Logitech Stock: It's Time To Consider After A 45% Sell-Off

Summary

• Logitech has a very solid mid- to long-term setup for capturing the potential of the actual secular growth drivers, as well as in at least three disruptive and future-oriented trends.
• Their ability to make a profit from the capital they employ in their business exceeds by far the industry average.
• Logitech’s stock price is undervalued by at least 28%, mostly because of uncertainties in the market about their ability to continue to grow substantially.
• The market prices in the downside risk, but ignores the upside potential.

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Swiss-based Logitech International S.A. (NASDAQ:LOGI) is often referred to as one of the “pandemic winners”. Despite this, after surging 335% since March 2020, the stock underperformed the technology index since the end of June 2021, and is down 45% from its all-time high. The stock price sell-off is way overdone as the market considers a 32% drop in sales in the current year, and a slower growth rate in the coming years, without considering the mid- to long-term opportunities for the company, which is now particularly well positioned in its industry to capture the ongoing digital disruption. From an investment point of view, this is one of the most interesting moments in the history of Logitech which is switching to a more marketing- and innovation-led business model. In the sections that follow, I will explain why I consider Logitech to be very well positioned in its industry and how I estimate a minimal 28% upside potential to its current share price.

Company Overview

Logitech, headquartered at the EPFL Innovation Park campus in Lausanne, Switzerland, was founded in 1981 and emerged as the leading mouse and keyboards maker during the 2000s. The company expanded into other product categories and today designs, manufactures, and markets computer peripheral and hardware products that help people connect to and interact with digital and cloud-based experiences. Through its subsidiaries, Logitech has had a long history of innovation and was able to establish its brand worldwide by growing a large customer base in both the professional and the private-consumption space. Logitech employs approximately 9,000 employees, of which about 11% are dedicated to research and development (R&D) and approximately 4,800 are located in the Suzhou manufacturing facility. The office workers are located in Asia-Pacific (48%), Americas (30%), and EMEA (22%). The company's shareholder structure is composed of 375 institutions, holding 41% of the 167M outstanding shares. The company is led by CEO Bracken Darrell since 2013, while one of the three founders, Daniel Borel, is still a member of the board and Chairman-Emeritus. Other than on the NASDAQ, the shares of the company are mainly listed on the SIX Swiss Stock Exchange, where the company is part of the blue-chip index SMI.

Business Segmentation

The company’s largest business segments measured by revenue are Gaming, Video Collaboration, and Keyboards & Combos. During the pandemic and the subsequent trend of working from home, other segments like PC Webcams, Tablets & Accessories as well as Pointing Devices or Audio & Wearables witnessed an acceleration in sales.

Author

A workstation at home is not something everyone sets up without being obliged to, but once you are confronted with having to work from home every day or at least in a hybrid form, you recognize the value of high-quality hardware with advanced functionalities and comfort. The awareness of the product changes when the object becomes part of our home. This is where Logitech is good at: delivering a superior product and making it even better in time. Sales in the most important geographical areas surged in 2020, especially in areas where stronger lockdowns were implemented. Cross-selling products to the same customers as they now work from home, and maybe also enjoy video games, became easier during the pandemic, as many of the gaming target customers of Logitech aged between 18 and 30 years were confronted with (partial) lockdowns or chose to limit their movements out of their home.

Author

Financial Overview

LOGI has a very seasonal business with sales typically ramping up in the last quarter of the calendar year, which is the Q3 in the company’s fiscal year. The pandemic has particularly enhanced this effect on the company’s sales during the last 12 months. In the latest quarterly report released on September the 30th 2021, revenue confirmed the pattern with just 4% growing sales on a Year-over-Year (YoY) basis. It is not surprising if, for example, Morgan Stanley analyst Erik Woodring doubts the company’s ability to deliver further strong growth in revenue when considering robust results of the last year.

