Vincent Shen: Welcome to Industry Focus, the podcast that dives into a different sector
of the stock market every day. I'm your host, Vincent Shen. Joining me today via Skype is
senior Motley Fool contributor, Asit Sharma. Hey, Asit! Thanks for hopping on!
Asit Sharma: Thanks so much, Vince! Happy to be here, as always!
Shen: As a reminder to anyone who has missed my previous announcements, this is the last show
I pre-recorded before saying my goodbyes to the Industry Focus team. Some 200 episodes
captured in this studio. I've said it before, I'll say it again, thank you for being a part
of this journey! Asit, I'm glad we're going to wrap up 2018
with a company that I personally think is building something special, and that company
is iRobot, ticker IRBT. It's been well over a year since our last update on the company.
In that time, the stock declined as much as 40% before returning to positive territory for 2018.
At least as of this recording, iRobot is up 10% year to date, topping the flat performance
for the S&P 500. We're not going to rehash the entire business description.
But for Fools who don't know this company or are only vaguely familiar
with its consumer robots, really quick, what's the story here?
Sharma: iRobot is the manufacturer of the very popular Roomba device, which is a vacuuming device.
It also makes a mopping device called the Brava. The company is a pioneer in the
technology that allows you to have a hands-free experience and have your house vacuumed.
Along the way, it's developed a lot of credentials in data mapping. It's a very tech-savvy company
and it's integrated some of its own learnings with companies like Alphabet and also Amazon
via Alexa. It's a very current and quite interesting product, between vacuuming and mopping.
And it has posited that in the future, we'll see a lawn mowing product. That, in a nutshell,
is this company's business. We'll talk more about its business model.
Sharma: Sure. Right now, there's absolutely no doubt that sales of these cleaning robots
like the Roomba, like the Brava and other models, is driving the business at this moment.
As you mentioned there, for a long time now, management has talked about the incredible
assets that iRobot is amassing by mapping all of the homes that its products are in,
that they're helping to clean and tidy up. They refer to this spatial awareness as something
that could serve as a really important tool, a hub for various smart home integrations
that have yet to debut to consumers, stuff of the future. I really feel like we're entering
Jetsons territory here. We'll talk more about that in a bit.
For their third quarter, iRobot had really strong results, showing a lot of momentum
throughout 2018. What jumped out to you? Sharma: Revenue growth of 29%. This is a on
the heels of two new product introductions -- the i7, which is a more upscale model of
the Roomba, and the e5, which is a more mid-price model. For three months ended September 29th, 2018,
sales were $264 million. Gross margin of 32%. That's pretty strong. Research and
development expenses increased, as did selling and marketing expenses, but the company was
able to increase its gross margin by almost 3% to 14%.
What I like about iRobot, which we're starting to see as the quarters go on, is the business
model has proved itself out. It's getting more of a direct result from the research
and development expenses that it's investing. It's helping the top line, very healthy growth.
This recent quarter shows to me, also, management's acumen at figuring out what features will
hit consumers with product rollouts. This sounds simple. You have a great product,
you spend a lot on research and development, it's time to upgrade your line. But longtime listeners
will know, our favorite whipping horse, GoPro, has struggled, as an example of a company
that's struggled with new product introduction. What is the feature that will bring customers in?
For this mid-price model, in the most recent quarter, the company introduced self-cleaning,
that's usually found in the higher models. That had a huge uptake among pet owners who
want that debris cleaned. If your analysis is correct, you understand how you can price
your next generation of products and swap features. And that really impressed me.
As well as with the higher-end model, the company now has price points that range in a stepladder fashion,
from $300 for entry level up to $600, and for the i7+, $900 to $950. There's something
for everyone in the offering, and that's showing up in these financial numbers.
Also, I'd quickly like to talk about the balance sheet. That really stands out to me, as well,
how strong it is. Vince and I just got through taping an episode, which hopefully most of
you have already listened to. We're pre-recording this episode. We just talked about a company
which has quite a bit of new debt on its books, Carvana. You can find that episode on our podcast list.
iRobot has been around for a while now, and it has no long-term debt on its books.
