CODA - Coda Octopus: Still Quite Attractive

2023-05-31 04:03:29 ET

Summary

• Coda Octopus Group has promising prospects with its volumetric real-time imaging sonar technology and Diver Augmented Vision Display (DAVD) system, which are gaining interest from the US Navy and other industries.
• Despite doubling its share price in the past year, CODA stock may still be undervalued due to potential underestimation of forward EBITDA estimates and 31% of market capitalization in cash.
• Risks include liquidity issues, supply chain disruptions, and dependence on specialized customers and the defense market, but the outlook for CODA's offerings remains promising.

Introduction

I first became aware of Coda Octopus Group ( CODA ) in August 2021 and gave it a Buy rating, which then changed to Hold a few months later . In the last article on the company, I wrote that Coda looked like an interesting micro-cap company to buy, but maybe a little later - since then CODA stock has actually moved sideways for some time before rising to its current level within a few weeks.

Obviously, I was too hard on Coda Octopus stock, expecting a much lower share price to buy. As the company's products evolved, CODA was able to start showing great results much sooner than I thought - let me tell you about that in more detail today.

The Company And Its Prospects

Coda Octopus Group, initially known as Coda Technologies, was established in 1994 and specialized in subsea mapping and visualization software. Through a series of acquisitions, including Coda Octopus Ltd, Coda Octopus, Inc., and Coda Octopus OmniTech AS, the company evolved into its current form. It operates 2 distinct businesses: the marine products business [MTB], which manufactures and sells 3D sonar systems, and the engineering business [MEB], which serves as a contractor for prime defense contractors. While both segments contribute to the company's revenue, MTB generates >68% of the net income due to its superior profit margin [amid 68.3% of consolidated sales]. In the latest reported quarter, the MEB segment was impacted by delays and stalled projects due to supply chain issues, resulting in a 12% decrease in sales, according to the 10-Q filing.

Commissions in Asia became a headwind for the MTB segment, slightly reducing revenue growth in general - the consolidated sales were almost unchanged YoY in the first quarter of FY2023.

As of January 31, 2023, CODA had $24.5 million in cash on hand and no debt. This represents a $1.6 million cash billed in the quarter. The whole amount represents 31% of the market cap - I see no liquidity problems here:

Coda Octopus is a small company with a market cap of just $104 million. But it has quite intriguing prospects, in my view. Its most promising products for the future's growth are its volumetric real-time imaging sonar technology and the DAVD [Diver Augmented Vision Display] system.

Their imaging sonars are capable of complex seabed mapping, real-time inspection, and monitoring, providing 3D/4D/5D/6D data of moving underwater objects in any water condition, including zero visibility. According to the latest IR presentation , competing products lack the ability to perform real-time inspection and monitoring. For the first time in diving, CODA's DAVD allows Diver and Supervisor to share the same view and information.

Pay close attention to the significant cost savings that can be achieved through the adoption of CODA technology across various use cases:

The DAVD system is being adopted by different teams within the US Navy and has transitioned from the R&D phase to the operational phase. The company holds proprietary technology and patents related to the DAVD system, including the concept of using transparent glasses as a data hub underwater. With patents in hand and plans to continue cutting R&D expenses as the product is ready, CODA's management is now in the process of "actively pitching," participating in various exhibitions and offering its innovative product to both the defense and commercial industries.

We had strong product sales and operational momentum for our Echoscope PIPE and DAVD system even as we navigated supply chain and foreign currency headwinds. We continued to pivot from R&D focus to sales and marketing and brand building and the first quarter 2023 saw us taking a number of actions in this direction, participating in several Industry Trade Shows for the promotion of our products and services, also holding key DAVD demonstrations for foreign navies and Tier I offshore service providers. We also had DAVD demonstrations with a U.S. Navy and Naval Surface Warfare Center, Panama City, which incorporated the DAVD in the new deep sea expeditionary with no compression diving suit. That's a diving suit called DSENDS.

Source: CODA's Earnings Call Q1 FY2023

And this is what's going on with R&D in reality:

As I see it, the MTB and MEB segments have synergies in terms of customers and specialized engineering skills, allowing them to bid jointly for projects and gain a competitive advantage.

And I totally concur with Seeking Alpha fellow analyst Confoundedinterest , who notes that Western-allied navies facing escalating pressures due to geopolitical events such as China's military buildup, the potential Taiwan conflict, and the Russian invasion of Ukraine, could benefit from Coda's DAVD product. Again - CODA just needs a bit more time to pitch it right. The overall favorable market environment positions the company for potential expansion and increased revenue in the near future.

Moreover, the increasing demand for 3D sonar systems, driven by the emergence of new underwater vehicles, offshore wind turbine installations, and the need for expanded oil and gas production, presents opportunities for growth from the commercial side. There are multiple niches where to apply CODA's products.

One analyst expects CODA's FY24 EPS to grow only 19.23% year-over-year, compared to nearly 37% YoY growth in FY2023. This is despite the fact that DAVD is just getting off the ground and R&D isn't putting as much pressure on earnings as it has in the past.

That in itself looks pretty implausible - I don't think the market will be saturated that quickly with only a few months to go until the end of 2023. Moreover, the revenue growth rate is expected to almost double in FY2024. Something is clearly wrong here.

At the same time, despite the doubling of the share price over the past year, the CODA stock can hardly be described as overvalued.

The forwarding EV/EBITDA ratio is currently around the middle of the TTM historical multiples. This means that in the worst case [for buyers], CODA is fairly valued today, in my opinion.

And if we remember that forwarding EBITDA estimates are most likely understated due to logical discrepancies, as well as the fact that 31% of market capitalization is still in cash - isn't that a sign of underestimation?

Risks & Your Takeaway

I know many of my readers avoid micro-cap stocks, and the reason is liquidity. CODA has an average 200-day trading volume of ~18 thousand shares, or just $176,600. Some mid-cap market participants can buy or sell the entire daily volume in a single transaction, and that is a big risk to be aware of.

Supply chain issues also pose a notable risk for Coda as it heavily depends on specialized semiconductors and parts. Recent years have seen the company facing challenges due to supply chain disruptions, which could persist or worsen in the future.

The company's dependence on a few specialized customers and its reliance on the defense market for growth pose significant risks. The defense industry is known for delays and budget uncertainties, which make it uncertain whether the military will adopt Coda's DAVD program.

But despite these risk factors, CODA stock still seems to me to be an interesting choice for those who are aware of all the risks and are willing to take them. The outlook for DAVD and other offerings seems very promising to me - once the source markets are saturated, I think the earnings should be revised, which should give further impetus to the current rally. Of course, that's if the overall market continues to be as positive as it's now.

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