Sharing Our iRobot Stock Recommendation (From May 2020) - 7investing 7investing
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Sharing Our iRobot Stock Recommendation (From May 2020)

The 7investing team recommended buying iRobot stock in May 2020. In light of iRobot's acquisition by Amazon announced in August 2022, we're making our recommendation report public.

October 28, 2022

– Advisor: Steve Symington

Companies: iRobot  

NOTE: On August 5, 2022, 7investing recommended members sell iRobot stock as a result of its impending acquisition by iRobot is no longer an active recommendation on our scorecard. Below you’ll find our original recommendation to buy iRobot, first published in May 2020.

The 7investing Key Takeaway

It’s difficult, even disappointing at times to try and reconcile the reality of investing in robotics with popular ideals for the future of the industry in our everyday lives.

On one hand for many people, thinking about robotics invokes grand visions of walking, talking Jetsons-style robots capable of zooming around and catering to our every need. But investors who follow the robotics industry closely, on the other hand, might rightly feel like we’re light years away from actually creating such interactive, autonomous helpers, let alone commercializing them at any meaningful scale.

With companies like iRobot (NASDAQ: IRBT) leading the way, however, that idealistic future of robotics might be closer than you think. Picking up shares of the home-robotics specialist now could mean staggering gains not only as it realizes the potential of its current core markets in the coming years, but also as it works to bring some of those grand ideals to fruition down the road.

What does iRobot Do?

iRobot is best known for its Roomba line of robotic vacuum cleaners (RVCs), selling over 30 million robots since introducing the RVC category in 2002.

Indeed, since divesting its Defense & Security business in 2016 – which largely focused on making rugged robots for military and government clients – followed by the spinoff of its Ava telepresence business, Roomba still generates the vast majority (around 88% last quarter) of iRobot’s consolidated revenue.

The company could derive a nominal amount of revenue from recently launched educational initiatives, including its Root coding robot and Create 2 programmable bots. But rather than serving as truly commercial efforts, these robots are aimed primarily at fostering enthusiasm from the next generation of robotics developers.

Meanwhile, iRobot collects most of the remainder of its sales through its popular Braava floor-mopping line of robots, which partly stemmed from technology purchased through the company’s late-2012 acquisition of wet floor care pioneer Evolution Robotics.

Together, Roomba and Braava represent the cornerstones of the company’s pivot toward exclusively focusing on the home-robotics segment of the market. So perhaps it’s fitting that the latest versions as of this writing (the Roomba S9+ and Braava jet m6) are now capable of wirelessly communicating with one another – with the Roomba vacuuming first, then giving the go-ahead to Braava to mop – in order to more effectively clean your home.

iRobot’s Roomba S9+ and Braava jet m6 robots. IMAGE SOURCE: IROBOT

But iRobot isn’t stopping there.

In early 2019 iRobot unveiled its first robotic lawn mower, dubbed Terra, in a bid to expand its presence outside the home into the multi-billion dollar lawn care market. Though Terra remained in beta tests with plans for a limited online commercial launch in 2020, the news fueled an incredible rally with iRobot shares surging nearly 40% higher over the course of a single month.

Earlier this week, however, iRobot temporarily shelved plans for Terra’s commercial launch in light of challenges created by the coronavirus pandemic. I’ll elaborate more on what to expect to that end below, but rest assured iRobot will bring this potentially lucrative product to market when the timing is right.

Why is iRobot Such a Good Investment?

Innovation is at the root of iRobot’s success. The company maintains an ambitious goal for steadily spending at least 12% of annual revenue on research & development — which, based on last year’s sales of $1.214 billion, meant the company poured nearly $146 million into both new product development and maintaining and improving its core businesses. Though activist investors have tried before (and failed) to get iRobot to abandon these heavy investments to bolster near-term profits, I believe maintaining its hardy R&D spending is key to realizing its future potential.

To better understand iRobot’s runway for growth, let’s break down each of its current market opportunities.

