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iRobot (IRBT) Stock Is Primed for a Rebound and Then Some

Luke Lango

Ouch! All the sudden iRobot Corporation (NASDAQ:IRBT) has a competitor in the robot vacuuming space and the stock is getting killed.  IRBT stock is down almost 20% in 2 days.

iRobot Corporation (NASDAQ:IRBT) IRBT stock

Source: Shutterstock

The specific catalyst? A really, really negative report from Spruce Point Capital Management. The short-selling focused investment firm, which is short IRBT stock, pointed out that dominant traditional vacuum company SharkNinja is aggressively entering the robot vacuum space.

Spruce Point thinks Shark’s entrance into the space is a huge negative for IRBT.

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The thesis is pretty simple. IRBT stock is priced for perfection, so competitive pressures aren’t really priced into the stock. But Shark has illustrated that they are able to rapidly and successfully eat market share (just look at how they ate Dyson’s lunch in the traditional vacuum space). Consequently, its reasonable to assume that Shark makes similar inroads in the robot vacuum space, implying that iRobot’s future revenue growth will be adversely affected by market share losses.

Shark is also coming into the market with a lower average price point than iRobot. When a competitor comes into a market with a lower price point and eats market share, the result is usually gross margin degradation.

Overall, then, Spruce thinks IRBT revenue growth will slow meaningfully over the next couple years while gross margins will erode. IRBT stock isn’t priced for this (31-times next year’s earnings estimate).

Net takeaway? IRBT stock will fall.

And it has fallen. But this dip may be a buying opportunity.

Here’s why.

Robotic Cleaning Is A Big Growth Market

Spruce Point is right about a lot of things. But the one thing that’s missing is just how big this robotic vacuum space will be.

The robotic cleaning market is a space that is expected to grow anywhere between 15% and 30% per year over the next several years. The midpoint of that range implies market growth of about 22.5% per year.

iRobot will almost certainly cede some market share to Shark. That means IRBT stock will grow revenues at a pace lower than 22.5% over the next several years. I think its reasonable to assume a 17.5% top line growth rate over the next several years. That implies IRBT will be able to grow with the market, but still cede some market share to new entrants.

On the gross margin front, I don’t see as much gross margin degradation as Spruce Point. Gross margins at IRBT have been on a tear. They went from 45% in 2012 to 48% last year and are trending around 50% in the first half of 2017. Shark’s entry almost guarantees that this gross margin growth trajectory will not continue, but it doesn’t necessarily mean that gross margins will suddenly fall off a cliff.

Shark makes traditional vacuums. Its what they do. But iRobot makes robotic vacuums. Its what they do. And that makes iRobot the more trusted brand in the space, meaning they can command a premium price point. They will lose some market share to more price sensitive customers, but overall, when people are looking to buy robotic vacuum cleaners, they will look to buy the Roomba because it is the market standard.

So gross margins won’t fall off a cliff. They will likely just flat line around 48%.

Meanwhile, accelerated revenue growth should drive some operating expense leverage. The Opex rate has been hovering around 40% over the past several years, but I think revenue growth can drive that number down to the mid-to-high 30s range.

High teens revenue growth, flat gross margins, and a few hundred basis points of Opex leverage imply that IRBT can grow earnings in excess of 20% per year over the next several years.

After the recent whacking, IRBT stock trades at 31-times next year’s earnings growth.

You won’t find many 20%-plus growth stocks trading at just 30-times next year’s earnings.

For example, look at Intuitive Surgical, Inc. (NASDAQ:ISRG), another robotics company which trades at 37-times next year’s earnings estimate. But earnings growth is expected at just 11% over the next several years.

Bottom Line on IRBT Stock

As I’ve said before, robots are starting to show up to the party. There are only a few now, but by the end of the night, robots will be everywhere at the party.

They won’t all be Roomba vacuums. Some will have the Shark logo. But most will be Roomba vacuums.

The recent sell-off under-appreciates just how much growth the robotic cleaning space will experience over the next several years. Of course, hyper-growth markets attract intense competition, but IRBT has established itself as the undisputed market leader.

So I’m buying this dip. I think this stock will bounce back quite soon.

As of this writing, Luke Lango was long IRBT. 

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