Editor's Note: This article covers a micro-cap stock. Please be aware of the risks associated with these stocks.
Cobra Electronics Corp. (COBR) is a Chicago-based maker of electronics and consumer technology products, which range from radar detectors, navigation devices, CB radios, marine electronics, two-way radios, power inverters, jump-starters, wireless technology products and more. These products are used by consumers as well as by professionals and businesses. This company has a very well-known brand name as it has been in business for over 50 years. Cobra generates revenues all around the world and it has offices in Dublin, Ireland and Hong Kong. After the company reported earnings on July 26, 2013, the stock saw a sharp decline, which appears to be a major buying opportunity for a number of reasons. Some investors appear to be overlooking "hidden assets" that Cobra has such as valuable tax credits, a globally recognized brand name, and the potential for it to be acquired. Let's go into these and other reasons why this stock looks too cheap now:
First of all, the financial results reported for Q2 were significantly impacted by charges related to the settlement of patent litigation. This settlement is actually great news in the long-run because ongoing litigation is very expensive, it can distract company management and create uncertainty for shareholders. It can also reduce the chances for a company to be acquired by another firm. We do not know how much of an impact the extra charges for this settlement caused in this quarter because as part of the settlement, the parties involved signed a non-disclosure agreement. However, in the conference call the Chairman and Chief Executive Officer, James R. Bazet described the settlement charges as "substantial." All this appears to indicate that the quarterly results were much better than reported, if adjusted for this one-time settlement expense.
For the second quarter of 2013, Cobra reported net sales of $25.6 million and a net loss of $1.9 million, or 29 cents per share. This is down from the net income in the prior year second quarter of $902,000, or 14 cents per share. Because of the non-disclosure agreement, we can only speculate on how much the "substantial" settlement charges contributed to this quarterly loss. The knee-jerk 20% drop in the share price from just over $3 to about $2.55 appears to be a major overreaction to this quarterly report when consideration is given for the fact that the settlement is very positive going forward. Furthermore, there are a number of other reasons why the sell-off in this cheap stock appears undeserved and should be considered as a major buying opportunity:
1. This stock is now trading for close to half of book value, which is about $5.51 per share. Book value is typically used by value investors to consider what a company might be worth if all assets were sold off today and all liabilities were paid. In this case, shareholders could be looking at a value of more than double the current stock price. This is a major sign of undervaluation. As one recent Seeking Alpha article on Cobra Electronics points out, this is even a stock that famed value investor Benjamin Graham could love.
2. Investors who are solely focused on the quarter are missing the point, that quarter has already passed and instead of looking at the rear-view mirror so negatively it makes sense to look at some of the future positives which include the end of litigation and the fact that the company has recently introduced cost-cutting measures which could boost profit margins in the coming quarters. Management has also provided guidance for full-year profitability. That means the next couple of quarters are expected to be quite strong, so this is hardly the time to give up on the stock. The expense reductions, end of litigation charges, and the possibility for improved sales results in Europe as that region recovers should all combine in the coming weeks and months and lead to much stronger results next quarter. In addition, the back-to school season tends to create strength in retail sales, and of course, the holiday shopping season is the best time of year for Cobra and many other companies.
3. Another major reason to be bullish as other investors give up is because the company is launching a number of new products in the second half of 2013. It is expensive to do design and research for new products and while these efforts have recently impacted financial results, the company now appears poised to benefit and generate revenue growth from new products in some major product categories.
In the earnings call transcripts provided by Seeking Alpha, Cobra stated it would be introducing over 40 news SKU's which are comprised of both line extensions and new categories. These new SKU's include 3 new radar detectors, which are "well-positioned" for late Q3 and Q4 sales. The company is also introducing a new, feature-packed CB radio in August at the "Great American Trucking Show" in Dallas, Texas. Cobra professional navigation units will also be featured at the show as these devices provide free live and predictive traffic information to help drivers increase safety and avoid delays. There are several other products that will be introduced and the company says it has "secured key product placements with many retailers for shipment this quarter and promotions for the key holiday selling season." All of this points to sales growth and higher revenues in the next couple of quarters.
4. With the share price at roughly half of book value, and with recent expense reductions, new product introductions and the busy back-to-school and holiday seasons coming up, this stock appears to be a great buy and turnaround play. This company has a history of earning about 50 cents per share annually in recent years. For example, in 2012, the company earned 48 cents per share and in 2011, it earned 47 cents per share. In 2005, the company earned a whopping $1.81 per share, which caused the stock to trade for about $15. Downside risks like management execution of company goals remain, and there is always the relatively small risk (for now) of an economic recession in the United States. European sales appear to have been impacted by high unemployment in that region, but some believe that the worst is over for Europe, which means this downside risk could be fading.
Smaller capitalization stocks can provide more risks than large cap stocks. Liquidity is one risk factor and this can lead to major volatility. For example, if news comes out that disappoints investors as we recently saw, there might not be enough buyers on any given day to keep the stock from making an exaggerated move. However, investors can also use this to their advantage and pick up cheap shares on "bad" days and when it gets to oversold levels as it is now. Another potential risk factor with smaller companies can be management execution. Larger companies tend to be better equipped to endure a bad management decision, or the departure of a top executive. These added risks are often commensurate with the higher rewards that can come with smaller cap stocks. For example, a giant oil company might not see as much volatility in the share price, but due to the law of large numbers, the stock price might not double for over a decade, while smaller companies can potentially see share prices double on a much more regular basis and in a short amount of time.
While Cobra Electronics is a smaller cap stock, the company does generate around $110 million in annual revenues, and this is equivalent to about $16.74 per share (in revenues each year). This is worth noting because the company is not as small as it might appear. This level of revenues on a per share basis also shows just how much upside potential there could be if management is able to increase profit margins through expense reductions and new products.
The stock appears to be at dirt-cheap levels now especially with management introducing dozens of new products and predicting profits in the second half of 2013. The downside appears to be limited when compared to the short-term rebound potential and the long-term growth it could deliver. Expense reductions and new product revenues could position the company to once again earn about 50 cents per share. With a conservative price to earnings multiple of 10, this stock could push back over $5, which is where it traded less than a year ago.
A couple of final points to consider is that the Cobra brand name is well-known to many distributors, retailers, and consumers. Investors selling at these levels appear to be overlooking the potential value of the brand name that could make Cobra a very attractive takeover target for another company or a private equity firm. The company seems to be aware of the potential for a takeover and it has adopted a stockholder rights plan intended to ensure that all of Cobra's stockholders are treated fairly in the event of a hostile takeover attempt and to encourage any potential acquirer to negotiate with the board.
On the earnings call, analyst David Rode from Stifel seemed to hint at this takeover potential and also brought up the fact that Cobra has valuable tax credits that are equivalent to about $1.30 per share. Tax credits are just one more reason why Cobra could be an attractive buyout target. These tax credits, cheap valuation, global brand name and all the other reasons detailed above lead me to believe the current sell-off below $3 is overdone.
Key Data Points For Cobra Electronics From Yahoo Finance:
Current Share Price: $2.71
52-Week Range: $2.46 to $5.40
Data is sourced from Yahoo Finance. No guarantees or representations are made. Please consult a financial advisor before making investments.