First, the global vacuum cleaner industry (including both traditional and robotic units) more than doubled in size over the past 7 years to represent an $11 billion market in 2019. But while RVCs nearly doubled their own share of that market over the same period, they still only represented around 24% of total vacuum sales last year (up from 13% in 2012).

And RVCs should only continue to gain traction going forward. According to iRobot CEO Colin Angle, RVCs have tracked along roughly the same points in their adoption curves as microwaves and dishwashers, which took the better part of two decades after their initial introductions to become truly ubiquitous. As such, iRobot believes its current installed base of Roombas could grow from roughly 16 million households today to 90 million over the longer term.

The wet floor care market is harder to quantify as Braava aims to replace cheaper manual alternatives than vacuums (think brooms, mops, and the like). But iRobot has previously pegged the industry as being worth approximately $3.2 billion as it stands.

Finally, the lawn care market is more concrete (pun intended), as consumers look to minimize outdoor labor and replace expensive riding and push mowers. When it launches – and if the positive beta feedback for Terra’s safety and efficacy carries over to the general population – iRobot estimates Terra could effectively cut into an addressable market worth nearly $5 billion.

What’s more, at its steady state (i.e. once we put tariffs and the coronavirus pandemic in the rear-view mirror, but more on that below), iRobot has built a solidly profitable core business and carries no debt with $264 million on its balance sheet at the end of its most recent quarter.

What’s Happening in the Bigger Picture?

If the Terra delay didn’t already hint at as much, iRobot is off to a rough start in 2020.

But we’ve known that would likely be the case for awhile now; iRobot issued a preliminary business update over a month ago withdrawing its full-year 2020 guidance – which previously called for full-year sales growth of roughly 10% – warning that the coronavirus pandemic was disrupting its sales and manufacturing supply chain activities.

Sure enough, when it released its first-quarter results earlier this week, iRobot confirmed revenue had declined 19% year over year, to $192.5 million – though that was still comfortably above the $175 million to $185 million range iRobot predicted in its preliminary release. That translated to an adjusted net loss of roughly $9.2 million, or $0.32 per share, swinging to the red from net income of $27.5 million, or $0.96 per share in last year’s first quarter.

iRobot also initiated “difficult, but necessary” cost-reduction actions that should generate roughly $30 million in net savings this year, including select furloughs, spending reductions for travel and short-term incentive compensation, and reducing its workforce by 5%.

But there were bright spots in the report as well.

According to the company, those cost reductions will enable iRobot to shift engineering talent from hardware to software solutions, accelerating strategic initiatives iRobot believes can help it build deeper relationships with customers as well as potentially lucrative recurring revenue streams.

Exactly one week ago, iRobot also learned it’s been granted its request for an exclusion from Section 301 tariffs on products imported to the U.S. from China. Recall these tariffs were initially instituted by the U.S. at 10% in late 2018, then raised to 25% in May 2019 as U.S.-China trade relations escalated. Though iRobot briefly attempted to raise prices last year to offset the cost of tariffs and avoid taking a significant hit to margins, it ultimately opted to revert to pre-tariff prices in an effort to defend its market share amid an influx of new competitors in the space. Even before the pandemic, adjusted gross margin was set to decline from 46% in 2019 to around 38% to 39% in 2020.

Now, though, the exclusion enables iRobot to seek reimbursement for the full $47 million in tariffs it has paid since 2018, and to benefit from a significantly improved margin profile as long as it remains in effect (currently through early August 7, 2020, as with other List 3 exclusions, unless extended).

Looking past these near-term headwinds, however, perhaps most exciting are iRobot’s plans for the future.

For one, with the rise of internet-connected devices all around us – and with multiple smart-home partnerships with the likes of Google and IFTTT – iRobot is also looking to spur that momentum by positioning Roomba as a sort of central, “unifying intelligence” to insert useful spatial awareness into future smart homes.

Today’s Roombas already create detailed maps of any given home they navigate (with users’ permission and labels, of course), including recognizing which room they’re in and how to get there. But in the future iRobot believes it should be possible for the robot to delineate specific items and more extensively categorize objects, giving it an invaluable perspective it could use to better inform other smart devices in the home – say, cleaning once everyone has left for the day, or recognizing which smart lights to turn on “near the couch in the living room.”

