2023-08-23 15:16:28 ET
Summary
- MIPS AB reports an expected decline in Q2 revenue and operating profit, but expects a recovery in Q4.
- Bike retailers are still digesting bloated inventory levels, impacting MIPS's sales.
- MIPS's share price dropped to my buy range whilst the long-term thesis is intact. I added to my position.
MIPS AB ( OTC:MPZAF ) ( OTCPK:MPZAY ) is a market leader in bike helmet safety systems , a compounder in the making. I am bullish with a write-up in May on the long-term as MIPS has multiple enduring competitive advantages that will prove challenging for competitors to replicate in the near future. It has compounded revenue by 49% CAGR, earnings by 62% CAGR, and free cash flow per share by 39% CAGR since 2014. The stock appears expensive on an absolute level but undervalued relative to historical levels, the uniqueness, and dominance of the business, the size, and trajectory of its moats, and growth potential.
On July 20th, it reported expected soft Q2'23 results (continuing the trend from challenging Q1'23 results ), where the management sees a recovery in Q4 instead of Q3 .
[…] Bike retailers in the key US and European markets continued to reduce their inventory levels during the period, as expected.
[…] We assess that the third quarter will continue to be challenging but expect to see a stronger fourth quarter and therefore show growth for second half of the year.
CEO, Max Strandwitz.
I believe in the long-term thesis and see myself owning MIPS for a long time.
People will continue to cycle to get from A to B, to exercise, and to be closer to nature, at the same time they want to be safe. Thus, consumers will continue to seek the best bicycle helmets.
As a result, I have no problem waiting for another quarter for the bike market to recover as the business expands to more brands and other greenfield opportunities (the Safety segment).
Negatives
As I review the headlines, MIPS's Q2'23 results appear rather negative.
(-) Revenue continued falling at a rapid clip by 51% YoY to SEK 102M from SEK 206M, as MIPS continued to digest the inventory build-up during Covid, a decline acceleration from -35% YoY in Q1'23 and -46% YoY in Q4'22. Management now expects Q3 to be softer than thought, and growth only to return in Q4.
(-) Operating profit (EBIT) fell 78% to SEK 23M from SEK 107M, pushing EBIT margin down to 23%, far below the 2027 target of 50%+, a small improvement from 17.5% in Q1'23 .
The decline in revenue and operating profit was driven by:
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Lower sales in the bike segment (-52% organic sales); retailers are still bloating with inventory, although likely to digest most of the old season models during Q3.
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Continued high investments in research and development and marketing (SEK 10M), which was higher than Q2'22 (SEK 7M) despite lower sales and the negative impact of currencies.
The market was disappointed, which explains the sharp -15% drop in the stock.
However, in my tweets right after the results announcement and conference call, I don't see any significant issue.
Q1 and Q2 are smaller quarters. Thus, the impact is smaller. The CEO, Max Strandwitz, expects MIPS to return to growth in the second half of the year, with EBIT margin ending around 40% (I will track this guidance).
The long-term thesis is intact, and I was happy to add to my existing position at SEK 458/share. I may add one more time to make it a 3% position, as the sentiment in the bike market segment continues to be grim.
Positives
+ Operating cash flow was SEK 9M, recovering from a negative SEK -42M in Q1'23.
+ Recovery is near. Bike demand is likely recovering in Q4 (management said Q3 at Q1'23 result), but nothing concerning as the macro environment is still grim, despite inflation data looking more favorable each quarter.
MIPS helmet sales are split into 50% low range and 30%/20% into mid and high range, respectively. The low range has been the worst-performing segment. As a result, Q1 and Q2 haven't done well, but management indicates that orders are coming in for the low range (which haven't been for the last 6-12 months). They see improvements in the second half of the year.
Even if demand to end customers is lower than last year, sales are higher than before the pandemic situation and we continuously gain market shares in all our key markets. This means that we will see a gradual increase in demand during the last six months of the year. We assess that the third quarter will continue to be challenging but expect to see a stronger fourth quarter and therefore show growth for second half of the year . With our significant customer base and models equipped with Mips solutions, we will gradually return to growth in the second half of the year, as helmet manufacturers produce helmets for the next cycling season.
+ Inventory levels have returned to historic levels.
Inventory levels at many retailers have returned to historically normal levels and we assess that inventory levels at retailers will be fully normalized during the third quarter.
As MIPS is a manufacturing company, most of the sales in FY2023 will come from new helmets for the next season, which will be manufactured in Q4. Thus, the recovery is weighted towards the back end of the year.
The other bright spot is:
+ Safety - is showing potential. Revenue grew 439% YoY to SEK 4M (1M), accelerating from 300% YoY in Q1'23. Brand partnerships remain at 12. As the largest total addressable market of 110M helmets annually, MIPS's future value will depend on how it captures market share in Safety. I'll be sure to monitor the progress closely. Max Strandwitz expects Safety to contribute SEK 20M by the end of the year vs. 4M for FY2022, a 5x growth.
Capital allocation
During the first quarter, investments impacting the cash flow amounted to SEK 1m (2m). Investments in intangible fixed assets amounted to SEK 1m (2m).