It has a current ratio of about 2.5X. That means current assets, current resources which aren't
long-term in nature, are about 2.5X the current liabilities, like accounts payable and other
types of one-year expenses that the company's obligated for. Inventory is up 50% since the
beginning of the year. That's a function of this sales path, we're seeing that 30% growth
that I talked about quarter over quarter. It's also a function of the new product launch.
That's a healthy increase in inventory. It's like the three little bears. Based on sales,
this feels just about right. You don't want too much inventory going into your channels,
because that can be inefficient. But, you don't want too little when there's demand
on the products you've introduced. I like this relationship between the 30% top line
growth and 50% in inventory. All in all, I had not looked at iRobot's financials
in a while, very impressed with what I see. It feels like a very solid company with
a product that, as Vince mentioned, is seeing a lot of demand in the marketplace. What are
your thoughts, Vince? Shen: I'll go back to this most recent quarter
with that 29% year over year growth. That's accelerating from the second quarter,
which had a 24% pace. Bottom line net income was up 44%. These are numbers that all exceeded
analyst expectations across the board. Units sold came in at 1.1 million units during the quarter.
Again, up big from the prior year. Something that management has stressed is
that revenue growth for the company will largely be driven by units rather than average selling prices.
One, that supports the broader trend of greater smart home device adoption.
Even then, as you mentioned, that step change in terms of the pricing for their products, $300-600
to as much as $900. Clearly, customers feel that the features that the company's introducing
are compelling, because average selling prices are increasing. They went from $260 to $289
year over year in this period. Gross margins expanding, I think you said 3%.
I think for the time being, this should be enough to hold off some of the critics,
some of the bears who have argued that iRobot will struggle to compete with a growing number
of low-cost competitors. The features, for example, for the premium i7 and i7+ that it
released are just incredible, looking at how it can really become a seamless part of your home.
Asit, do you actually own anything like this, any of these robotic vacuums, even from
a competitor or anything? Sharma: For those who can watch the video later,
I only shoot myself shoulders up. I say that to make the point that I need
all the exercise I can get. I use a broom manual process. We have some friends who bought
a Roomba when it first came out, and many since then have converted, so I'm very familiar
with it. It's one of those pieces of tech that I'll probably give into. But for now,
I think I will hold out for as long as I can. I have to keep this waistline in. Curious,
Vince -- of course, you're moving on and traveling. Do you happen to have a Roomba?
Shen: No, I don't. But honestly, the more I look into what some of these products offer,
especially from iRobot, it really becomes tempting. With this latest i7 release,
if you purchase it with a dock, it can clean a room and detect on its own when its dustbin
is full. Then it will return to the dock to automatically empty the bin within the unit
before moving on to clean more. It can also learn room names. An owner of one of these
devices can give the command to the Roomba to clean specific places in the house.
All the while, the machine will map and learn to optimize the cleaning process. It's a pretty
impressive feature set in the top-of-the-line for these Roomba vacuums.
Demand for these new models, like this i7, they really helped domestic sales outpace
other markets at 45% in this most recent quarter. As they expand the launch for them abroad,
I think that will be a really strong tailwind as they reach these other markets and drum
up demand on their own. This latest report is undeniably strong,
but there were some elements outside of the company's control that are, I think, driving the near-term
story for iRobot. Some of the issues with tariffs, for example, have investors concerned.
I'm curious, Asit, how worried do you think investors should actually be about these tariffs
and how they might hurt the bottom line in the near to medium-term?
Sharma: Investors should be aware of the impact. Sometime ago, Secretary of Commerce Wilbur Ross
had projected that effective tariffs would be very minimal on any company.
