Reassessing the Q1 analysis of SurgePays (NASDAQ:SURG) in light of Q2 earnings.
In my previous evaluation, SurgePays was rated as a Buy, with the potential for rapid expansion. My recommendation was based on three key factors. Firstly, SurgePays achieved profitability in Q1 and is projected to experience further growth in the second half of the year. Specifically, management guidance anticipates a double-digit EBITDA margin after years of being unprofitable. Secondly, the neighborhood store distribution model facilitated low acquisition costs and ample room for growth. Lastly, the company’s valuations were lower compared to the industry and reflected an undervalued business.
Although concerns regarding reliance on government subsidies, competition, and the ability to deliver on promised scale remained, SurgePays shares experienced a significant decline of over 30% in July due to negative reports about regulatory compliance. However, the company strongly contested these allegations.
Despite the negative reports, SurgePays had a successful Q2, exceeding expectations in terms of profitability. The Affordable Connectivity Program continues to thrive, and the company is expanding its distribution methods while remaining on track to achieve its neighborhood store acquisition target. Moreover, valuation multiples indicate that the stock is undervalued compared to previous analysis.
Based on the fulfillment of my Q1 thesis and the successful performance aligning with management guidance, I maintain my Buy rating for SurgePays, particularly considering the current lower price.
Expansion Progressing as Planned
SurgePays’ primary expansion strategy involves partnering with convenience stores to install tablets, allowing customers to register for subsidized cell service. The company intends to be present in 13,000 stores by the end of this year, with confirmation during the Q2 earnings discussion that they are on track to achieve this goal.
In addition to their existing methods, SurgePays has collaborated with ParichuteConnect to raise awareness of subsidized cell service through public schools and community service organizations. They have also partnered with LeadEx Solutions to prompt customers during ATM transactions. Both collaborations provide additional customer sources with low acquisition costs.
Given SurgePays’ reliance on the Affordable Connectivity Program, concerns about its sustainability emerge. However, bipartisan support and expected program renewal offer reassurance.
Record-Breaking Q2 Performance
In Q2, SurgePays achieved record revenue, EBITDA, and net income. The company is 37% towards fulfilling its full-year revenue guidance, consistent with growth expectations. Although SurgePays does not provide profitability guidance, their EBITDA estimate of $26 to 30 million is already 40-45% fulfilled, surpassing expectations.
Despite significant investment in inventory, cash flow has improved, and SurgePays is already operating with positive cash flow, exceeding initial projections. As more stores come online annually, the inventory versus net income ratio is expected to improve further.
While store numbers are not reported, management confirmed during the earnings call that SurgePays is on track to achieve its goal of 13,000 stores this year and 25,000 stores the following year. Subscriber numbers, however, are reported and currently stand at 275,000, representing a significant increase from the previous year and reaching 55% of the annual target.
Strong Buy Indicators
SurgePays presents compelling buy signals. Firstly, valuation multiples are substantially lower compared to the industry, despite achieving double-digit net income. Secondly, the quant rating indicates a strong buy for all measures, except for momentum, which is affected by the regulatory compliance allegations. Nevertheless, quant still suggests a buy recommendation.
Wall Street analysts consistently provide strong buy ratings, with an average price target of $12.75.
A conservative discounted cash flow (DCF) analysis yields a price target of $9.92, nearly double the current market price. This DCF assumes management’s successful delivery on 2023 guidance, Q4 performance as a basis for 2024, and a 3% growth rate alongside inventory improvements.
Managing Downside Risks
The primary downside risk to SurgePays stems from a potential disruption to the Affordable Connectivity Program. However, broad bipartisan support and the program’s likely renewal mitigate this risk. With an expanding customer base, SurgePays can more easily maintain a solid customer set even if program modifications occur.
While competition poses another risk, SurgePays’ proactive distribution model places them several years ahead of potential competitors. The existing relationships with convenience store partners also safeguard revenue.
Finally, there is the risk of SurgePays not achieving its scaling targets. So far, the company remains on track, having diversified into additional distribution channels. However, future performance will determine the ultimate outcome.
SurgePays has demonstrated resilience and controlled growth despite regulatory compliance challenges. Q2 results showcased record-breaking revenue and EBITDA figures, reaffirming the company’s ability to fulfill full-year guidance.
The expansion and diversification of SurgePays’ distribution model position them favorably in the market and provide a competitive edge. Attractive valuation multiples and a conservative DCF analysis indicate that the stock is undervalued.
Managing downside risks effectively and maintaining promising strategies contribute to SurgePays’ potential for significant upside. Therefore, I reaffirm my Buy rating for SurgePays, considering its recent performance and promising growth prospects at the current share price.
Editor’s Note: This article focuses on microcap stocks. Please be aware of the associated risks.