Despite the challenging market, I see a continued commitment to reinvest in the business as R&D, sales, and marketing increase (highlighted below).
MIPS has also paid a dividend of SEK 5.50/share or SEK 144M (SEK 133), a 10% increase from FY2022, 82% of earnings FY2022 (SEK 175M), with cash and equivalents remaining healthy, SEK 356M (398M).
Moats movement
The main reason for tracking quarterly results is to gauge the movement of the business's competitive advantage and the change in market share. I don't see any notable change, so I keep my Sleep Well Investment score for MIPS at 13/20. You can check out the explanation in my previous write-up here.
Below you can see how market shares have changed since I published my writeups.
Long-term target and thesis on track
As a reminder, with large untapped markets, MIPS aims:
To triple its annual revenue to SEK 2B and expand its EBIT margin to over 50% by 2027, an upgrade from SEK 1B and a 45% EBIT target by 2025 set in 2021 . It will require MIPS to grow at a 35% CAGR in the next five years, achievable compared to the 50% CAGR it has done in the past decade.
The management remains confident in achieving the long-term target. And I tend to agree as the slow start of the year is not due to demand but Covid-unwinding.
I see a company still winning brands, gaining market share, and committed to reinvesting for the future. The Tour de France stats were encouraging and showcased MIPS's brand power.
Over 70% of male competitors' helmets and 87% of female competitors were equipped with MIPS safety components.
Risks
(-) The biggest risk is execution . Management had set an ambitious target of reaching SEK 2B sales and 50%+ operating margin by 2027, an increase from the first two targets at IPO and in 2021. Unfortunately, their track record hasn't been squeaking clean. First, it missed the sales target of SEK 400M in 2020 set at IPO while over-delivering the 40% EBIT target by 5%. Secondly, since entering the motorcycle market in 2013, sales (SEK 47M in 2022) for this segment have remained under 10%, and growth has been rather unimpressive. Meanwhile, Leatt has done very well in the off-road motorcycle market. Now, MIPS aims to enter the Safety market, a market 3x bigger than its Sports segment, but it remains to be seen if it can take market shares from the incumbents such as Honeywell or 3M.
(-) The second risk comes from competition . Current alternatives come from own-branded solutions (KASK, LEATT) or specialized safety solutions (SPIN, WaveCel) with limited commercial reach. Both are considered low-risk in the short-medium term.
(-) The third risk is the awareness of rotational motion protection . The benefits of MIPS technology may not reach the masses, particularly in the lower-range market, where it is more difficult to convince the end-users to pay more for increased safety. MIPS targets spending 7% of revenue on sales and marketing and 5% on R&D to collaborate with universities and institutions to ensure they are at the forefront of communications to end-users, market developments, and stay ahead of new test standards. The dilemma is that competition may increase due to growing awareness of rotational motion and MIPS technology.
(-) MIPS has had some customer concentration issues , with 45% of revenue coming from the top 2 customers. However, that risk has reduced to just 26% of revenue in FY2022, 30% in FY2021, and 29% in FY2020. As MIPS grows, revenue from other customers also takes more shares of the total revenue. However, MIPS dropped disclosing the top 3 customers in FY2022, which could imply that they lost a large customer during the year. I will keep an eye on this.
Valuation
This quarter the valuation is looking more reasonable as the stock drops.
The initial market reaction pushed the share price down to SEK 433/share and traded around SEK 500/share during the day.
At the current price, MIPS appears undervalued using the DCF method and on multiple valuation bases.
My DCF model indicates a fair value of SEK 561/ share or SEK 14.7B market cap in a base case , SEK 380/share or SEK 10B market cap in a bear case , and SEK 729/share or SEK 19B market cap in a bull case. Following are the workings and assumptions:
*CPI numbers have declined in the last ten months since the June 2022 peak. I am considering reducing my WACC rate from 8% to 7.5%, increasing the fair value to SEK 711/share in the base case. However, the following workings use 8% WACC to be conservative.
Base case: SEK 561/share or SEK 14.7B market cap
I assume MIPS would underdeliver the long-term target of SEK 2B sales and 50% EBIT margin by 2027 . As such, it would only grow revenue by 22% until FY2027 and reach SEK 2B sales and 50% EBIT margin two years later than expected, in FY2029. I also assume a 3% terminal growth rate and an 8% WACC, my personal hurdle rate.
The growth expectation of 22% for the next five years is reasonable considering that:
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At 22%, I assume MIPS to continue outpacing the industry growth (as the bottom line), albeit at a much lower rate than the past nine-year growth rate at 50% and pre-COVID growth rate at 62%.
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The level also aligns with the pre-covid level in Q4'19 at 20%.
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My assumption is likely achievable as MIPS has a more extensive installed base of customers, helmet models, and the number of helmets sold, which supports a higher revenue base as helmets go through the next replacement cycle. The more extensive installed base also implies lower costs of customer acquisition in the future.
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Lastly, I assume MIPS will convert sales in the Safety market as it expands MIPS's focused market by 110M helmets annually.
In conclusion, I reiterate a BUY rating for the stock.
Stay tuned for my future updates on MIPS and my additions.
For further details see:
MIPS AB: Q2 2023 Results, Recovery In Q4, Share Price Is Reasonable