2023-09-05 12:18:05 ET
Summary
- NETGEAR's stock has dropped over 80% in the last 5 years.
- The company's financial metrics, including declining revenues and low profitability, do not show a turnaround yet.
- NETGEAR's current share price is considered too expensive, with an intrinsic value of $10.14 per share.
Investment Thesis
I wanted to take a look at NETGEAR's ( NTGR ) financial performance over the last couple of years now that the stock has been down over 80% in the last 5 years. I wanted to see if the drop was warranted. I believe the company has been overvalued for a long time and the valuation is coming back to earth, however, I still believe it is too expensive right now, with declining revenues, margins not making a huge difference, and the main financial metrics are not showing a turnaround yet, therefore I give the company a hold rating as I believe there isn't much downside left, but I would like to see further pullback.
Briefly on the Company
NETGEAR provides networking hardware for consumers, businesses, and service providers. Their products include Wi-Fi extenders and routers, mesh Wi-Fi systems, access points, and switchers. The company operates through two revenue segments: Connected Home and Small and Medium Business or SMB.
Financials
Just to note, all the graphs below will be as of FY22 because I like to see the full-year performance rather than fluctuations through quarters as that will give me a better understanding of where the company is going.
As of Q2 '23 , the company had $106m in cash and $96m in short-term investments, bringing around $200m in liquidity, against zero debt. That is a good position to be in. This gives the company more flexibility in how to deploy the cash to grow the business or reward shareholders with buybacks or dividends. The company will be able to weather any further macroeconomic headwinds if there are any in the near future.
The company's current ratio is good and bad. Good because it is well above my minimum range of 1.5-2.0, which tells us that the company will not have any issues paying off its short-term obligations, however, it is bad also because it seems that the company isn't utilizing its cash position very efficiently. If the company used its cash position more and also tried to lower the inventory levels, the current ratio would come down to my preferred range, which would be, in my opinion, a much better financial position.
Speaking of efficiency, the company's ROA and ROE plummeted in FY22 and even before then, these metrics weren't the greatest either. I am looking for at least 5% on ROA and 10% on ROE. The company, like many, had a tough year last year, but even looking historically, the company wasn't performing any better. The management needs to do something about how it uses the company's assets and shareholder capital because it is not looking good right now.
In terms of competitive advantage, I am looking for at least a 10% ROIC and the company hasn't reached that minimum either, it only got worse in FY22. This tells us that the company doesn't seem to have a competitive advantage or a strong moat at all. Even during the pandemic, when people were on their computers most of the time, the company could only reach 6% ROIC.
In terms of margins, it's the same story too. FY22 was not good at all and looking at the most recent quarter, gross margins for Q2 '23 stood at around 31.3% while operating margins stood at -10.3%. The problems are still apparent, and no profitability has been achieved in the last two quarters at least.
In terms of revenue, it is not looking good, and the company is on its way to reporting another 19% decline in revenues in FY23 according to Seeking Alpha . NTGR lost around 31% of its revenues in the last decade and is going to lose another 14% in FY23 according to estimates.
Revenue Growth or Lack Thereof (Author)
Overall, I don't see a company that has its ship in order yet. I do not see a turnaround story unfolding here just yet and that will require a much larger margin of safety for my calculations. It was an extraordinarily tough year for NTGR for sure, but the negative growth in revenues, and fluctuating, and tight margins explain the share price depreciation over the last 5 years. Let's look at some scenarios and what price I would be comfortable at owning the company.
Valuation
As I mentioned earlier, the company managed to lose around 31% of total revenues in the last decade. It looks like the company is going to lose another 19% revenue in FY23 according to the analysts. On average, the company saw a 3.5% revenue decline in the last decade. I will approach the valuation with a more optimistic outlook and will say that for my base case, the company will grow at around 4.5% CAGR for the next decade. For the optimistic case, I went with 6.4% CAGR, while for the conservative case, I went with around 2% CAGR. All three scenarios are much more optimistic than what the company managed to achieve in the past.
In terms of margins, I decided to improve gross margins by around 400bps or 4% over the next decade while also improving operating margins by around 500bps over the same period from FY22 margins. These figures seem achievable to me but still on the more optimistic side.
The financials of NTGR have not shown any promising future so far. For that reason, I will apply a 40% margin of safety to the final calculation. With that said, NETGEAR's intrinsic value is around $10.14 a share, which means that the current share price is a little too expensive. This is the price I would be willing to pay to accept that kind of risk.
Closing Comments
The last two quarters showed that the company is still operating at a loss and a bigger loss than it had a quarter ago. The historical metrics did not show a company that is at a turnaround point yet, and I don't think the rest of 2023 will be good for NTGR. As I mentioned at the beginning, the company's share price lost around 80% of its value in the last 5 years, so I don't think that it will come back down much further, however, if it does come down to my PT or even below, then that is when I would be interested in owning the company because risk/reward is much more enticing at around $10 a share or below.
I have set a price alert at around $10 a share and if it hits in the next couple of months, I'll revisit the company and see if anything has changed since.
For further details see:
Netgear: A Financial Overview, No Turnaround In Sight