I’m also giddy for the optionality iRobot enjoys with potential future projects; in addition to RVCs, floor mopping, and lawn care, iRobot has previously expressed interest in robots to tackle tasks such as laundry folding, bathroom cleaning, litter boxes, home security, and opening doors to retrieve packages. In a Bloomberg interview earlier this year, Angle even confirmed iRobot is developing a “household helper that will have arms that could load dishes, pick up clothes, or bring food from kitchen to table,” though he added the butler-style bot wouldn’t be commercially ready for at least another five years.

What are the Key Risks?

There are several risks that could hinder iRobot’s quest for home-robotics world domination.

Tariffs are one, particularly if iRobot isn’t able to extend the duration of its aforementioned exclusion past its expiration in early August. That said, iRobot has also moved manufacturing of several of its entry level Roombas to Malaysia to negate this threat, and can now expand the models made there as needed.

Competition is arguably the greatest threat. Thanks to its treasure trove of more than 1,400 issued and pending patents, iRobot has a long history of successfully fending off copycat competitors over the years.

Nonetheless, iRobot currently has an ongoing battle in the courts with vacuum industry giant SharkNinja, which last year introduced significantly cheaper, strikingly similar versions of several of iRobot’s most popular vacuum models.

That said, pricing power here isn’t nearly as much of an issue as you might think; iRobot management has previously noted that its newest (and most expensive) products tend to have lower gross margins at first than the cost-optimized versions they’re designed to replace. As such, iRobot doesn’t hesitate to drop the prices of its robots as soon as it’s able to do so. And it should only become more efficient to that end as the company continues to grow.

Management and Vision

It should come as no surprise that iRobot Co-founder, Chairman, and CEO Colin Angle graduated from MIT with a bachelor’s degree in electrical engineering and a master’s degree in computer science. He previously worked at MIT’s Artificial Intelligence Laboratory, where he met fellow co-founders Helen Greiner and Dr. Rodney Brooks, and ultimately spun off the company from MIT into the practical-robotics leader we know as iRobot today.

And I think that focus on practicality is key to iRobot’s continued ability to survive, thrive, and ultimately commercialize next-generation robotics for millions of consumers around the world.

One quote from a 2013 interview with Angle often stands out in my mind, when he outlined his straightforward view on commercializing robotics:

We need to pick applications that have real concrete value to customers, deliver or exceed their expectations, and move on.

While it might not be as exciting as some investors would hope given idealistic views on what robotics should be, I think iRobot will continue to outperform if it keeps following that simple blueprint.

What Should We Be Watching?

Here are a few useful metrics and trends investors should watch going forward:

  • R&D spending: iRobot has historically looked to spend around 12% of annual revenue on research & development. Look for it to maintain these levels going forward, as I believe these investments are crucial to its ability to innovate, sustain, and extend its industry leadership.
  • Gross margin: As a placeholder, last year iRobot’s gross margin stood at 46%, and was expected to decline to a range 38% to 39% in 2020 largely due to tariffs. Ideally iRobot will be able to increase gross margins to greater than 50% in time, assuming it can maintain its tariff exclusion or mitigate them with manufacturing diversification initiatives in Malaysia.
  • Market share: iRobot held a 52% share of the RVC market in 2019, steady from 2018 but down from 62% in 2017 as competitors entered the market. I expect iRobot’s market share to steadily decline in time as each respective industry matures, which is acceptible as long as it can continue growing its top and bottom lines as those markets expand.
  • New product launches: iRobot has suspended its plans to launch the Terra mower on a limited online basis in 2020, but the company continues to expect to launch new products, including improved Roomba models later this year. We should also watch for clarification on the opportunities for “highly profitable recurring reveue streams” that Colin Angle described during this quarter’s call.

Disclosure: At the time of this recommendation, Steve Symington and Simon Erickson owned shares of iRobot.