Logitech stock: Best to wait for idle money to release first (NASDAQ: LOGI)

Nilanka Sampath

After a fall of more than 50% over one year, Logitech International SA (NASDAQ: LOGI), with P/E multiples trading at less than 12x looks particularly cheap for a mainstream tech stock, especially since its earnings (shown in the orange chart below) only suffered a 25% shortfall from the peak in the December 2020 quarter.

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Data by YCharts

Moreover, it remains a profitable business and also pays dividends. For investors, I am looking for the reasons for such a drop in the share price by looking for the reasons why the fourth quarter 2022 (Q4) earnings are lagging almost 20% of those obtained in the same period l last year.

The top line and the bottom line

First, the exceptionally high revenues were due to the Covid pandemic, which began to impact humanity in the first quarter of 2020. It completely changed the way we work and play as entire cities and even countries have gone into lockdown mode.

As a result of these restriction measures, employees began to work from home using more computers, including keyboards, headsets and webcams for video conferencing purposes. As for gamers and people looking for entertainment, they bought more consoles. This is the type of equipment provided by Logitech and, due to the sale of more of them, revenues have increased. Additionally, as the graph above shows, the fact that fourth quarter sales remain above pre-pandemic levels suggests that Logitech’s products have shown great resilience in the face of changing conditions. of the market.

Continuing further, Covid sales also led to higher operating profits, resulting in EBIT (earnings before interest and tax) margins peaking in December 2020, as shown in the chart below. Subsequently, these began to decline, but at 10.9% in the fourth quarter, they remain above the 8.1% before the start of the pandemic.

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Table constructed from data from (www.seekingalpha.com)

Looking at the reasons for the reduction in profitability from the second half of 2021 despite the absence of a sharp drop in revenues, I noticed that the problem was more related to a decline in gross margins. Looking further, these were due to the rising cost of revenue due to supply chain disruptions. In this respect, tighter supply means higher transportation and raw material sourcing costs, and for Logitech they have also resulted in a significant increase in inventory, as the company has stocked more items for mitigate potential disruptions.

However, part of these higher inventories was also caused by forecast demand for some of the company’s products not converting to sales as expected. However, this can work in favor of Logitech’s operating cash flow if demand picks up, especially in the event that competitors also affected by component shortages are not necessarily able to produce computer accessories or game consoles. In such a case, with its distribution centers and manufacturing sites holding three times pre-pandemic capacity, as shown in the orange graph below, the company could potentially produce faster and grow sales faster. than the competition.

The risks

On the other hand, if the above prediction does not materialize and the company is unable to reduce its inventory in time, its cash position which has decreased both on a sequential basis and year on year, as shown in the blue graph below, will continue to deteriorate.

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Table constructed from data from (www.seekingalpha.com)

In the worst-case scenario where there is destruction of demand due to a severe downturn in the economy, these inventory levels may prove unsustainable and the company may have to liquidate them at a discount.

However, management isn’t overly concerned about the high inventory, which is expected to last through the end of the year. So, in the words of the CFO, “I like our position with inventory. I think that’s a good use of the balance sheet.”

The CFO’s enthusiasm may be explained by the fact that his company has only $41.9 million in debt against total cash and cash equivalents of $1.33 billion. Additionally, with average quarterly operating expenses of $373 million for the last four quarters and capital expenditures of approximately $25.3 million in Q4-2022, Logitech has enough cash to maintain inventory. higher for the rest of this year. Conversely, expect working capital to decline in the second half of 2022, below the $50.5 million reported last quarter.

Looking for an industry-level comparison, competitors also saw their quarterly inventory levels increase, as shown in the charts below, but Logitech’s inventory, as shown in green in the chart below, is much higher than ASUSTeK Computer (OTC: OTCPK: ASUUY) and others. .

Chart
Data by YCharts

Therefore, with so many unused items sitting in inventory instead of being sold, it’s no wonder the company’s growth suffered, so much so that it was given an F rating. by the SA rating system. Additionally, it is flagged with a risk of poor performance as the stock comes with “momentum slowdown”, which is historically associated with poor performance. Therefore, Logitech inherits a sell rating from the Quant rating system, as shown in the table below.

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Quantitative assessments and factor ratings (www.seekingalpha.com)

However, the chart also shows the company earning a B+ for profitability, a key metric I’ll discuss in more detail below.

Discussion

Going back to the inventory, according to the executives, part of the items also consist of components that were purchased before the cost increases. Now, going forward, that means Logitech will incur fewer manufacturing costs, which, in turn, will lead to higher gross profit margins when items are sold.

In addition, the other part of the inventory consists of finished products which can be easily exchanged for cash once the supply conditions have eased, wholesalers no longer have to bear transport costs. higher. Now, in addition to revenue, the company is also expected to benefit from better profits in case it raises prices in a constrained supply environment for its competitors. To that end, Logitech can leverage a well-diversified revenue base encompassing games, video collaboration, and more, as shown in the table below.

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SEC filings with segment earnings for Q4-2022 (www.seekingalpha.com)

However, don’t expect increased profitability in the short term, as higher air freight costs due to Covid-induced supply disruptions in China and unfavorable exchange rates are expected to keep costs high and putting pressure on cash flow from operations.

Evaluations and key points

Therefore, barring a favorable corporate update, expect greater volatility when the first quarter 2023 financial results are announced in early August. Now, thanks to the decline, the stock is now undervalued relative to the IT sector median by at least 30% when looking at price-earnings and price-to-sell metrics.

However, there is another important metric in the form of current operating cash flow that deserves more attention. The fact that it is shaded orange in the chart below indicates an overvaluation, of 58%. While some may look at the P/E as I mentioned in the introduction, measuring cash flow is critical due to the Fed’s monetary policy tightening to combat high inflation. To this end, in a market where the value strategy prevails, analysts are more likely to focus on cash in the second half, in addition to profitability.

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Ratings (www.seekingalpha.com)

Thus, unless you have a long-term investment horizon, it is better to wait for clear signs of improvement in operating cash flow, which is down more than 80% over one year. Given the current high level of inventories, an improvement should only occur towards the end of the year.

So, in summary, a lot of Logitech’s cash is sitting idle right now, but from a profitability standpoint stockpiling components isn’t a bad idea when prices continue to rise amid the crisis. of supply, particularly when the cash position allows such movement. Along the same lines, having many finished products ready to ship as competitors struggle to meet production targets is another positive. As for demand, with the Americas accounting for around 42% of total sales and the Consumer Technology Association expecting the US market to grow 2.8% in 2022 compared to 2021, the chances of the company’s products do not find buyers are thin.

Finally, it would be tempting to buy stocks at these levels, but, in these very uncertain times, it is better to wait for clear signs of the release of operating cash from stocks before investing.

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