Hi Stephan, I know it's a bit of an old post, but I have a question about the numbers you used in financial projection. The gross profit for Y22 and Y23 on the sheet are 13 and 16 million CAD, but when I go over their financial statements, gross profit is 11 and 12 million CAD. When I checked the June edition of ROE reporter (https://donvillekent.com/investing-resources/), they also reported 13/16 million, so I feel like I'm missing something. Would you mind clarifying where you got the numbers?
I didn't know that depreciation is included as a cost of goods in Canadian accounting rules. Once you add depreciation in the reported gross profit, you'll be able to reach those numbers.
Hi Anton, thanks for your question. Exactly, you've caught that the difference is due to depreciation of equipment. I moved depreciation below gross margin as my personal preference is to consider gross margin excluding depreciation.
I still own Zedcor and was really impressed with their latest quarter. Their results and management commentary (on the call) was even better than I expected; they even reduced their related party transactions which was a nice bonus.
There was insider selling recently, but I don't always fault them for that as we know management can sell for many reasons; especially after the recent run up in share price.
Stephen, thanks for your comments. Admittedly I'm not early in Zedcor investment - I initiated a small, but not tiny, position recently -, but the prospect of the company is really interesting. I was surprised to learn there aren't that many companies as vertically integrated as Zedcor.
Have your thoughts on the first risk (moat) changed or evolved since the publication of this article? Just to share my thoughts
- I agree with the innovator's dilemma. Incumbents in security guard industry has zero transferrable knowledge in monitoring services. Incumbents in detection/monitoring services through sensors are better positioned but still have to cannibalize themselves to move towards computer vision-based surveillance.
- I do see a path to scale economies and some network effect. Vertical integration should help Zedcor becoming the lowest cost provider, and the operating cost of monitoring should have a decreasing marginal cost. And as they collect more data and experience, the quality of their service should improve over time.
I just can't wrap my head around how strong the barrier of entry they have. It doesn't seem like they own tons of proprietary technology, such as computer vision model or surveillance software, that would allow them to enjoy a bigger network effect. Competitors may be able to license similar sets of technology.
If this is the case, are we to rely heavily on the first mover advantage? First mover advantage in a market as fragmented as security/surveillance, especially in a niche vertical within this market that Zedcor operates, is likely to be huge, but I suppose it will hurt their utilization rate and revenue growth durability sooner.
As someone without a finance background I appreciate your posts being consistently written with a level of lead in and/or explanation that allows me to understand even the most complex terms and topics you discuss.
Regarding Zedcor would you ever consider an increase in property crime or building construction investment a useful indicator?
Thank you for the comment Chris, I definitely agree there are tailwinds in the security sector right now. Anecdotally, it feels like crime is on the rise.
And construction should also pick up once interest rates are low enough, especially in residential.
Interesting thesis. I will look at the valuation numbers. If your assumptions are reasonable (and they look like they’re) there’s a long runway ahead.
Penetration to the US was a challenge and the agreement with HD was their way in. They are quite heavily dependent and their customer base is too concentrated, hopefully there’s a plan to address this risk
Thank you Leroy. I just want to clarify one thing: their customer base isn’t as concentrated now that the pipeline has wound down. From their 2023 annual report: “The Company generates approximately 40% of its revenue from its top three customers (twelve months ended December 31, 2022 - 72% from largest customers). Only one customer accounts for more than 10% of revenue.”
These numbers are also for the full year. So if the largest customer is the pipeline operator, which didn’t significantly wind down until the end of the year, the 40% number is skewed higher. Customers two and three are both less than 10%.
Thanks for that clarification. There’s progress in the right direction but still quite concentrated imo. Any of the top 3 customers pulling out for any reason (not that there’s any likelihood of this happening) has a material impact on their valuation and business.
I think we saw in 2023 what happened when their biggest customer (72% of revenue!) ended their project — they mostly maintained revenue QoQ since they were able to upgrade and relocate those towers.
So I agree that losing a big customer is not great and they didn’t show much revenue growth (as a result of the upgrade and relocation time), but not really a material impact on their business as (1) there is excess demand right now and (2) the initial tower capex is not lost, just relocated.
If customer concentration does continue to decline, losing a customer should have even less of an effect.
So long as they have demand > than the number of towers they can put in the field (and there is a big question of how long it will last) customer concentration risk shouldn’t be as bad as it is for some other companies.
