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Tariffs Won’t Kill iRobot, but IRBT Stock Is About to Get Cheap

Even with the tariff headwind, IRBT stock looks compelling on drops to $75

By Luke Lango, InvestorPlace Contributor

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Tariffs Won't Kill iRobot, but IRBT Stock Is About to Get Cheap

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Consumer robotics leader iRobot (NASDAQ:IRBT) reported robust third quarter numbers after the bell on Tuesday. It was a huge double-beat-and-raise quarter that saw revenues top expectations by essentially the widest margin in company history, and saw earnings come in more that twice as high as the consensus estimate. Yet, IRBT stock failed to rally.

Instead, it went the opposite direction. After initially popping more than 10% higher in after-hours trade, iRobot stock proceeded to swing to a huge loss. As of this writing, iRobot is down more than 10%.

Why? Because while it was a beat-and-raise quarter, the “raise” part came entirely from strong Q3 results. The implied Q4 guide is slightly weak on revenue and very weak on earnings.

What’s to blame? Tariffs. iRobot management said that tariffs are causing the company’s costs to go up. But, presumably because iRobot is in a competitive marketplace where price is king, management isn’t going to pass along those higher costs to consumers. Instead, they are gong to absorb those costs. That means lower margins, and lower profits.

There is no end in sight to the trade tensions between the U.S. and China. As such, this tariff headwind is here to stay. Investors are now pricing this into IRBT stock. According to my numbers, the 10% drop makes sense.

But, tariffs won’t altogether kill iRobot. If this stock continues to drop towards $75 or lower, I think the buying opportunity looks compelling. At prices below $75, tariff headwinds are completely priced to last for a lot longer. That likely won’t happen. This issue will likely be resolved within the next 1-2 years. As such, below $75, IRBT stock looks like a buy.

iRobot’s Quarter Was Great, but the Guide Wasn’t

At its core, iRobot’s third quarter report was outstanding, and the fourth quarter guide was anything but outstanding.

Third quarter revenues topped expectations by $20 million, their biggest beat in recent memory. Earnings came in more than double expectations, also the biggest beat in recent memory.

New products drove robust 45% revenue growth in the United States. Gross margins continued on their upward trajectory. The operating expense rate fell back due to huge revenue growth. Profit growth was nearly 50%.

Overall, the quarter affirmed iRobot’s secular growth trends. The robotics vacuum market is just starting to go mainstream. iRobot is the leading that revolution, and new products are only further differentiating iRobot from the competition.

Meanwhile, the company isn’t really feeling any competitive pressures, and gross margins are roaring higher. Overall, the third quarter print affirmed that this is a 20%-plus revenue growth and 20%-plus profit growth company over the next several years.

But, the guide called into question that 20%-plus profit growth outlook. Not because of anything competition related or company-specific. Rather, because the U.S. and China can’t seem to find a resolution to present trade tensions, tariffs are being slapped down left and right.

Those tariffs are causing prices to go up for iRobot. Because this company can’t afford to raise prices in a nascent market while trying to win over customers, iRobot is absorbing those higher costs. Long story short, that means lower margins and lower profit growth.

That is why implied fourth quarter earnings missed Street expectations by a mile. The Street was looking for $0.80 EPS in Q4. iRobot’s guide implies around $0.50 EPS in Q4.

That is no good. As a result, IRBT stock dropped in a big way. This drop makes sense considering the tariff headwind isn’t showing any signs of letting up anytime soon. But, if the sell-off persists, iRobot could become a compelling buy.

iRobot Stock Is Being Priced for Tariff Headwinds

Wise investors always say trade the market you have, not the market you want. The market we want is a market without trade tensions and tariffs. The market we have is a market with trade tensions and tariffs. As such, at the current moment, investors are re-pricing iRobot for the market we have.

By my numbers, the current re-pricing makes sense. I don’t think tariffs in their current state will have a meaningful impact on revenues. But, they will have a huge impact on margins, and the $5 million operating profit tariff hit management is expecting in Q4 amounts to about 1.5% of implied revenues. At worst, over the next several years if tariffs accelerate, that impact widens to 2%.

If I take down my long-term margin estimates for IRBT stock by two percentage points, I start to understand the current correction. Without tariffs, I think this is a company with $6 EPS potential in five years. Throw a 20X forward multiple on that, and discount back by 10% per year. You arrive at a 2018 price target of $90.

With tariffs, I think EPS potential gets knocked down to $5 in five years. Do the same calculus. You arrive at a 2018 price target of $75.

Tariffs almost assuredly won’t last for the next five years. Trade issues should be resolved within the next one to two years, especially given that both the China and U.S. economy are starting to feel real pain from them. Thus, I think fair value on IRBT stock lies somewhere between $75 and $90. Assuming 50/50 odds, then iRobot stock is worth just over $80 today.

From this perspective, I think any dips towards $75 or lower are buying opportunities.

Bottom Line on IRBT Stock

The Q3 report affirmed that IRBT stock is a long-term winner with a major tariff headwind. It is a wild card when it comes to how long this headwind will persist. But, assuming resolution within the next one to two years, IRBT stock is a buy if it drops to $75 or lower.

As of this writing, Luke Lango did not hold a position in any of the aforementioned securities. 


Article printed from InvestorPlace Media, https://investorplace.com/2018/10/irbt-stock-get-cheap/.

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