Logitech: Leveraging On Strong Capabilities To Grow In Big Markets – Seeking Alpha

Investment thesis

In my first article about Logitech International S.A. (NASDAQ:LOGI) “Logitech Stock: It’s Time To Consider After A 45% Sell-Off”, published on January 6, 2022, I underscored the high potential of the company which is very well positioned in multiple secular growth trends, with a strong balance sheet and consistently high profitability. In the latest analyst and investor presentation on March 3, 2022, Logitech confirmed its recently increased outlook and explained the great opportunities the company was facing in the coming years. I now provide a more detailed analysis of its strong competitive position and I updated my valuation model, which, despite being affected by some changes, is still showing an upside potential of at least 23%, more likely of 59%, from the actual share price.

An update since my last article

Logitech closed its Q3 as expected on a high level, nearly sustaining the record level of the fiscal year 2021 with $1.63B in sales, 40.60% gross margin in their long-term range of 39-44%, and despite an increase in operating expenses, the company still managed to achieve 18.50% operating margin. The cash balance was almost maintained at the same level Year-over-Year (YoY) at $1.36B, despite Logitech spending $116M on share repurchases in Q3 and returning a total of $450M to its shareholders in the last 12 months through share repurchases and dividends. Other than substantial share repurchases, the company also increased its sales and marketing expenses by 32% YoY to $259M, as well as expenses related to research and development by 41% YoY reaching $71M in the quarter ended December 31, 2021. The company pointed to industry-wide higher freight costs, which negatively affected gross margins by approximately 2%.

Despite some headwinds in its smaller business segments, Logitech is performing well in its most relevant segments measured by revenue. The gaming segment grew 8% YoY on top of the already high 73% growth rate of last year, the sales in Keyboards & Combos increased by 29%, while Video Collaboration slightly declined by 2% YoY but increased by 23.70% compared to the quarter before.

In its geographic segments, Logitech achieved over 38% sales increase in the EMEA region Quarter-over-Quarter (QoQ), while also the other regions achieved solid growth rates. EMEA was also the only region in which the company achieved a slight sales increase YoY. We may expect stagnation or a decrease in sales for the coming quarter, as historically, it is the weakest quarter of Logitech’s fiscal year.

Work-from-home will persist, also post-COVID

With many countries worldwide easing some of the COVID-related restrictions, some investors fear that the trend of working from home could be affected and therefore negatively impact Logitechs’ revenue. Analysts recently lowered their price target for Logitech’s stock, mostly driven by worries over slowing sales in the post-COVID economy. Wedbush Securities Inc. lowered its price target to $90 from $95 on 01.21.2022, Credit Suisse lowered its price target from CHF 114 (approximately $104.90) to CHF 107 (approximately $98.45) on 01.26.2022, Morgan Stanley raised some concerns about apparently increased inventory levels among Logitech’s distributors and lowered its price target from $77 to $74 on 02.17.2022. These assumptions about the inventory levels were invalidated by Nate Olmstead, CFO of Logitech, during the latest analyst and investor day, where he confirmed that the inventory levels are significantly lower than assumed by some analysts.

When it’s true that some employees will not work 100% from home anymore, in a study performed by Microsoft (NASDAQ:MSFT) 66% of the global companies consider adapting their offices and processes for hybrid work. A survey conducted by Ernst & Young with 16,264 responses from 16 countries across 23 industries, where millennials represented more than 50% of the respondents, shows that 9 out of 10 employees want flexibility in where and when they work, and on average, employees expect to work at least two to three days per week remotely after the pandemic. 64% want better technology in their office and 48% want home office hardware investments. The study also reveals that 54% of employees globally would quit their jobs if not provided post-pandemic flexibility. I strongly believe that a more hybrid work model will be adopted by many companies that recognize the advantages, mostly in productivity, efficiency, and financial terms.

Among the elements with major impact to a permanent hybrid work model, we can find reduced business travel as well as commuter travel and the consequently reduced carbon footprint, major savings in office spaces, increased productivity and morale among the employees who will benefit from not having to commute every day to their workplace and take advantage from the increased flexibility in time and working place. Increased adoption of automation and AI will have a significant impact on many jobs, with less-skilled workplaces mostly affected, by accelerating the ongoing digitalization in many industries, while the interaction with those systems is geographically independent. The challenge will come from the cultural side, it can be difficult to maintain and develop a common corporate culture when the employees are working remotely.