Hi Stephan, I know it's a bit of an old post, but I have a question about the numbers you used in financial projection. The gross profit for Y22 and Y23 on the sheet are 13 and 16 million CAD, but when I go over their financial statements, gross profit is 11 and 12 million CAD. When I checked the June edition of ROE reporter (https://donvillekent.com/investing-resources/), they also reported 13/16 million, so I feel like I'm missing something. Would you mind clarifying where you got the numbers?
I didn't know that depreciation is included as a cost of goods in Canadian accounting rules. Once you add depreciation in the reported gross profit, you'll be able to reach those numbers.
Hi Anton, thanks for your question. Exactly, you've caught that the difference is due to depreciation of equipment. I moved depreciation below gross margin as my personal preference is to consider gross margin excluding depreciation.
I still own Zedcor and was really impressed with their latest quarter. Their results and management commentary (on the call) was even better than I expected; they even reduced their related party transactions which was a nice bonus.
There was insider selling recently, but I don't always fault them for that as we know management can sell for many reasons; especially after the recent run up in share price.
Stephen, thanks for your comments. Admittedly I'm not early in Zedcor investment - I initiated a small, but not tiny, position recently -, but the prospect of the company is really interesting. I was surprised to learn there aren't that many companies as vertically integrated as Zedcor.
Have your thoughts on the first risk (moat) changed or evolved since the publication of this article? Just to share my thoughts
- I agree with the innovator's dilemma. Incumbents in security guard industry has zero transferrable knowledge in monitoring services. Incumbents in detection/monitoring services through sensors are better positioned but still have to cannibalize themselves to move towards computer vision-based surveillance.
- I do see a path to scale economies and some network effect. Vertical integration should help Zedcor becoming the lowest cost provider, and the operating cost of monitoring should have a decreasing marginal cost. And as they collect more data and experience, the quality of their service should improve over time.
I just can't wrap my head around how strong the barrier of entry they have. It doesn't seem like they own tons of proprietary technology, such as computer vision model or surveillance software, that would allow them to enjoy a bigger network effect. Competitors may be able to license similar sets of technology.
If this is the case, are we to rely heavily on the first mover advantage? First mover advantage in a market as fragmented as security/surveillance, especially in a niche vertical within this market that Zedcor operates, is likely to be huge, but I suppose it will hurt their utilization rate and revenue growth durability sooner.
As someone without a finance background I appreciate your posts being consistently written with a level of lead in and/or explanation that allows me to understand even the most complex terms and topics you discuss.
Regarding Zedcor would you ever consider an increase in property crime or building construction investment a useful indicator?
Thank you for the comment Chris, I definitely agree there are tailwinds in the security sector right now. Anecdotally, it feels like crime is on the rise.
And construction should also pick up once interest rates are low enough, especially in residential.
Interesting thesis. I will look at the valuation numbers. If your assumptions are reasonable (and they look like they’re) there’s a long runway ahead.
Penetration to the US was a challenge and the agreement with HD was their way in. They are quite heavily dependent and their customer base is too concentrated, hopefully there’s a plan to address this risk
Thank you Leroy. I just want to clarify one thing: their customer base isn’t as concentrated now that the pipeline has wound down. From their 2023 annual report: “The Company generates approximately 40% of its revenue from its top three customers (twelve months ended December 31, 2022 - 72% from largest customers). Only one customer accounts for more than 10% of revenue.”
These numbers are also for the full year. So if the largest customer is the pipeline operator, which didn’t significantly wind down until the end of the year, the 40% number is skewed higher. Customers two and three are both less than 10%.
Thanks for that clarification. There’s progress in the right direction but still quite concentrated imo. Any of the top 3 customers pulling out for any reason (not that there’s any likelihood of this happening) has a material impact on their valuation and business.
I think we saw in 2023 what happened when their biggest customer (72% of revenue!) ended their project — they mostly maintained revenue QoQ since they were able to upgrade and relocate those towers.
So I agree that losing a big customer is not great and they didn’t show much revenue growth (as a result of the upgrade and relocation time), but not really a material impact on their business as (1) there is excess demand right now and (2) the initial tower capex is not lost, just relocated.
If customer concentration does continue to decline, losing a customer should have even less of an effect.
So long as they have demand > than the number of towers they can put in the field (and there is a big question of how long it will last) customer concentration risk shouldn’t be as bad as it is for some other companies.
We’ll see though; just thinking out loud.