Is Nautilus Overvalued Or Still A Good Investment?

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 |  About: Nautilus, Inc. (NLS), Includes: BDE, JOUT
by: Justin Kuepper

Nautilus Inc. (NYSE:NLS), a consumer fitness products company that owns brand names like Bowflex and Schwinn, has jumped more than 70% so far this year and more than 120% over the past 52 weeks. Better-than-expected third-quarter earnings and fourth-quarter guidance, both surpassing analyst estimates, largely drove these gains over the past few months.

During the third quarter of 2012, the company announced earnings of 4 cents per share that blew past analyst estimates of a 1 cent loss. The firm also expects its fourth-quarter net sales to reach $65 million and fully diluted earnings to come in at between $0.21 and $0.23, which is higher than analyst estimates of $62.3 million in revenue on $0.19 in earnings.

In this article, I'll take a closer look at these drivers and determine if the stock has more room for upside over the coming year or if investors should consider selling.

Benefiting from a Two Trends

Nautilus reported a modest 1.7% increase in net sales to $38.1 million during its third quarter, due largely to a 19.6% increase in sales of its broadening line of cardio products and a 4% increase in consumer credit approval rates to 31% in its Direct division. But, since shifting from strength equipment to cardio equipment, gross margins improved 590 basis points versus the year-ago period, providing a strong boost to the bottom line.

These results offset the Retail division's net sales that fell 16.9% due to measures taken by the company to stabilize its declining gross margins. Since it raised prices during the third quarter of 2012, many consumers purchased ahead of the increase during the second quarter of 2012, explaining part of the fall in revenues. The lower sales volume led to a 16.7% reduction in the division's cost of sales, which also helped boost the bottom line results, however.

In the end, the transition to higher margins in both its Direct division - via the move from strength to cardio - and the Retail division - via the price hike - helped produce the stronger-than-expected earnings per share during the third quarter. The strong performance in the Direct division, potential revenue increases in the Retail division moving forward, and strong margin improvements in both divisions have catalyzed the stock price.

Still a Reasonable Valuation

Nautilus trades with a trailing 12-month price-earnings ratio of 28.67x and a forward price-earnings ratio of 13.38x, according to Yahoo! Finance data. While there are few direct comps for the company, these figures fall between companies like Johnson Outdoors Inc.'s (NASDAQ:JOUT) 16.08x trailing and 10.06x forward numbers and Black Diamond Inc.'s (NASDAQ:BDE) 44.78x trailing and 73.27x forward numbers. But notably, its price-to-sales ratio is below both comps at less than 1.0.

With analysts expecting 312.5% growth this year, and 50% growth over the next five years, according to Yahoo! Finance, the company's P/E and P/S ratios may under-represent the opportunity. The P/E to growth ("PEG") ratio - a better measure taking growth into account - stands at just 0.37 taking into account five year expected growth rates. Right now, investors appear to be pricing in about 30% growth over the next five years using a 1.0 PEG.

Assuming growth falls somewhere between the two at 35% to 40% per year, the stock's value based on a PEG of 1.0 could stand somewhere around $7.77 per share or a 30% discount to the current price (using $0.21 TTM diluted earnings per share and a 37% long-term growth rate).

Some Risks to Keep in Mind

  1. Third-quarter Retail division sales should pick up during the fourth quarter and beyond, judging by the company's guidance, but some investors are concerned that the price hike could have a longer lasting impact on top-line figures.
  2. The company hasn't generated strong free cash flow yet, with a decrease of cash and equivalents of $2.2 million during the third quarter. During that period, the company's $4.3 million in operating cash was consumed by purchasing and debt repayments.
  3. The company's price-to-book ratio is higher than many of its peers at 5.2x, which is acceptable as long as growth rates sustain the valuation. However, value investors may want to look elsewhere for a stock with a solid floor.
  4. In terms of surpassing analyst expectations, the large changes that caused the excitement in 2012 may be replaced by simply meeting expectations in 2013, suggesting that stock price performance may moderate in the future.

Conclusions

Nautilus' recent growth rates and margin improvements have made its valuation appear cheap, causing the stock price to rise over the past few months. While the company still appears to trade at a reasonable valuation and could have room for upside, the days of 70%+ annual returns may be limited unless management produces some exceptional top-line gains in 2013.

Investors may therefore want to consider taking some money off the table, while still maintaining a long-term position in the stock, if they believe management can keep up top-line performance in 2013. With options trading on the stock, writing covered call options may be a good way to sell and generate some extra income given the volatility.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.