IROBOT CORP IRBT S
September 21, 2018 - 11:36am EST by
go2bl93
2018 2019
Price: 106.29 EPS 2.46 3.15
Shares Out. (in M): 28 P/E 43 34
Market Cap (in $M): 3,012 P/FCF 0 0
Net Debt (in $M): -127 EBIT 0 0
TEV ($): 2,885 TEV/EBIT 0 0
Borrow Cost: Available 0-15% cost

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Description

This a pretty straightforward idea (and potentially time-sensitive), so I’ll try to keep this as short and sweet as possible. I am recommending shorting iRobot (IRBT) due to an expected imminent negative impact on their business from the recently enacted tariffs on Chinese goods.

 

Key points

  • IRBT outsources 100% of their manufacturing to China
  • About half of IRBT’s revenues are in the US
  • Vacuums, including IRBT’s well-known self-driving ones (Roomba’s), are included in the list of goods from China on which 10% tariffs are to be imposed beginning on 9/24/18
  • Current management guidance explicitly does not incorporate any negative tariff impact
  • The 10% tariff could cause a 25% hit to IRBT’s bottom line, and there will be a far larger impact should tariffs rise to 25% on Jan 1, 2019 as currently scheduled
  • I expect the company will have to negatively revise their forward outlook to incorporate tariffs either when they report Q3 earnings or before
  • Stock has ripped since reporting a slight beat and raise in July (stock +50% vs just a +2% raise in annual operating income guidance), leaving little margin for error
  • After this recent run, it is trading at very full 43x CY18 EPS for what is teens organic growth, again leaving little margin for error
  • The number of shares sold by insiders quarter to date (Q318) is more than double that in any other quarter in the last 2 years

 

Background

IRBT sells the popular self-driving vacuum cleaners most commonly under the Roomba name. They essentially own this market (80%+ share in US). Their products are priced from ~$300-$800, depending on functionality. They include features like wifi (yes, your vacuum needs wifi).

Vacuums, including IRBT’s, are included on the list of the $200B of Chinese-manufactured goods that will be subject to a 10% tariff beginning on Monday, 9/24/18.

https://ustr.gov/about-us/policy-offices/press-office/press-releases/2018/september/ustr-finalizes-tariffs-200

Given that IRBT outsources all its manufacturing to China (2017 10-k) and approximately half their revenues come from the US (51% in CY17), IRBT is highly exposed to the negative impact of the tariffs.

 

Tariff impact

For the sake of simplicity, let’s look at current CY18 guidance and adjust for the impact of the 10% tariff as if it applied for the full year. The most recent annual guidance is for revenues of $1.06B-$1.08B, GM ~51%, EBIT $90M-$96M, and EPS $2.30-$2.50. Below summarizes the theoretical full year impact of the 10% tariff on 2018 guidance.

 

 

This is based on full year CY18 guidance and, with tariffs set to take effect on 9/24/18, the above is not intended to (and will not) represent the actual impact on CY18, but should be representative of the post-tariff implementation earnings run-rate.

Given inventory days that I expect to be 100+ at the end of Q318 (96 at Q218) and assuming 1 month of inventory in China or on the boat, I think it’s reasonable to assume that the company would have about 2+ months of inventory domestically that delays the income statement impact of the tariffs, perhaps until around the end of November.

Given that Q4 is the company’s biggest quarter of the year and my estimate that tariffs should start impacting margins with a decent amount of the quarter (~1 month) to go, I expect the company to have to address this with their Q4 guidance, and revise downward. This would also then bring up the question in investors’ minds (should the tariff situation remain status quo) of what will happen when the tariff rate goes up to 25% starting 1/1/19. Without reproducing the entire table from above, plugging in a 25% tariff rate results in a 67% decline in EPS!

 

Management Comments

Management was asked multiple times on the Q218 call about the potential impact from tariffs, as it was known at that time that IRBT was included in the list of goods potentially set to be hit by tariffs.

When giving their annual guidance, they had explicitly said that it did not contemplate any impact from tariffs. Here’s the relevant comments from the call addressing tariffs:

 

 

 

 

Risks

  • Trump strikes a deal with China to withdraw tariffs posthaste
  • The company raises prices to offset the tariff impact
    • This is a hard one to call; they can certainly do this, with the only question being how much this hits volumes (it’s not zero)
  • I think the company probably beats Q3 EPS (no view on revenue)
    • Looking at historical seasonality in Q3/Q4, street seems to be miss-modeling the Q3/Q4 cadence on GM/OpEx making them too low on Q3 EPS, and possibly too high for Q4 EPS (pre-tariffs). The company only gives annual guidance
    • I don’t like this, but the company has a pattern of routinely blowing away Q3 estimates. They have done so the last 3 years, but the stock sold off on 2 of 3 of those prints. I believe the buy-side is already well ahead of the street for Q3
  • 39% short interest

 

 

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

Negative forward earnings revisions

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