Introduction and Investment Thesis

It seems iRobot (IRBT) has somewhat surprisingly had a very good year so far in 2020. Prior to this year, it was thought that 2020 would be a transitional year with profits limited as iRobot scaled up their manufacturing in Malaysia. Their plans got interrupted due to the COVID-19 pandemic. Despite the pandemic greatly slowing down the global economy, iRobot’s sales growth has been strong. Perhaps this is a sign that iRobot has found solid footing in the higher end robot vacuum sales category. I will go in depth some about the future of iRobot, their outlook this coming year and try to value the company and identify potential risks going forward for investors.

Company Background

i7(Source: iRobot.com)

I want to start the article out with a quick background on the company. iRobot designs and sells household robotic vacuum cleaners branded as Roomba. They also sell a mopping robot branded as Braava as well as coding robots for children. They partner with 3rd party manufacturers to build the robots, and currently almost all of the production of the robot vacuums is done in China. Their products range in price and features. Here is a chart of iRobot’s current vacuum products:

Roomba models(Source: iRobot’s website and author spreadsheet)

Here is a chart of their Braava robotic mopping products:

Braava models(Source: iRobot’s website and author spreadsheet)

iRobot also sells coding robots that help children learn programming. These products would seem to have possible strong demand from schools and/or parents. However, iRobot’s management doesn’t consider the coding robots to have any material impact to revenue as stated by their CEO Colin Angle in their Q3 2020 earnings call:

So, that robot root is a robot that was developed and included in our product portfolio as part of iRobot’s commitment to STEM education. We think it’s an amazing product available online. I think it will benefit from the growth in direct-to-consumer commerce that we described. We don’t view it as a material revenue driver at this point. So, I wouldn’t put it into your growth driver calculus. We hope that it is incredibly successful from an impact perspective, particularly in an environment today where remote learning is so challenging and good tools to help students stay advancing, fingers crossed, in their educational journey. So, it’s a strategic robot more on our Company’s commitment to impact rather than revenue growth at this point.

– Colin Angle, Q3 2020 Earnings call

Perhaps their strategy may change to one that promotes the coding robots more aggressively in the future to educational institutions, but it seems like management is content right now with their primary product portfolio of robot vacuums, mops, and in the future lawn mowers.

Competition

I feel like I can’t write an article about iRobot without mentioning their competition. Competition is broad and fairly intense in the robotic vacuum/mopping market. iRobot counts Shark, Ecovacs, Roborock, Neato, iLife, and eufy just to name half a dozen. That doesn’t even include traditional vacuum companies that have entered/established themselves in the market such as Dyson, Bissell, Hoover or large electronic device manufacturing powerhouse companies like Samsung, LG, Panasonic, etc. The have dominated robotic vacuum sales for products >$200, but as you can see from the chart below, their market share has shrunk by over 10% over the last 4 years:

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Robot_market_share(Source: Baird 2020 Global Industrial Virtual Conference presentation)

While iRobot’s market share for higher-end (>$200) robot vacs has decreased, their sales have still grown in large part because the overall market for higher-end robot vacuums has increased substantially:

product mix(Source: Baird 2020 Global Industrial Virtual Conference presentation)

It seems iRobot successfully predicted the market shift towards higher-end robot vacs, and it likely was a meaningful reason for the surprisingly strong results this year so far (along with tariff exemptions).

To expand a little on this topic, I know two of the biggest concerns I have with iRobot as an investment is the competition in the robot vacuum market and the concern that the market is too “niche.” I’m finding both of these concerns to be less and less relevant as the market for robot vacuums and, specifically higher-end robots vacuums, continues to grow. Short-sellers are apparently still not convinced, as the short interest on the company is still over 35%(as of 11/26). It seems to me that iRobot’s dedication to improving product technology that results in new highly desired and convenient features, their product quality, and brand loyalty all set the company apart in the robot vacuum market.

Company’s Plans for 2021

Besides the market shift towards higher-end robot vacuums, another reason for iRobot’s surprising success this year has been that they were granted tariff exemption for most of the year (as well as the refunding of past tariffs). While that has been great for the company’s income statement this year, management is convinced that the tariff exemptions will expire at the end of the year:

We’re going back to a world where we’re anticipating 25% tariffs on product manufactured in China. The COVID pandemic has delayed our original plans to get to Malaysia by the end of this year, and instead pushed our transition of manufacturing well into 2021. We believe that those investments have — are finite, and by the end of 2021, we will have the vast majority of product coming into North America manufactured efficiently in Malaysia. And so that what starts out as a tailwind ends the year as — sorry, starts the year as a headwind, ends the year reversed as a tailwind moving forward.

