iRobot: Cleaning The Global Market Part 2

Jul. 31, 2019 4:29 PM ETiRobot Corporation (IRBT)10 Comments
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Midas Investor
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Summary

  • IRBT's earnings are protected due to the fundamental advantage of the higher quality and performance of the products than its competitors.
  • Acquisitions of global distributors SODC and Robopolis allows a vertical integration, allowing the company to have more control over the brand and operating margin.
  • A strong management team with a focused view on innovation along with the company's well-capitalized balance sheet gives the firm a competitive advantage.

I recommend a long position in iRobot Corporation (NASDAQ:NASDAQ:IRBT), a robotics company that designs and manufactures home-cleaning products, which currently trades at $74.58 per share. As mentioned in the previous article, it is undervalued by 30-40%, the market has incorrectly overemphasized the impact of trade tariffs on the top line, and the narrower margins. There is significantly more upside to its newly introduced suite of high-end products Roomba i7, i7+, S9+ and Braava jet m6 than the market has given it credit for.

What's important to note is that my theses on the company have not changed much since my last article. In fact, the stock traded 71% higher after I published the idea, until it came back down to the same level as in 2017 due to the implementation of tariffs in May 2019. While there have not been much changes to the fundamentals of the stock, the news had a direct impact on the bottom line on the company's earnings and no one could have seen it coming. Two key takeaways from this volatility in the stock price: 1) macro news is usually just a noise but if it has a direct impact on the company's earnings for the foreseeable future, then you need to take that into account in your analysis, and 2) diversification is critical.

I will go straight into my thesis as I explained the company's background, culture, and management in my 2017 article.

Valuation

Its current peers are currently trading at 39x NTM P/E while iRobot’s multiple recently fell to 21x. Based on peer valuation measures such as P/Sales, EV/EBTIDA, and P/E, iRobot’s stock price is valued at about 34% discount to its publicly traded competitors, including Ecovacs, Viomi, Whirlpool, Arlo Technologies and Sonos.

I did not run a DCF this time due to the uncertainty on the trade talks and interest rate path going forward as the Fed is expected to cut rates on Wednesday.

A number of catalysts could potentially lead to value realization in the next 6-12 months. The introduction of its new products that have advanced feature like Automatic Dirt Disposal (ability to empty its own bin into the clean base) and Imprint Technology (ability to map and adapt the floorplan to be able to choose a specific room to clean) have further set apart iRobot products versus its peers. The popularity will increase as it is ever more convenient to operate an iRobot vacuum cleaner. The company’s third quarter earnings release, holiday season sales, and trade negotiation talks could drive up the stock in the near future.

Analysis

I put more trust on numbers when analyzing companies but they are only the results of the company's differentiation, not the drivers. Thus, the companies I write about have all passed the smell test in terms of financial metrics, including growth rates, valuation, liquidity, debt service coverage, leverage, and working capital efficiency.

iRobot's products are fundamentally have been consistently outperforming its peer products in the market. Market reviews are a great source of indicator for this qualitative view.

Notice the number of reviews next to the ratings. While customers may look for lower-priced, non-iRobot products to try new suite of cleaners, the buyers will most likely steer back to iRobot as some of the other products may require more manual touch or perform poorly.

Key differentiator for iRobot is not only its portfolio of quality products but also the culture of the engineering team. iRobot designs its products, engineers functionalities, and outsources the manufacturing to its contractors to implement its ideas. The critical part of this process is the design in which the products are created from. Because designs are developed by software engineers within the company, it would be important to investor whether they are satisfied and properly motivated to work. A quick glance at the company workplace rating will be enough to smell test this qualitative factor.

Acquisitions of distributors in Japan (OTCPK:SDOC) and Europe (Robopolis) have been important developments for the company since 2017. From a top-level perspective, a product company like iRobot can only outperform if it is differentiated from the competitors. Differentiation usually involves product quality, marketing strategies, and manufacturing efficiency. In this case, iRobot is differentiated in all three pillars, with the acquired distributors contributing to a more controlled marketing effort. Colin Angle noted in the earnings call that the purpose of these acquisitions was to have direct control over the distribution within Japan and Europe. What that means, in my view, is that the company wishes to be able to control the target customers, develop a certain theme in its brand, and scale within the regions to be able to reduce fixed costs. While it may be too early to assess the potential success of the strategy and not possible to pinpoint to an indicator that can explain the current progress of the global distribution efforts, I plan to constantly monitor and inquire the company to keep track. Please look out for my update on the company.

RVC market is also large enough for iRobot to expand within the segment. While its market shares have been shrinking globally due to the increasing number of competitors, iRobot still maintains large market share within the North America market. This indicates that through successful marketing channels and product realization, countries with higher disposable income (specifically Japan and China) will increasingly shift their preferences towards iRobot's products.

Lastly, I emphasized the importance of assessing the management's capability to run the company. All of the executive members have been with the company before the crisis. They all have experiences in the RVC industry for more than 15 years.

A key role for the management is capital allocation. Looking at the balance sheet, it is well-capitalized with high liquidity, relatively lower working capital than in the past, and manageable amount of goodwill and long-term obligations.

For a tech company, it is normal to see a healthy balance sheet but one thing to watch out for is the goodwill, as many software companies have gone bust due to the absurd amount of premium that they paid for in their acquisitions. For iRobot, goodwill represents about 16% of its total assets, which is relatively low for a product-based company.

Moving onto the cash flow statement, the company has continued to allocate significant capital into capital expenditures, spending about $32mm in 2018 to roughly match the depreciation. It has also spent $50mm in stock repurchase in 2018, which is neither good nor bad. While it may boost EPS in the short-term, it is a sign that the company was not able to secure a good capital allocation opportunity in order investments other than in its own stock.

I am more comfortable with iRobot than its peers because there are not many red flags in the company's current financial health.

One thing to note is the rising inventory level. While the management indicated this is in anticipation of a larger demand during 2019, we continue to monitor this throughout the year as it can be an indicator that global spending has been cooling down.

Conclusion

Despite the increasingly competitive market, iRobot is in a position to capitalize on the growth in the RVC market through its value-added premium products that will empower many household cleaning productivity.

This article was written by

Midas Investor profile picture
126 Followers
I enjoy reading about markets and analyzing companies in my downtime. Thanks for reading my articles. I understand that they need work and I appreciate your patience. Thank you.

Disclosure: I am/we are long IRBT. 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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