Can This Stock Offer Security to Your Portfolio?

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The home security market is becoming a difficult nut to crack as new entrants are making the industry more competitive. The recent purchase of LifeShield Home Security by DirecTV marks yet another pay-TV distributor entering the home security business after Time Warner and Comcast put ADT’s (NYSE: ADT) stock on watch.

Secure earnings

ADT’s first quarter results were announced recently. Net income for the quarter increased by 1.9% to $107 million and GAAP diluted EPS came in at $0.47 per share. I would say these were average results, keeping in mind that ADT is still the nation’s top security services provider and commands a major chunk of the market share. The highlight of the call was improved performance of ADT Pulse, a revolutionary holistic security management program that allows customers to efficiently use remote security and other features.

Pulse of the business

Being counted upon as a major driver of ADT’s business, its take rates reflect strong momentum in the consumer markets. In the direct residential sales channel, take rate was 32.7%, up 3 percentage points from the previous quarter. A unique feature embedded in Pulse enables customers to manage lighting of the home remotely, and is very popular with users. As for the small business sales channel, the take rate was over 25%, up 5 percentage points from the prior quarter.

An impressive thing about ADT is that it is immensely focused on Pulse, a next-gen product and the main driver for its business. Constant efforts are necessary to innovate and provide customers with new features in order to sustain demand for the product. For instance, the company recently rolled out a new feature called Modes that allows a customer to pre-program certain recurring situations. In simple words, you can manage things like lighting and temperature with more ease and without programming every single time.

Price escalations accounted for 65% of the increase in average revenue per user (ARPU), whereas the remaining 35% came in due to a richer mix from new customer additions. Only 0.6% of the 5% growth in recurring revenue came from an increase in overall customer base. In my opinion, this is not a major area of worry, but that being said, the company should bear it in mind when making price changes to its products. As I mentioned, the home security market is becoming increasingly competitive, and that elevates the pressure of retaining and adding new customers.

Tyco’s specialization

Tyco’s (NYSE: TYC) shares saw bullish movement last month after the stock rallied because of strong quarterly results. ADT’s spin-off from Tyco in 2012 was received well by the market, both then and now. Both companies have become behemoths in the markets they serve. Tyco specializes in fire protection equipment and serves huge markets across Europe, North America, Canada, Asia, and the Middle East. Earnings per share for the second quarter, before special items, was $0.42, up from $0.30 in the same quarter last year.

Management’s strategy around inorganic growth is commendable and has paid off handsomely in the last year. The company acquired Chemguard and Visonic last year, both of which have performed beyond expectations and increased Tyco’s presence in oil and gas verticals and wireless technology platforms, respectively. Based on full year EPS guidance in the range of $1.80-$1.85, it is currently trading at 17 times earnings, a highly justified valuation.

More from the industry

Brink’s (NYSE: BCO) delivered strong results in the first quarter, beating Street estimates with an EPS of $0.35 per share. A one-time robbery incident hurt profitability as Brink’s had to reimburse customers for stolen diamonds on a plane attack at Brussels Airport. North America, a region that is fiercely competitive, underperformed for the company. As a result, the management lowered its margin outlook in the region to 2%-3% from 4%. On the brighter side, performance in Latin America was commendable as profits were much stronger than anticipated. The company is doing right by focusing on achieving long-term success on essential parameters like cost management, productivity, and solution-selling.

Final take

The home security industry is becoming increasingly competitive, which is disrupting demand for industry leaders like ADT. Now, summer is an ideal season for security services providers because a lot of Americans will go on at least one vacation in the season. This increases their vulnerability to burglary, which fuels the demand for proper security. As such, ADT is looking to capitalize on this spurt in demand.

One of the major things to watch for the remaining half of the year is capital spending, which is poised to increase as a result of higher investment in Pulse penetration in the dealer channel. As such, the challenge would be maintaining reasonable cash flow for the year. In spite fierce competition and internal challenges, I would recommend a "buy" for this stock because it is just beginning a great selling season with innovative products that have new and desirable features.

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Mihir Mehta has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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