Karooooo's third quarter results

Karooooooooo with all the o's has released its third quarter 2021 results. This company is firmly in my long-term JSE portfolio and I was happy to see a positive market response to the result with a 2.5% rally.

This is without doubt a growth stock, which requires strong belief in the story and the potential for future cash flows. I love the subscription model that generates recurring revenue. The downside to Karooooo (JO: KROJ )'s model is that significant cash flow investment is required to generate new customers.

In particular, the group has to spend a fortune on the tracking equipment fitted to the vehicles of new subscribers. This creates a situation where operating profits and especially free cash flows lag revenue growth.

Another key element to the company narrative is that Covid has impacted the group's sales efforts in Asia. After bulking up the sales team and executing the international listing, the company had to absorb the costs during the pandemic without managing to achieve the expected level of revenue in that region.

The company has used Covid as an excuse for sub-par growth in Asia Pacific for a few quarters now. At some point, the story will become stale. South Africa posted subscription revenue growth of 21% and Asia Pacific posted 17% revenue growth on a constant currency basis in this quarter. Considering the extensive investment that has been made for international growth, I want to see that rate accelerate in Asia Pacific

.At group level, subscribers have increased 18% year-on year to 1.47 million subscribers. This drove revenue growth of 22% vs. the comparable quarter last year, or 25% on a constant currency basis. Subscription revenue was up 17% in rand and 19% on a constant currency basis, so revenue per subscriber has been fairly consistent.

Other revenue items include R24 million from Carzuka (still in beta phase) and R18 million in Picup, a cloud-based logistics technology company in South Africa.

Karooooo's (JO: KROJ ) annualised recurring revenue is now R2.76 billion, up 16% from a year ago. This means that if the company didn't lose or gain another customer for the next 12 months, this would be the revenue.

The revenue story certainly sounds exciting. It may shock you that the company's operating profit only increased 3% despite the big jump in revenue.

Due to the significant up-front investment in equipment and the bulking up of the sales team, the payback period on a new customer has become rather long. The lifetime value (LTV) of a customer is considered by the company to be 9x higher than the cost to acquire a customer. This means investors have to be patient for the cash flows to come through.

This is typical of a growth stock. Another typical feature is that the company is pushing ahead with a major recruitment drive in preparation for further growth. Sales and marketing expenditure increased 23%, R&D increased 80% off a subdued base during Covid restrictions and general / admin expenses increased by 10%.

The percentage of revenue spent on sales and marketing as well as R&D has increased from a combined 15.1% to a combined 17.6%. The percentage spent on general and administrative expenses has decreased from 21.3% to 20%.

The net effect of all this is that earnings per share increased by 10%.

The company talks about the "Rule of 40" - a principle that a software company's combined growth rate and profit margin should exceed 40%. You just add the two percentages together e.g. revenue growth of 25% and profit margin of 20% would add up to 45% and is thus higher than the Rule of 40. I personally don't focus too much on this kind of thing, but Karooooo notes that it has beaten this rule in the past four quarters and I wanted to explain what the concept means.

Karooooo generated R750 million in cash from operations over the first nine months of this financial year and invested R445 million into equipment and infrastructure. Due to the significant investment in growth, free cash flow for the 9 months at R306 million was 25.5% lower than in the comparative period. That's the kind of thing I focus on.

The company expects to end the year (i.e. after the next quarter) with between 1.5 million and 1.6 million subscribers. Subscription revenue will be between R2.5 billion and R2.7 billion. Adjusted EBITDA margin will be between 45% and 50% (excluding Carzuka and Picup).

I continue to hold the stock as I believe in the international growth story and I like the underlying economics. I am keeping an eye on the extent of investment for growth vs. the actual growth being delivered. The company needs to start showing a higher growth rate internationally than in South Africa.

Disclaimer: the author holds shares in Karooooo

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