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Wednesday, December 17, 1997

RockShox, Inc.
(Nasdaq: RSHX)
Phone: 408-435-7469
Website: http//www.rockshox.com
Price (12/16/97): $7 3/4


HOW DID IT FIND TROUBLE?

As once-hot mountain bike manufacturers have found the road to increased sales steeper and bumpier than they figured, even the best shock absorbers have had trouble cushioning the ride. That's the story at RockShox, the dominant maker of bicycle suspensions whose stock has experienced a shocking collapse since July.

After a September 1996 IPO at $15, RockShox shares hit a high of $19 1/8 earlier this year. FY97 results (reported April 30) showed pro forma earnings up 37% to $1.03 per share on just 27% higher sales. But the good times couldn't keep rolling along.

First quarter numbers reported on July 21 showed just a 10% rise in EPS. While sales to bike manufacturers jumped 32%, purchases by independent dealers declined, in part due to a shift in seasonal orders. That, plus RockShox's move into the mid-tier, lower-priced bike market explained a slight dip in gross margins to 35%.

Most importantly, chair and co-founder Steve Simons noted that softening domestic demand for mountain bikes was causing the company to take "a conservative outlook for the balance of the year."

Second quarter results first reported Oct. 8 confirmed the problems, as sales rose just 2.5% due to a fall-off in shipments to bike makers. Earnings declined to $0.25 per share versus $0.28 a share a year ago as gross margins sank to 33.9% from 36.8%. Simons said the remainder of FY98 would be "challenging," meaning that the second half results will come in below those seen a year ago.

BUSINESS DESCRIPTION

San Jose, California-based RockShox is the world leader in high-performance bicycle suspension products with a 60% market share. It makes front suspension forks, rear shocks, and newly introduced disc brakes under brand names such as Judy, Indy, Ruby, Boxxer, SID, and Deluxe.

Last year, 72% of sales came from bike manufacturers such as Trek, GT Bicycles (Nasdaq: GTBX), and Specialized Bicycles. Its products are also sold in the replacement market through a network of 10,000 independent dealers.

RockShox made its name in the premium mountain bike category, but the introduction of its new SID lightweight cross-country suspension fork is part of a move to broaden its offerings by bringing some high-tech comfort to mid-priced bikes. The company's new sub $200 products have started showing up on bikes in the $400 range.

RockShox leads in sales of front suspensions and is number two in rear suspensions. Competitors include LDI Limited's Answer Products division, Fox Factory, and bike maker Cannondale (Nasdaq: BIKE).

Co-founders Simon and Paul Turner own a third of the stock.

FINANCIAL FACTS

Income Statement
12-month sales: $110.2 million
12-month income: $14.2 million
12-month EPS: $1.01
Profit Margin: 12.9%
Market Cap: $108.9 million

Balance Sheet
Cash: $9.9 million
Current Assets: $45.4 million
Current Liabilities: $19.4 million
Long-term Debt: None

Ratios
Price-to-earnings: 7.7
Price-to-sales: 0.99

HOW COULD YOU HAVE SEEN IT COMING?

It didn't take an old Schwinn-lover to realize that the market for increasingly sophisticated (and pricier) mountain bikes couldn't keep growing at the 51% clip RockShox had enjoyed over the last three years. In fact, sales began declining last year and margins also seemed at risk of falling as the company broadened its offerings. Growth stories ready to find trouble often show up, as RockShox did, on Business Week's May listing of the "100 Best Small Companies" in America.

The collapse in the stock of mountain bike manufacturers such as GT Bicycles (Nasdaq: GTBX) earlier this year also should have been a wake-up call. Finally, investors might have guessed it was time to hit the road after the CEO turned cautious in July.

WHERE TO FROM HERE?

Analysts see a rough road ahead. For FY98, which ends in March, the company should make $0.78 per share, with $0.94 per share expected in FY99 (range $0.85 to $1.03). That puts the stock at just 8.5 times consensus earnings six quarters out. YPEG fair value based on those earnings and estimates of 18% long-term growth is $17.

With industry sales contracting, though, that growth rate should be questioned. In fact, the significant increase in second quarter inventories and receivables suggest some potentially serious problems ahead.

RockShox's future depends on broadening the market for its suspension products by moving aggressively into mid-priced bikes while continuing to improve its manufacturing efficiencies. The bike makers seem enthusiastic about the new disc brakes. They're also working on new designs that should bring high-tech/high-comfort features to the now bigger-butted baby boomers who helped make the mountain bike craze more than just a fad.

Another positive is that co-founder Simons recently relinquished the CEO position to George Napier, a RockShox board member and former chief operating officer of Wilson Sporting Goods. Successful founders are frequently ill equipped to handle the second phase of growth, but they are often too proud to bring in outside managers until the company is on the rocks.

RockShox remains a technology leader with strong brand recognition and still solid profits in a marketplace that's entering its first real downturn of the decade. This smooth executive transition seems well timed and suggests that the co-founders know their limitations.

Though the bike biz has lost a spoke or two, RockShox represents one of the best ways to invest in any broad recovery when and if it comes.

-- Louis Corrigan
(TMFSeymor@aol.com)


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