Rekor Systems: Risk-Reward Unattractive Due To Potential Liquidity Risk

Rekor Systems (NASDAQ:REKR) is a company providing AI-driven hardware and software technology that gathers mobility data from transport activities to deliver roadway intelligence.

REKR changed its name from Novume Solutions in 2019, and the stock appears to have gone public at a price of $2 in 2017. All-time return since then has been below average, in my opinion. REKR saw its all-time high of $23 upon the completion of common stock offering in 2021, but performance continued to deteriorate since. Most recently, since last year, REKR has gained quite a momentum. It is currently trading around $2.4 per share, up 117% over the past year.

I initiate my coverage with a neutral rating. My 1-year price target of $2.7 presents 12% upside from the current trading price of $2.4. I conclude that the risk-reward here is unattractive, mostly due to the potential liquidity risk in FY 2024.

Financial Reviews

Fundamentals have been mixed. Though REKR has been able to maintain over 70% annual revenue growth as of FY 2023, the company has not yet reached cash flow positive and net profitability over the past five years. Net loss margin has been relatively steady, but still suggests a huge gap to breakeven. Meanwhile, operating cash flow (OCF) burn has increased to over $30 million as of FY 2023 from merely mid-to-high teens pre-2022.

The lack of cash generation has put pressure on liquidity and forced REKR to mostly rely on external financing from debt and equity issuances to sustain its operations. This has resulted in extensive dilution for shareholders and an increase in its debt-to-equity ratio. Shares outstanding have doubled to over 63 million since 2020, while the D/E ratio more than tripled to 0.8x YoY. Meanwhile, the liquidity outlook still does not appear ideal today. Having raised close to $71 million in 2021 and then over $45 million again in 2023, REKR ended FY 2023 with just over $15.4 million of liquidity. If OCF burn continues at the current rate, I believe there is a decent possibility for REKR to run out of cash in FY 2024.

Catalyst

As commented by the management in the Q4 earnings call, the increase in demand from state and federal governments to improve public infrastructures, especially roads and highways, should continue to benefit REKR in 2024 and beyond:

Yes, if you can hear me, okay. Yes, we are starting to see money freed up as a result of distributions from the IIJA, which is otherwise known as the Bipartisan Infrastructure Law, or BIL. It’s about – I would say, about $300 billion has been deployed over 2022 – late 2022 and also coming into 2023. And so, there’s a lot of – I’d say, a lot more to go, but the funds are already being released, and we are seeing that states are starting to reap the benefits of that freed up injection of capital.

Source: Q4 earnings call.

Furthermore, as stated in the earnings call, government-funded programs will continue to support the demand, enabling states to have the funds readily available to execute on the projects. On that note, in addition to the BIL, the recent federal initiative to disburse over $3.3 billion of infrastructure grants to various states will serve as a key catalyst for REKR today.

The $3.3 billion capital injection into various states aims to build transportation infrastructure to provide communities a better access to healthcare, schools, and other facilities. As state governments continue to build sidewalks, transit routes, or even highways, I expect demand for REKR AI-driven solutions, which are mostly focused on better traffic monitoring, to increase.

In the meantime, the recent follow-on offering completed in February 2024 will also provide REKR with a $26.5 million of additional liquidity, effectively helping in lengthening REKR’s runway. This near-term cash injection has come at the right time, considering that REKR may still be burning through OCFs this year, especially as it anticipates a potential increase in demand.

Risk

Risk remains high. I believe the recent follow-on capital raise is merely a short-term fix for REKR. There is also further uncertainty regarding REKR’s ability to save or raise more money to meet its liquidity needs in FY 2024. When asked about how REKR may address this issue in the earnings call, it appears that the management has not yet had a clear action plan just yet, as per the comment:

It doesn’t necessarily need to wait until the end of calendar 2024. It can happen in calendar 2023, and we believe it will. And we’re going to continue to work hard to cross that bridge. I can’t predict a day, but it’s going to happen. So, but we also respect the accounting rules and how strict they are, and how difficult it is to do these things.

Source: Q4 earnings call.

While liquidity remains a concern, another key risk lies in the moderate concentration of its revenue within a particular customer. As stated in its 10-K, a particular customer made up 18% of REKR’s revenue as of FY 2023. More importantly, the level of concentration has also increased from last year. The same customer last year only made up 10% of revenue.

Valuation / Pricing

My target price for REKR is driven by the following assumptions for the bull vs bear scenarios of the FY 2024 projection:

1. Bull scenario (50% probability) assumptions – I expect REKR to achieve an FY 2024 revenue of $66.6 million, a 90.7% growth, in line with the market’s estimate. I assume a forward P/S to stay at 4.4x, bringing the stock to $3.7, near its 1-year high.

2. Bear scenario (50% probability) assumptions – REKR to deliver FY 2024 revenue of $60 million, missing the market’s low end estimate by about $5.5 million, a rather considerable miss. I assign REKR a forward P/S of 2.3, assuming a correction to $1.72.

Consolidating all the information above into my model, I arrived at a FY 2024 weighted target price of $2.7 per share, projecting a potential upside of around 12%. I would rate the stock neutral.

At 12% upside, I consider risk-reward to be unattractive. More importantly, I believe the uncertainty around REKR’s liquidity situation today presents a huge risk that investors should not take lightly. It is important to note that my projection assumes another 27% additional shares outstanding for FY 2024 for both scenarios due to possible capital raise from common stock issuance, which means that it already incorporates a going concern assumption. As such, without this assumption, any target price projections, including mine here, will not be meaningful at all.

The P/S multiple of 2.3x – 4.4x also means that REKR’s valuation is relatively less competitive compared to other similar players in the transport IT space, such as Iteris (ITI) and PowerFleet (PWFL). Both stocks have P/S of 1.2x, and are in better financial positions than REKR.

Conclusion

REKR is a company providing AI-driven roadway intelligence solutions. There is a potential increase in demand for its solutions, driven by the recent federal initiatives to deploy more capital to build and improve public transportation infrastructures nationwide in the US. One of these initiatives would be the recent $3.3 billion grants announced by the Biden administration, which I believe should present a key catalyst for REKR. On the flipside, REKR could face a liquidity issue. The recent follow-on capital raise with William Blair is no more than a short-term fix, in my opinion. This makes the 12% upside provided by my target price model potentially unattractive from a risk-reward standpoint. I rate the stock neutral.