Skullcandy Ripe For A Huge Reversal

| About: Skullcandy (SKUL)

Skullcandy (NASDAQ:SKUL) has recently hit a new low of $11.79/share, and has very heavy downward momentum right now. The big hit came on September 14th, when Morgan Stanley (NYSE:MS) dropped its price target from $21 to $15 and stamped an "equal weight" recommendation on SKUL. Shares dropped over 16%, adding to earlier losses and mounting short interest.

According to Forbes, Morgan Stanley analyst Jay Sole cited some signs that the company's sales were going to be threatened in the near future from competition and lower average sales costs. He also felt that the arrival of Apple's (NASDAQ:AAPL) "earpods" (their improved line of headphones) was going to crush Skullcandy's sales. Awfully strange how he had the opposite opinion in early August.

Competition in the headphone space is certainly fierce, but I don't really buy the argument against SKUL until I see the company posting sales data that actually reflects a diminished outlook. I also find it strange that Wall Street has been ignoring the company's stellar financial data until now, when momentum might slow down.

Is a marginally better headphone released by Apple going to hit Skullcandy's sales enough to warrant a stock downgrade? No. Skullcandy's prospects aren't exactly helped by Apple (and other large competitors), but Skullcandy has been trading as if the firm were about to announce bankruptcy or some sort of major share dilution.

While I'm not assuming that Skullcandy is going to grow as much as Apple has in the last few years, I am still seeing a company that has no major problems with its business model and double-digit revenue growth that has the highest short interest on the NASDAQ. Short interest is a bit skewed by huge institutional ownership of the company, but still presents the chance of an enormous short squeeze waiting to happen.

Just to point out how solid Skullcandy's financial data is, here are some numbers from the last quarterly report:

-Sales grew 38% relative to last year with slightly faster growth abroad (59%), exceeding Apple's sales growth on macs or iPhones (but not iPads)

-Enormous profit margins of 49%

-Skullcandy is making progress online with around 22.8% sales growth

-The recent jumps in the company's expenses are related to aggressive expansion efforts that should ease the way for more growth in 2013

-The company has no long term debt, and has about $122 million in current assets

Checking the latest data, note that 11.25M shares out of a float of 14.43M will have to be bought eventually. If the analysts decide to take a more reasonable approach to SKUL's valuation any time soon, and if the market's pessimistic outlook is proved wrong, look for a new 52-week high after ~30% upside.

Even if there are signs that Skullcandy's competition, especially Apple, have their eyes on the headphone market I don't see the justification behind the extreme bearishness surrounding SKUL. It's an uncomfortable long position due to the volatility, but SKUL is one of the better contrarian plays right now.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in SKUL over 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.

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