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Logitech’s product portfolio was well-positioned and the management reacted promptly to capture the increased demand for peripherals needed during the initial transition from the traditional office-based workplace to the hybrid or completely home-based office in the latest remote working tendency. The management made a big bet at the beginning of 2020, by investing significant resources in building up inventory and strengthening its delivery capacity, and by doubling down on its bet in the next quarters. Inventory rose by $167M to $828M in the first semester this year, the highest value in the company’s history. I see these decisions rather positively: whereas other companies struggle significantly with industry-related bottlenecks in the supply chain, Logitech can face this problem with more ease in the short to medium term and protect its operating margin from unforeseen price fluctuations. When screening for new investment opportunities, I look for companies with high margins, robust cash flow, and a strong balance sheet, one of the main reasons Logitech is one of my favorite stocks right now. Its gross margin, which historically was averaging 34%, increased in the last 3 years until reaching 45.70% in 2020, and by now is slightly consolidating at 42-43% in 2021. Following the release of the second quarterly data ended September 2021, the company held $1.137B in cash, up $0.22B YoY, which is a significantly strong position, considering also the negative effect on the cash from financing activities caused by the dividend payout of $159M and the share-repurchase worth $317M during the last 12 months. Other than the high inventory value, what is noticeable is the negative cash flow from operations in the last quarterly report - an exception for the company recorded only in 6 quarters in the past 10 years. The negative cash flow from operations was also justified by the substantial increase in net working capital.

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Logitech’s business and financial statements were already solid before the pandemic, and have now improved substantially. Logitech has a massive Return on Capital Employed (ROCE) of 45.20%, with the tech industry averaging at 9.30% in 2020. ROCE is calculated on the trailing twelve months (TTM) to September 2021, by dividing the company's EBIT by the total assets minus the current liabilities. This means that Logitech’s ability to make a profit from the capital they employ in their business exceeds by far the industry average. Considering its leverage, Logitech ranks in my top positions among the companies which conservatively manage debt; net debt has been negative in the past 14 years and total debt was just recorded in the recent quarters since June 2019 because of a change in accounting standards related to a capital lease. The latter is a real fresh breath in a predominantly indebted industry where the average total debt/total assets ratio increased to 26% by 2020.

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Competitive Analysis

The CEO of Logitech, Bracken Darrell, affirmed recently in an interview, that great market categories attract great competitors. And that is the case for Logitech. To better understand how Logitech is investing in future-oriented solutions while facing stronger competition, I look at the R&D expenses which are at their highest level in the company’s history, averaging $69M in the past three quarters as stated in the relevant quarterly reports, up 28.60% YoY. Logitech is leveraging its R&D capacities in the area of PC peripherals, in particular, to address the substantial demand growth in the gaming market. Direct competitors in this industry such as Corsair Gaming Inc. (CRSR) and Razer Inc. (OTCPK:RAZFF) deployed much smaller R&D investments, with both companies averaging $15M in the last three quarters, up only 12.40% and respectively 5% on a yearly comparison. Logitech also substantially increased its Selling and Marketing Expenses (S&M), averaging $252M in the last three quarters, increased 86% YoY in the equivalent timeframe, by keeping these expenses at 18-20% of its revenue. Razer’s S&M expenses average only at 7% of its revenue, down from 10.9% in 2018 and 8.9% in 2019. Corsair despite not publishing details on its specific S&M expenses, increased its Selling, General and Administrative Expenses (SG&A) by 33%, averaging 17% of its revenue in the last nine months ended September 30, 2021.

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Compared to its major competitors LOGI is very well positioned in terms of profitability and growth, showing also the highest Return on Invested Capital (ROIC), which measures how well a company generates profit relative to the capital it has invested in the business - a metric I like to consider when comparing a company’s profitability within its industry or peers. Logitech delivers a substantial annualized ROIC of 72.10%, compared to competitors such as Microsoft's (NASDAQ:MSFT) 57.01%, Turtle Beach (NASDAQ:HEAR) at 33.14%, Razer Inc. 18.05% and Corsair Gaming, Inc. at 20.96%.

finbox.com

Creating interoperability among its products is one of Logitech’s strengths, while customers can benefit from a platform with strong compatibility and multiple functionalities. Technologies like its "Flow Multi-Device Control and File Sharing" are of great benefit while working from home and switching between several devices and operating systems in a fast, safe, and intuitive way. The company has continuously demonstrated to have a solid price power sustained by its strong brand equity and the quality of its products. 2,214,490 ratings and 632,296 online reviews on Amazon for 2,212 products range at an average score of 4.2/5, emphasizing high customer satisfaction. All those elements are underlining the strengths that Logitech has when compared to its competitors. The management is now leveraging these strengths as it is shifting to a more marketing and innovation-led business model which should have a significant long-term impact on its overall stake in the global computer peripheral market.