He used Campbell's soup cans as an example, a cent or two on a Campbell's soup can. What we're
finding is, in reality, the effects of imposing tariffs become concrete over time. The fear
factor ratchets up commodity prices, and then the actual imposition of tariffs, of course,
makes things more expensive. This is one of the companies that has actually
quantified an impact. The company says it's about a $5 million impact, which is going to affect
total year gross margins by about 1%. While that's not a huge number,
you also have to balance it with the fact that management said, "Look, for now, we're not going to
pass that on to customers, we're going to absorb that in our gross margin." This is something,
like a developing story, that investors should watch.
I would say, over time, Roomba products are leading the market in innovation, so there's
some price elasticity there, which Vince talked about a couple of episodes ago. Again, we'll go back
to Econ 101. The company has some pricing power in its products. I think the
tariffs is a great example of this. Let's say, after a couple of quarters, iRobot decides
that it will pass on $5-10 increase, let's say on its middle-of-the-line product.
Customers will probably pay for that. Essentially the same with the higher-end. What management
has said recently, I think in the most recent earnings conference call, is that at the higher
end of the product spectrum, there is price elasticity which exists, and that's where
the company wants to innovate. That's the counter argument for the bears.
If you can keep ahead of the lower-price competition -- just to give you an example, I think Samsung
has an excellent entry-level product for $300. That's a very formidable competitor,
with massive resources. If you can keep ahead of a competitor like Samsung with innovation,
then, when you have these external events like a trade war, which impact your commodity
costs and makes it more expensive for you, you can pass on some of that effect to customers.
Now, we don't know eventually how serious the trade war will be when all is said and done,
or how long it will last. But I think that an event like this makes management keener
to roll out new products with an ever-higher attachment rate among those people who are
willing to pay for the features that Vince just described -- the ability for a Roomba
to empty itself 30 times before you have to take action, which is an incredible feature to me.
What do you think about the tariffs and the effect on their P&L?
Shen: Just quantifying it, you mentioned the $5 million, that's the hit to iRobot's operating
income in the fourth quarter as a result of a 10% tariff on specifically vacuums made
in China. But even worse, the tariff will increase the 25% at the start of 2019.
So, iRobot is stuck here, where they have to grapple with the increased costs. This is a situation
where iRobot contracts all of their production for the robots to Chinese manufacturers.
It's not going to be easy for them to find a quick solution to avoiding the tariffs.
On top of that, also, in the near-term, like you said, management has indicated they want
to avoid passing the cost increases onto consumers and raising prices. They're working on cost
reductions, other ways of handling the elevated 2019 tariffs. But at some point, it may require
that they do that to protect a little bit of the profitability. 25% is pretty significant
in terms of the potential hit there for the company. It could hurt the strong momentum that they've
so far built in 2018 as they enter the new year.
I will say, softening the blow from that, nine U.S. customers make up more than half
of total revenue. The smaller but growing Brava line for the mops, that's unimpacted
by the tariffs. Right now, Brava makes up less than 10% of revenue, but there's a big
market for that in regions like China, for example, where hardwood or tiled floors are
more common than carpeting. They've mentioned that as a potentially major growth driver looking ahead.
Given the solid financial footing that iRobot's in, they have this
pretty solid cash pile, about $135 million, no debt. That cash reserve
has reduced recently, since 2017, because iRobot shelled out about $150 million to report
to acquire their distribution arms for their products in Japan and Europe. I think that was
the right move, given it has allowed the company to control the marketing, the messaging,
better for these international markets. I think they've improved some of their volumes there,
and also their selling prices there as a result of those moves.
The cash flow that this company is generating is sufficient to sustain its R&D spending.
That's going to be essential for a tech focused consumer products business like this.
R&D was at $113 million in 2017, $135 million in the trailing 12-month period.
It's good for about 25% of the company's gross profits. Related to that spending, and the pretty bright
long-term outlook that I think exists for this company, iRobot announced in October
a deeper relationship with Alphabet. You mentioned this at the beginning of the show.
