Digi International Inc.: Why this Small IoT Play Has Great Upside Prospects

Digi International Inc. Why this Small IoT Play Has Great Upside Prospects
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Digi International Inc. Has High Potential in the Age of IoT

We all know about the expected strong growth in the Internet of Things (IoT) segment, as 5G technology comes online to power devices’ ability to communicate with each other in a nearly instantaneous manner.

An intriguing IoT small-cap play that could return strong gains is Digi International Inc. (NASDAQ:DGII), which has a market cap of around $338.0 million.

While Digi International has been around for over 30 years, the company hasn’t been able to break out yet. But perhaps things are about to change.

Digi International Inc. sells to global clients in food service, retail, healthcare, transportation/logistics, and education. What makes the company particularly interesting is its focus on making machine-to-machine (M2M) communication hardware for the IoT segment.

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DGII stock outperformed the S&P 500 this year, returning 19.3%. And there could be much more to come because of the company’s improving fundamentals.

Chart courtesy of StockCharts.com

The above Digital International stock chart shows it trading around trend-line support and the 50-day moving average. An upward breakout would initially target $15.00, while the downside risk is $10.50 to $11.50.

My Fundamental Bullish Thesis for DGII Stock

To say Digi International Inc. has done very little over the past five fiscal years is an understatement. The company’s revenues have barely moved, seeing declines in three of the past five years, although they increased by a significant amount in fiscal 2018.

Fiscal Year Revenue (Millions) Growth
2014 $192.7 -1.4%
2015 $203.9 5.8%
2016 $203.0 -0.4%
2017 $181.6 -10.5%
2018 $228.6 25.7%

(Source: “Digi International Inc.,” MarketWatch, last accessed June 21, 2019.)

Digi’s revenue growth rate doesn’t appear to be sustainable, but its revenues are expected to expand.

For fiscal 2019, the company is estimated to ramp up its revenues by 11.6% to $254.9 million. For fiscal 2020, it’s expected to follow this up with a 6.7% rise to $271.9 million. (Source: “Digi International Inc. (DGII),” Yahoo! Finance, last accessed June 21, 2019.)

Digi has also produced positive earnings before interest, taxes, depreciation, and amortization (EBITDA) and profits in five straight years, which is impressive for a company of this scale. Furthermore, its EBITDA grew in three of the last five years.

Fiscal Year EBITDA (Millions) Growth
2014 $7.4 -58.8%
2015 $17.2 133.3%
2016 $23.0 34.1%
2017 $13.3 -42.1%
2018 $18.0 35%

(Source: MarketWatch, op. cit.)

The profit picture needs some work though. Digi International Inc. has recorded two straight years of negative earnings growth, as the following table shows:

Fiscal Year Diluted Earnings Per Share Growth
2014 $0.07 -68.2%
2015 $0.26 273.1%
2016 $0.53 101.3%
2017 $0.35 -33.4%
2018 $0.05 -86.5%

(Source: Ibid.)

The good news is that Digi is estimated to grow its earnings to $0.32 per diluted share in fiscal 2019 and to $0.47 per diluted share in 2020. (Source: Yahoo! Finance, op. cit.)

DGII produced positive free cash flow (FCF) from fiscal 2015 to fiscal 2017 before reporting a disappointing negative FCF in fiscal 2018, the company’s worst reading in five years.

Fiscal Year Free Cash Flow (Millions)
2014 -$1.6
2015 $9.6
2016 $24.4
2017 $0.7
2018 -$4.6

(Source: MarketWatch, op. cit.)

But given Digi’s expected earnings growth, I would expect the company to produce much better FCF over the next two years.

Analyst Take

Digi International Inc.’s improving fundamentals should translate into a higher share price on the horizon.

The strong institutional ownership of 170 institutions holding 81.3% of the outstanding shares is a bullish sign, especially for a small company such as this. (Source: Yahoo! Finance, op. cit.)

Digi International stock trades at 22 times its high estimate and it has a price/earnings-to-growth ratio of 2.02. Both figures indicate that the stock is not cheap, but given the company’s potential in the IoT market, DGII stock appears to be worth a higher multiple.