My introduction to Head NV (OTC:HEDYY) comes from my love for tennis. Head NV is certainly not a well-known stock among investors and traders. This is evident from the fact that Head NV is thinly traded in the US exchanges. On the other hand, Head NV is a household name among sports lovers (particularly tennis), with some of the leading players such as Novak Djokovic, Andy Murray and Maria Sharapova, among others, endorsing the company's products. The popularity of the company's products and its visibility can be gauged from the fact that the company's Facebook page has 1.3 million followers. The conclusion of the introduction is that Head NV certainly has visibility in the domain where it makes money. It still needs visibility in the domain where others will make by investing in this growing business.
A quick mention here that investors who might have identified this little gem ($194 million market capitalization) at the beginning of 2012 would already have gotten 50% returns. This article will discuss why the upside trend in the stock will continue.
Also, before getting into the main story, I would like to mention here that the company has also generated significant interest from bond investors. In September 2013, the company had to increase the size of its new bond issue from 45 million Euros to 60 million Euros due to high investor demand. Besides the bullish view of bond investors, the immediate positive that I see is that Head NV has comfortable access to a relatively lower cost of funding growth and equity dilution might not be on the horizon for this growth company. I speak of this upfront because investors do fear loss of value in smaller entities through equity dilution.
A Bit More On The Company
HEAD NV is a global manufacturer and marketer of premium sports equipment and apparel. The company's business is organized into five divisions: Winter Sports, Racquet Sports, Diving, Sportswear and Licensing. For the year ended December 2012, the company's winter sports division contributed to 43% of the revenue with the racquet division contributing to 41% of the revenue. I started with a focus on the racquet sports division as it will be one of the major revenue drivers of the company going forward. In terms of geography, the company's major market is Austria, which happens to be the company's economic domestic market. For the year ended December 2012, sales in Austria contributed to 41% of the company's revenue, with North America contributing to 27% of sales. There is no specific customer concentration risk in the company's business with its products being sold to nearly 37,000 customers.
The Racquet Sports Division - Primary Growth Driver
While the winter sports division is the biggest revenue contributor as of FY12, the company's racquet sports division is the key growth driver. This trend is clear on looking at the sales contribution of the divisions for FY11 and FY12.
The sales contribution has declined meaningfully for the winter sports division while it has increased for the racquet sports division. This has been primarily due to the strong brand visibility created by roping in top tennis players to endorse the brand. An advertising expense of nearly $58 million for FY12 is significant for a $194 million market capitalization company. However, the target market is significant and the brand positioning is working going by the revenue growth trend. According to company's estimates, the total market for tennis racquets is $405 million and for tennis balls is $280 million. In other words, the company still has a large market to tap and the current brand positioning and advertising will help revenue growth to sustain.
The Geographical Shift To A Bigger Market
Another noticeable and strategic shift in the revenue trend is the geographical revenue contribution, which again underscores the point that the company's brand visibility and advertising efforts are paying off. The company primarily catered to the winter sports market in Austria where its sales percentage has declined from 45% in FY11 to 41% in FY12. During the same period, the company's revenue share from North America has increased to 27% from 25%. Head NV is therefore gradually penetrating into a larger market and this will help in driving revenue growth going forward.
Also, the market share in Asia is just 8%. The market however has the potential to gain significant traction in the future. I am of the opinion that the company will shift its growth efforts to Asia once they consolidate further in North America. It is important to mention here that these growth initiatives and a strategic shift are reflected in a 50% share price increase in 2013 YTD for Head NV. As marketing efforts and introduction of new products continues in 2014, the stock will continue with its upside momentum.
Introduction of Own Apparel Line
Besides the continued growth in the racquet sports segment and the strategic shift to a bigger market, the launch of new products will be the stock price driver for Head NV. In particular, the introduction of its own apparel line in FY12 serves as a revenue upside trigger going forward. After a decline in growth for the first quarter of 2013, the company's sportswear segment bounced back in the second quarter with a 10.9% revenue growth to $1.4 million. While the segment forms only a small part of the company's revenue, Head NV is leveraging on its brand visibility to generate robust sales in the apparel division. Going forward, the apparel sales will be another significant revenue and earnings driver for the company.
Head N.V. Compared To Industry Multiples
Head NV has a strong growth strategy and the same is reflecting in the earnings. If this growth is coupled with undervaluation, investors have an excellent opportunity to consider exposure to the stock at current levels. The table below gives some of the key margin, efficiency and valuation parameters for Head NV compared to the industry average.
Starting with the valuation parameters, Head NV is trading at an attractive valuation compared to the industry in terms of P/S, P/B and P/CF. The PE valuation [TTM] is on the higher side and investors might argue that the stock is overvalued. However, the stock is discounting robust growth prospects ahead and if one considers the forecasted EPS of 15 cents for FY14, the stock is trading at just 15.5 times the forward PE. This makes Head NV look attractive even in terms of PE valuation.
An important point here would be - Why is the stock trading at a discount compared to the industry?
The reason relates to the companies ROA and ROE. As evident from the table above, the company's return on asset and equity is significantly lower than the industry average. The primary reason for this is the high advertising and selling expense incurred by the company. As the company's brand visibility increases further, the advertising expenses will decline as a percentage of revenue and result in higher return on assets. With the company's focus on the racquet segment already showing positive results, the stock is already covering the valuation gap. Going forward, the uptrend in the stock should continue as the management effectiveness ratios improve along with robust revenue growth. An earnings growth estimate of 200% for FY13 and 22% for FY14 underscores my point.
Being a relatively small company, Head NV is exposed to certain risks. In an uncertain economic environment, funding growth is the primary risk. Any equity dilution can depress the EPS. However, this risk is mitigated to some extent by the fact that the company has good access to the debt market. Another risk for the company comes from the existing competition in the apparel business. Head NV is exposed to direct competition from larger players such as Nike (NKE) and Adidas. The company plans to mitigate this risk by focusing on the skiwear market, which is regionally very fragment and provides the scope to make some inroads.
Head NV is an under covered stock which is leveraging on the racquet segment to grow at a robust pace over the next few years. The stock price has been discounting the successful growth strategies of the company with a 50% rise in 2013. Key valuation metrics, however suggest that the stock has further upside before it closes the valuation gap against the industry. Investors can consider exposure to this small gem with an initial time frame of one year. The initial time frame provides a test of earnings growth for the remainder of 2013 and for 2014. If the racquet business continues to grow, it would not be surprising to see the stock trend higher by another 50% in the next year.