-CEO Colin Angle, Q3 earnings call

What’s especially frustrating is that 2020 was supposed to start the transition of manufacturing away from China to other parts of Asia, especially Malaysia. COVID-19 has pushed those plans forward to 2021, meaning that investors should expect lower margins, especially in the first half of 2021.

The other big negative impact that COVID-19 had on iRobot in 2021 was the company was forced to push their product launch of the Terra robot lawn mower forward to 2021. This is especially disappointing as the market for robot lawn mowers has already been established some by other companies like Husqvarna and Worx. The company is still dedicated to the lawn mower market though as stated by CEO Colin Angle:

We haven’t given any comments on timing for Terra, and I don’t want to create speculation. We certainly continue to believe that lawn mowing, using our robotic technology is a attractive future market. So, people would benefit from robot lawnmowers.

-CEO Colin Angle, Q3 earnings call

Company’s Plans Beyond 2021

CEO Colin Angle has been very straightforward about iRobot’s business direction going forward. Here’s a quick excerpt from the last earnings call:

Strategically, we move forward with a laser-focus on the consumer and on making sure that our customers never look to leave our franchise. A happy Roomba owner is an incredibly valuable asset that loyalty will create meaningful opportunities for us to expand the scope of our relationships with our customers worldwide. To that end, we remain committed to product diversification. Top priority for us over the next several years will be to build out our direct-to-consumer capabilities. We believe that progress on this front will increase the likelihood that we can successfully and efficiently enter new product categories. Based on this, our go-to-market plans to enter the robot mower market with Terra will remain on hold for the foreseeable future. To the extent we restart these efforts in this area, we will do so in stealth mode and will not be providing updates on a quarterly basis.

-CEO Colin Angle, Q3 earnings call

Basically, the company is still focused on product loyalty. They are also focusing on expanding their customer relationships, and as mentioned before, eventually launching new products when they are ready such as the Terra lawn mower. Colin Angle did mention one more thing though in the earnings call that caught my eye:

Consistent with this view, we believe our instruments to deliver a highly differentiated cleaning experience will further expand our investments — sorry, will expand our direct-to-consumer sales channel and scale new service offerings, which will increase our competitive moat and support long-term value creation.

-CEO Colin Angle, Q3 earnings call

I’m going to speculate a little about what services he is referring to in the above statement. The first service that comes to mind would probably be that of software upgrades. The interesting thing to me from the chart comparing vacuum models I shared in the first section of this article, is that the difference between the i7 Roomba and i3 Roomba appear to be almost entirely software differences. Which to me means they could offer software upgrades in the future. Another potential service that I speculate could be an option in the future is that iRobot may offer services that help set-up their vacuums for less tech-savvy customers.

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Lastly, something that has always piqued my curiosity regarding iRobot has been commercial sales. I suspect they have always gotten interest from small businesses such as law offices for robotic vacuums to clean small offices, and they do have a commercial sales site, but I have wondered if they have plans to expand this business. Perhaps one of the services Colin Angle mentions in the earnings call may be related to business services such as leasing, providing on-site technical support, etc? This is definitely an area I’d like to see them expand into and I will continue to pay attention to see if they pay mention to it in the future.

Valuation

One of the biggest factors in valuing a company is trying to predict a company’s growth. Seeking Alpha has pegged iRobot’s revenue growth at ~12% over the last 12 months. Their average annual revenue growth over the last 3 years though has actually been closer to 23%. Given that the robotic vacuum market alone is still growing considerably, I would say 10% – 15% growth is definitely achievable over the next 10 years. Here’s what the valuation looks like for iRobot at the more conservative 10% growth assumption and non-GAAP EPS of $4.0/share:

10 percent

(Source: Moneychimp DCF valuation)

Here is what the valuation looks like at 15% growth:

15 percent

(Source: Moneychimp DCF valuation)

Currently the stock trades in the high $70s per share, which represents a slight premium to my more conservative valuation. Personally, I’d love to buy this stock below $70 per share to maximize margin of safety. Keep in mind also, that as mentioned above, this stock is fairly heavily shorted. I don’t really get the short thesis for this one unless you do have very serious concerns about margins getting squeezed by competition, tariffs having permanent impact on the company, or that robotic vacuums never become mainstream enough for a company that relies on the products to have long term success and growth. In my opinion, there is a decent chance for a squeeze as shorts finally give up their positions.

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Conclusion

In a market that seems to overvalue technology stocks and way overvalue growth without profit, one has to wonder why the market is discounting a technology company that is still growing at impressive rates with actual profits. At $78/share, one could easily argue this company is still reasonably priced, and if the stock falls below $70/share this stock looks like a very good deal with a good amount of margin of safety to boot. If iRobot can maintain it’s position as the leading high-end robotic vacuum maker, add sticky service revenue, as well as other products with growing demand like robotic lawn mowers, then this company could be a steal at these prices.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in IRBT 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.



Via SeekingAlpha.com

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