Valuation

For the valuation of Logitech I use a Discounted Cash Flow (DCF) model over 5 years based on 3 different sets of assumptions ranging from a more conservative to a more optimistic view, based on the metrics determining the Weighted Average Cost of Capital (WACC) and the terminal value, where the latter is the most determinant part for the estimated fair value of the company. Work from home will tend to expand further with a mix of hybrid and fully remote, depending on the available IT infrastructure, the culture, and the type of industry. Gartner, Inc. estimates that in 2022, 31% of the global workforce will be remote, with the U.S. leading the statistic with 53% of its workforce. This trend also applies to Europe with 52% of its workforce, India, and China with respective 30% and 28% of penetration rates. The pandemic caused many companies to reform their working processes marking a fundamental change in how the consumer structures and values his workflow. Those changes will further drive the demand for peripherals with enhanced productivity and innovative functionalities, more adapted to the hybrid or fully remote working habits.

Author, using data from S&P Capital IQ

While the actual main growth drivers of Logitech are the transition from audio to video call, working remotely, gaming as well as e-sports, investing in Logitech today means investing in major trends which I believe bring a major disruption with them and which I consider to be the main drivers of the company’s long-term growth potential, namely:

• Virtual and Augmented Reality

• Next-generation gaming (cloud-based or decentralized)

• Content creation

Virtual Reality (VR) has its roots back in the 1950s and saw many attempts to become a breakthrough technology, but we never saw as many companies investing in this technology, as we saw in the last 10 years. While in the past it was considered a niche market with little adoption among innovators and tech-passionates, in the past few years, thanks to major companies such as Sony (NYSE:SONY), Apple (NASDAQ:AAPL), Alphabet (NASDAQ:GOOGL), Meta (NASDAQ:FB), and Microsoft, VR began to reach a broader audience composed by early adopters and is heading towards mass adoption in the coming 5-10 years. Nowadays, many consumers can already access Augmented Reality (AR) features directly on their smartphones and developers are increasingly creating applications and functions around this technology. According to forecasts by GlobalData, the global VR market, worth $5B in 2020, will grow to $51B by 2030, and cloud or even decentralized gaming will be increasingly prominent in the VR space, sustained by emerging technologies and integrating functionalities of next-generation networks such as 5G, Artificial Intelligence (AI), Machine Learning (ML) or Blockchain technology. In the fast-growing gaming industry, as well as in a VR world such as the Metaverse or new blockchain-based software, everyone can become a content creator, and many other industries will take their market space in it, accelerating the adoption of IT in general and creating a major demand boost for products and services related to it. For Logitech, this Megatrend will not only increase the demand for their existing solutions, the hardware needed to code, design, and create the software related to VR and its applications, but will also boost the demand for next-generation peripheral devices which will be needed by anyone who wants to interact with these technologies. How much of the VR/Metaverse/Next-generation gaming is already priced in? From my point of view, close to zero. First of all, because the stock price still shows a major sensitivity to the very actual growth vector of Logitech, namely the trend of working from home; secondly, because aside from pilot projects such as the Logitech VR Ink Pen, no other product of the company still addresses directly VR and its potential applications; and last but not least, the whole market potential is still difficult to quantify as it is always the case with ongoing market disruption at the very early stage.

Author

On the one side, my valuation takes into account the massive potential of Logitech’s growth drivers and, on the other, the increasingly competitive environment as well as other market-related risks. Consumer product cycles have substantially shortened and, in order to continue growing its market share while bearing the risk of failure, LOGI has become much faster with lean structures, a high degree of innovation, and an effective supply chain. This is why I consider different possible outcomes for LOGI’s share price, whereas the middle valuation with a target price of $140 is my preferred and more realistic scenario which would value Logitech at $23.54B while assuming a rather conservative perpetual growth rate of 2% and a WACC of 6.55%. This scenario would imply a stunning 65% upside potential to Logitech’s current share price.

