Good Passes and a Great Fail for this Robot Maker
Eric is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
The Fool classifies some great long-term investments as Rule Makers. While iRobot (NASDAQ: IRBT) passes several Rule Maker tests easily, the test iRobot fails might be the best reason to invest in this robotics company, since this failure shows why owning iRobot could pay off big.
A recent acquisition and a promising partnership make iRobot's future prospects look even better. The Rule Maker tests show that iRobot already has several traits of an industry leader, even though it's still a small company, and highlight several of iRobot's major strengths.
iRobot's robotic vacuum cleaners need to be more effective than its competitors' robots, and one way to make robotic vacuums clean better is by making them smarter. Evolution Robotics' competitive advantage was its visual recognition technology, which helped its Mint vacuums recognize the layout of a household instead of just randomly moving around a room and hopefully collecting all of the dust.
In a transcript at Seeking Alpha, iRobot CEO Colin Angle discusses iRobot's recent acquisition of Evolution Robotics, and the patents iRobot gained from the buy. iRobot now owns Evolution's visual recognition technology, which iRobot can use to build Roomba vacuums that see the inside of a house better. Better Roombas could also help iRobot take market share from traditional vacuum cleaner companies.
iRobot could also use Evolution's visual recognition technology to make its military robots smarter, which could help iRobot capture market share from QinetiQ (LSE: QQ). QinetiQ obtained TALON battlefield robots when it acquired the manufacturer Foster-Miller. TALON robots are designed to perform tasks that iRobot's military robots also perform, such as detecting explosives, monitoring for hazardous material, and conducting police observation. QinetiQ's MAARS robot can also carry and fire several types of weapons, although QinetiQ explains that the MAARS robot will only fire a weapon if a human operator gives it a command.
Lockheed Martin (NYSE: LMT) has also made a vehicle that can find its own way around a battlefield: the Squad Mobile Support System. Reuters reporter David Alexander explains that Lockheed's SMSS is about as big as a golf cart, but instead of carrying golf clubs, the SMSS carries around soldiers' gear. Evolution Robotics' visualization technology could help iRobot design larger battlefield robots that could help iRobot compete against Lockheed Martin in this field as well.
Cash king margin
Software companies may have an easier time with the Cash King margin, but iRobot still hits the 10% threshold with $460 million in sales and $48 million free cash flow, which results in a 10.4% Cash King margin.
QinetiQ barely misses on the Cash King test, since its $1.47 billion in sales and $134 million free cash flow result in a 9.1% margin. Electrolux, (NASDAQOTH: ELUXY.PK) which makes a wide array of household appliances in addition to the Trilobite robotic vacuum, has $16.34 billion in sales and $352 million free cash flow, which leaves it a 2.2% Cash King margin. Lockheed's $47.5 billion sales and $1.92 billion free cash flow produce a 4% margin, so Lockheed doesn't pass the Cash King Margin test, either.
The flow ratio analyzes how well a company puts its cash to work. Subtracting $157 million cash from $277 million in short-term assets gives the Flow Ratio numerator: $120 million. iRobot has no short-term debt, so the denominator is simply iRobot's $71 million in current liabilities. iRobot's Flow Ratio comes out to 1.69, above the 1.0 Flow Ratio threshold.
The Evolution Robotics buy reduces both iRobot's short-term assets and cash balance, so the numerator doesn't change. Even though this is a miss, the Evolution Robotics buy shows that iRobot will spend its cash when a good opportunity appears, so I still think iRobot uses its cash wisely. Speaking of cash, Electrolux has $1.31 billion in its own bank account, which is more than enough to buy iRobot.
Sales and sales growth
Failing one part of this test shows that iRobot could get a lot bigger. With 16.1% sales growth over the last year and 15.6% sales growth over the last five years, iRobot clears the 10% sales growth hurdle. iRobot's $460 million in annual sales don't reach the $4 billion threshold though, so iRobot fails the total sales hurdle.
Achieving $4 billion in sales would take iRobot 16 years if its sales grew by 15% a year, and iRobot's sales growth over the last year came out better than its five-year figure, so the company might even reach $4 billion sooner. Passing the total sales test might actually be worse for iRobot since maintaining rapid sales growth can be harder for large companies, although iRobot has opened up new markets and kept its growth rate up by building new types of robots before.
Colin Angle founded iRobot and still leads it -- another point in iRobot's favor. A CEO who understands iRobot's AI technology also understands when to buy companies like Evolution Robotics, and when to stockpile cash for better opportunities. Although Angle did sell some shares recently, Yahoo! Finance states that iRobot still has 7.9% insider ownership.
With a 2.63 PEG, iRobot needs to beat the earnings estimates resoundingly for the undervaluation argument to hold water, although iRobot did report a major earnings beat last quarter. The Associated Press reported that analysts expected iRobot to earn $0.10 per share last quarter, and iRobot's actual earnings figure was $0.26 per share. Expansion into a valuable new market could provide a push that could help iRobot surpass the estimates again, and iRobot recently made a major announcement about a project in the health-care industry.
iRobot has been working with InTouch Health to develop a telepresence robot that could help a physician treat a patient at a different hospital. Evan Ackerman, at the IEEE Spectrum, reports that the RP-VITA robot was specifically designed to work with medical devices and medical databases. Health-care regulations could also help iRobot build a moat, since cheaper robots might not meet FDA standards. If the RP-VITA robot can improve access to medical care or reduce physicians' costs, this robot could show up at hospitals around the country and give iRobot a major income boost.
Software that helps a household robot identify a table or a chair could also help a battlefield robot identify a bomb or an enemy tank. With the Evolution Robotics acquisition, the Mint no longer threatens iRobot's market share anymore, and iRobot gains patents that provide some protection from other potential market entrants. These two factors alone could produce an earnings beat, but there's still health care to consider.
Medical telepresence robots could literally have life-or-death implications, because the specialist a patient needs could be thousands of miles away. Health care robots won't pay off immediately, but health-care robots offer great long-term growth prospects for iRobot.
Passing several Rule Maker tests, and failing one of them, shows off iRobot's strong competitive position, and explains why iRobot's income could grow faster than investors expect.
enovinson has no positions in the stocks mentioned above. The Motley Fool owns shares of Apple and Google. Motley Fool newsletter services recommend Apple, Google, and iRobot . Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.