NAPCO SECURITY TECHNOLOGIES, INC. 
It designs and manufactures commercial & residential security products, which are sold through more than 10000 dealers, 2000 integrators and 200 distributors in the United States (B2B business model). In addition, it is the only company to offer products in all three security sectors: Alarms & Connectivity, Locking, Access Control. The group has 4 main companies: Napco (50% Commercial & 50% Residential), Marks USA (100% Commercial), Continental Access (100% Commercial) and Alarm Lock (100% Commercial).
The American specialist has recurring revenue products ($12-$26/month) such as StarLink. It is a line of wireless communication devices that enable alarm signals to be transmitted from security alarm systems to a central monitoring station via cellular (Verizon, AT&T and T-Mobile) or internet networks. The strength of StarLink Connect is that it works with millions of existing competitor alarm systems, it is connected to iSecure (manageable touchscreen tablet) which is hardware-enabled SaaS (Software as a Service) solutions ($7-$13/month) and users pay a monthly management fee to the company. It also enjoys intellectual property with two dozen patents and proprietary software and copyrights.
Napco's customers are divided into 2 different sectors: Commercial (5 million buildings) & Residential (120 million homes) creating a $4.9 billion opportunity. It benefits from an excellent TAM (Total Addressable Market) where school security represents a $10 billion opportunity (over 131,000 educational institutions). The increasing number of mass shootings is forcing schools to modify or upgrade their security and alarm systems. More than $1 billion has been budgeted for this purpose and an additional $2 billion may be allocated over the next ten years. It provides a fully integrated solution for schools of all sizes, ranging from K-12 to universities; its clients include prestigious institutions such as Stanford and Columbia.
The main competitors of Napco in the security equipment industry in the US includes Resideo Technologies, ADT, and Allegion, along with approximately 12 other companies that also provide security equipment and may have greater financial resources. To differentiate itself, the company invests 6-8% of annual revenues on R&D and competes on the basis of features, quality, reliability, pricing, and the incorporation of the latest technological advances. In addition, it emphasizes its technical support services, reputation, and ability to provide timely product delivery, but acknowledges that its business may be materially impacted by competitors announcing or introducing new products or services, as well as implementing effective marketing or sales strategies. Therefore, the group is under pressure from rising costs caused by supply chain disruptions, which can have a negative impact if it is unable to offer a lower price or similar product to its competitors.
However, the company benefits from an excellent management, but above all from a CEO, Mr. Richard Soloway that has more than 30 years of expertise in the security and electronics industries and who leads the business with a firm hand. He won various honors such as Ernst & Young's “Entrepreneur of the Year” and Guardian Angels’s "Champions for Safety through Education".
Financial Analysis:
Napco has experienced strong growth in recent years with a market capitalization up 1029% since 2015 for a stable share count around 37 million. The company's net sales have grown significantly by 42.57% during the period 2020-2022, which is a strong indicator of demand for its products and services. EBITDA has grown exponentially from $14 million in 2020 to $33.6 million in Q2 2023, representing a CAGR of 41.9% with net margins (industry-leading) expected to evolve around 20% in 2023 and 2024. Net income also grew strongly from $7.65 million in 2018 to $19.6 million in 2022 and analysts expect $31.3 million in 2023 and $41.7 million in 2024.
However, the increase in inventory (2020-2022) has resulted in a decrease in free cash flow (-$15.15 million), due to the business's decision to purchase hard-to-get parts used in products that generate recurring service revenue. Despite this, FCF is expected to reach $16.7 million in 2023 and $42 million in 2024. The P/E ratio is currently high, around 40x earnings (quality is expensive), but should decline to 30x in 2024 and around 22x in 2025.
Net sales for Q1 2023 climbed by 27% (compare to Q1 2022) to a record-breaking quarterly total of $42.3 million from $33.4 million. Research and development expenses rose by 12% to $2.2 million, or 5% of sales, from $2.0 million. Selling, general, and administrative costs for this quarter dropped by 5% to $7.8 million from $8.2 million (which represent 25% of sales), for the same time the previous year. Operating income climbed by 643% to $9.4 million for the quarter, while net income reached a quarterly record of $8.4 million, or $0.23 per diluted share, up from $1.0 million, or $0.03 per diluted share (+714%).
Napco is a profitable, well-managed company, well-positioned in a very competitive and steadily growing industry. It is, however, subject to the effects of general economic and market conditions: in times of economic downturn, the number of independent distributors, dealers, and installers of security equipment may decrease. It will therefore be critical to continue to develop their security products in educational institutions. However, it deserves a place in your Watchlist.