Institutional Sponsorship and Short Interest

During the latest stock price pullback, some high-quality institutional investors increased their positions substantially. BlackRock Investment Management (UK) Ltd. (NYSE:BLK) in particular raised its long position by 4,866.13% in the past few months, owning almost 10% of Logitech.

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Some other institutions or their subsidiaries - for example, UBS Financial Services, Inc. (NYSE:UBS), Goldman Sachs International (NYSE:GS), J.P. Morgan Securities PLC (NYSE:JPM) - have as well added between 200% and 300% of their positions. Despite this, LOGI’s short interest remains relatively high at 6%, decreasing from its peak in August at 10%. The short ratio is now 14.66 days while on the 13th of August it reached 24.12 days. As an example, Tesla’s (NASDAQ:TSLA) short interest is 2.57% with 1.13 days of short exposure and in general, observed average values are less than 5% short interest and 1-3 days short exposure. On the other hand, these short positions need to be covered, and looking at the short exposure, it could therefore trigger a shortsqueeze once the short sellers are under pressure to close their positions, this could lead to a significant increase in the share price over the short term.

Risks

The biggest short-to-medium-term risk for Logitech is a prolonged disruption in the supply chain which extends for a longer time than the company had forecast. This would possibly affect the delivery capacity and subsequently, revenue growth as the company could face bottlenecks in the sourcing of important parts and materials or suffer from logistic delays. The production capacity in China could be affected by stricter Covid-related restrictions and a further deterioration of the ongoing tensions between China and the United States. Regulations in the world's biggest gaming market in China are of concern for companies in the sector since they can directly affect the demand. Moreover, since VR is a very attractive and profitable market with high projected growth rates, it will attract many competitors and lead to highly competitive market conditions in which Logitech will have to establish its market share. Despite those risk factors being a threat for Logitech, I am convinced the company will be able to mitigate those risks as it did with challenges in the past. Logitech is already a very well-established company in its main markets and can count on a robust balance sheet with a significant amount of cash and inventory, high margins, strong brands, and a superior innovation capacity to capture the potential offered by future growth drivers. The management is constantly monitoring the international supply chain risks as well as political and commercial tensions between China and the USA, mitigating those risk factors. Regulatory activity in the gaming market in China is focusing on young gamers under the age of 18 years, while over 80% of Logitech’s business in this category originate from customers over that age. The market has already discounted a 32% decline in revenue for this year, causing the stock to decline over 45% since its all-time high in June 2021. From my point of view, those risks are therefore already priced-in and the market underestimates the upside potential of the stock.

Conclusion

With a significant cash position and no long-term debt, an excellent capital allocation capability in its businesses, strong pricing power, and brand equity, robust investments in R&D, and the transition to a more marketing- and innovation-oriented business model, Logitech is fundamentally positioned for achieving its long-term goals of revenue growth between 8% and 10%, significantly outperforming the expected annual growth of 4% compounded between 2021 and 2025 in the global computer peripheral equipment market forecasted by Research and Markets. The stock has been under substantial pressure since its all-time high at $140.17 on the 9th of June 2021. The 45% sell-off since then was mostly driven by the company’s slowing sales and a rather conservative short- to mid-term outlook given by the management. Even though sales are slowing down YoY, the company’s revenue is still slightly growing at a very high level, and I expect the current quarter's sales to accelerate due to typical seasonal effects. I see the actual price as a possible entry point for more momentum- and swing-oriented traders, and depending on the individual risk management, investors can wait for a possible breakout confirmation, since technically the stock has still not determined a new uptrend. For long-term investors who recognize the potential of the growth drivers and value Logitech’s strong fundamental setup, the actual price level is really attractive and offers a substantial upside potential by already pricing in a major drop in sales.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of LOGI either through stock ownership, options, or other derivatives. 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.