Not with the company itself, mind you. To the contrary, MK applauds iRobot's 20.4% compounded revenue growth rate over the past five years, and predicts we'll see sales up more than 28% this year, with further double-digit growth to follow. Catalysts fueling growth include PackBots upgrades, new military robots, growing Roomba sales, and "entry into new consumer segments, like health care." Gushes the analyst: "We expect iRobot to display one of the fastest growth rates in our coverage universe and the broader industry."
What's wrong with that?
But none of that changes MK's opinion that at today's valuation of 49 times estimated 2010 earnings, and 24 times 2011's expected take, the stock simply costs too much: "We believe this potential is already fully priced in at current valuation levels." Hence, MK's initiating coverage with a "hold" rating.
I think that's off-base, and I'll tell you why.
Morgan Keegan: We do our best work underground
First off, there's the analyst's record. While a great picker of oil stocks, where MK's "coverage universe" is currently crushing the market with a combined 475 points worth of market outperformance, this banker isn't all that impressive in iRobot's home demesne in the Household Durables sector. MK's only made four picks in this sector over the past four years, and only two of them are currently "in the green" -- guesses that both La-Z-Boy and Furniture Brands would underperform the market.
Not to disparage common sense or anything, but it didn't take a genius to guess that furniture stocks would struggle in the midst of the Great Housing Crash. That was a pretty obvious call.
Vacuuming up cash, and scrubbing the inventories
That's the problem with applying the "red thumb" to iRobot's valuation today. It's too obvious. In a nutshell, I believe MK pays too much attention to the company's GAAP income statement, at the expense of the more important cash flow statement and balance sheets. It's there that we see just how much iRobot has cleaned up its act this year. It's there I believe iRobot's true value shines through.
You see, MK's right to praise iRobot's sales performance. Last quarter, revenues rose 67% year over year. Even more impressive, though, are that accounts receivable increased only 12% and inventories actually declined 3% in the face of this massive sales drive. Simply put, iRobot has become a lean, mean, cash-generating machine.
Free cash flow topped $30.5 million over the past 12 months, far in excess of iRobot's $11.3 million in reported GAAP "profit." So forget about what iRobot might achieve this year, or in 2011. Based on trailing results alone, the stock already sells for less than 17 times free cash flow. For an expected 20% long-term grower, I think that's a steal of a price.
To top it all off, as MK notes, iRobot's cash kitty is overflowing with "$85.3 million in cash and no debt." Which means the price you're paying for the underlying business, ex-all its spare cash, is even cheaper than the 17-time ratio mentioned above.
Roombas and PackBots and (no) rivals, oh my!
Final point now, and it relates directly to the business in question: Think quick, and tell me: Who's iRobot's most dangerous rival?
That's a trick question, of course, because there are no rivals. No one serious, at least. Honda (NYSE: HMC ) makes home robots, of course, but so far its Asimo is good for little more than photo ops and spontaneous trumpet recitals. Electrolux supposedly makes a robotic vacuum, but I challenge you to try and actually find one on Amazon to buy. When you think "home robots," there's only one name that leaps to mind, and that's iRobot.
Granted iRobot does have some competition on the military side of things, primarily England's QinetiQ and its Talon warbot. But iRobot has already swept past QinetiQ in the "most robots deployed in-theater" competition, and as MK's comments make clear, iRobot's got real momentum in this segment.
As for local competition, for the most part, major U.S. industrial companies have chosen not to fight iRobot's military robot dominance, but to partner with iRobot instead. Boeing (NYSE: BA ) , Deere (NYSE: DE ) , and SAIC have all chosen to collaborate with iRobot. (General Dynamics (NYSE: GD ) is about the only major U.S. defense contractor I know of making warbots that could go head-to-head with iRobot, and even them, I have not heard from in years.)
iRobot's dominance in home and military robots is as obvious as its undervaluation is hidden. With superb free cash flow, a steadily strengthening balance sheet, and a lack of serious rivals in either of its two key fields of endeavor, this stock is not the "hold" MK says it is. To the contrary, it just might be worth buying.
Disagree? Feel free. Tell us what you think about iRobot on Motley Fool CAPS.