings will be less than 3% higher than 2014's actual results of $2.02 a share. In other words, those fiscal 2016 consensus estimates of $2.08 a share are relatively unimpressive.

Based on that, ADT stock is likely to underperform the S&P 500 index in 2016. So, despite how cheap these shares might appear at 15 times 2016 estimates (one point lower than the S&P 500), ADT lacks the earnings muscle that would justify buying its shares ahead of Wednesday's results.

This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.

Loading ...