Alphabet, obviously, a pretty big player at this point, in terms of their smart home technology.
On the surface, there's this obvious value-add for consumers. For example, they have the
ability to use Google smart home devices to give commands to iRobot products. That's something
that's available both through Google and Amazon's Alexa. But as smart home solutions become
more and more prevalent in homes -- I visited some friends in your neck of the woods in
North Carolina a couple of weekends ago. I was pretty impressed to see that they have
all their security, their HVAC system, and all these other elements in their home that
they purchased recently, already integrated into a smart home apparatus. The more functionality
that these smart home devices offer, they'll need more and more data and insight into the
physical space. Again, iRobot is the company right now that's best-positioned to provide
that kind of information, given they've sold 20 million robots around the world,
they're in so many homes doing that mapping, collecting that data. So, on the horizon.
You also mentioned the hints of a robotic lawn mower that might be coming soon.
There's the greater adoption of the Brava that we've talked about. I think a strong holiday season
will also be in the cards for the company thanks to the new product launches.
Let's wrap up. Any final takes? Also, valuation? What are your thoughts there?
Sharma: I absolutely want to talk about valuation. It's pertinent to everything that you just
discussed, Vince. Currently, the stock trades at a forward P/E ratio of 30X. The stock is trading at
30X one-year forward earnings. The market cap of this company is about
$2.5 billion. How are these two pieces of information related? This is essentially still a small-cap stock.
I was surprised to see the market cap, which I hadn't looked at in a while. I thought
it would be greater. What that tells me -- I spoke about this a couple of months ago on
a show -- for a small-cap company, to trade at 30X earnings means that you're right
in line with the Russell 2000 index. That's the average forward valuation for a company
of this size, all things considered. So, in my opinion, although 30X forward earning
sounds a little pricey, there's not really much of a premium there. Investors who are
short-term oriented may feel that's great. Those who are longer-term oriented may see
that the market is discounting the forward opportunity of integration that Vince talked about -- again,
going back to a concept that he mentioned at the very beginning of the show,
the spatial awareness. The data that a Roomba can provide to other components in
a house that are integrated, the Internet of Things devices, which are all communicating
with each other, those potentialities are enormous if you just start to brainstorm
what a Roomba might be able to provide. Myself, a random one I came up with -- what if your
Roomba could tell your Sonos speaker to play the volume up a little bit, because it's coming
to vacuum, but your kid's still in the room? You can just imagine, if it does, indeed,
integrate with other devices and sell some of its capabilities, that's a marketplace advantage.
That's hard for a competitor who's just manufacturing a device on a price-point
to compete with. I think the stock long-term looks attractively
valued here, especially, it's sold off along with the general tech sector as of this recording
a little bit this year. What are your thoughts, Vince?
Shen: I think for a company in this position, you have the market share leader.
They're putting up well over 20% top line growth in 2018. Over 15% on the bottom line. The 30X
forward earnings doesn't look quite so pricey to me. I think a long-term investor can generally,
not quite shrug off, but not put as much weight on, for example, the near-term hit with the tariffs.
That doesn't mean you can't protect your yourself by building out your position
over time. Given the strong demand for these new products that they launched,
those are going to be big story drivers in the holiday season. Strong sales, maybe weaker profits,
but the company is going to work into that with these new features and building up their ASPs.
You have a company here that's the leader
in this young industry. As you said, it's very small, $2.5 billion market cap.
Again, I've really been excited to look into this company, get updated on it again. It's a very
cool business. Alright, that's all the time we have for today.
Thank you, Asit, for joining us! Sharma: Thanks so much, Vince! It's been a pleasure!
Shen: Thank you, Fools, so much! For Austin,
Asit, all the other contributors, I'm signing off from Industry Focus. Thank you for all your support!
People on the program may own companies discussed
on the show, and The Motley Fool may have formal recommendations for or against any
stocks mentioned, so don't buy or sell anything based solely on what you hear during the program. Fool on!
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