Video collaboration had already been the major growth driver before the COVID-19 pandemic, which accelerated further the adoption and those solutions. Logitech made a huge leap forward in this segment and advanced to become the market leader in only two years, gaining over 15% in additional market share.

It shows how much Logitech is determined to achieve leadership in its markets, by recognizing the advantages of such a position, and how efficient they are in implementing their strategy and capturing the potential in their markets. The fact of being strongly positioned in different markets is giving Logitech a significant advantage over its competitors.

Competitive analysis

I want to give a more detailed view of Logitech’s competitive positioning and the following peers’ comparison was made considering trailing twelve months (TTM) data. For Shenzhen Rapoo Technology Co., Ltd. (SHE:002577), the values have been converted into USD to allow the comparability of absolute data. Despite being a small company in this comparison, it’s interesting to see how a smaller company focused on the peripheral industry is doing when compared to bigger players. Other companies are direct competitors of Logitech as well, Microsoft, ASUSTeK Computer Inc. (OTC:AKCPF) with its brand Republic of Gamers, HP Inc. (NYSE:HPQ) mostly with its brand Hyper X, but as just part of their businesses is strictly comparable with Logitech, a direct comparison would not make much sense, and I will focus on more similar peers, Corsair Gaming Inc. (NASDAQ:CRSR), Razer Inc. (OTCPK:OTCPK:RAZFF), and Turtle Beach Corp. (NASDAQ:HEAR) to provide more suitable comparability.

Logitech is undeniably in a very strong competitive position. The company created a substantial moat around its business and disposes of a significant amount of cash, which can strategically be used e.g. to enter new product categories or gain market shares in already existing product segments. The company had a negative net debt for more than 17 years, and could significantly increase its leverage if needed, which gives it additional options. I believe that Logitech will continue to be very innovative in terms of product development, its R&D expenses have been increased by 40% YoY and the company has full control over its manufacturing process, which is instead not the case for companies like Corsair or Razer, which rely totally on third parties. I also believe that Logitech will further increase its market penetration and further increase its market share in its segments, since its Selling and Marketing Expenses (S&M) grew by 27.40% YoY in the last quarter ended on December 31, 2021.

In the past 6 years, Logitech’s Return on Invested Capital (ROIC) kept on a range between 46.04% and 74.35% with an exceptional spike in 2020 to 174.43%, consistently improving since 2019, and showing substantial strength when compared to its competitors over the same period. Among the analyzed competitors, it’s worth observing that Razer had the most significant improvement in terms of the allocation of its capital. While consistently reporting a negative ROIC between 2016 and 2020, the company improved its investment profitability until reaching 63.20% in the last 12 months. When there is a significant spread between ROIC and the Return on Capital Employed (ROCE) it implies that the core business of the company is highly efficient in terms of capital allocation, but the actual returns accrued to investors are significantly lower due to the idling cash in the company’s balance sheet. In the cases of Logitech or Razer, both companies sit on a significant amount of cash, which could be invested efficiently to create value for the investors.

Despite Corsair having a spike in its ROIC in 2020 to 20.88%, the company was struggling to achieve a sustainable return on its capital allocation in the 3 years before the outbreak of the COVI-19 pandemic, averaging less than 4%. The company carries a significant amount of relatively expensive debt. Between July 2019 and June 2020, the company’s interest payment relative to its operating income topped 70%, and in the two years before that, Corsair’s interest payment was even significantly higher than its operating income. While the strong increase in sales during the last two years improved this metric, Corsair is growing at a relatively high cost.

Logitech achieved a consistent CAGR of 35.74% in its operating margin over the past 5 years, and 50.56% over the past 3 years. While some competitors experienced higher growth rates as well, Turtle Beach achieved 39.92% over the past 4 years and Corsair 80.91% in the past 3 years, their operative profitability is not as consistent as Logitech’s and is subject to higher volatility.

In terms of gross margin, it can be noted that Corsair has consistently improved its profitability over the past 14 years from 9.60% in 2007 to 27% at the end of 2021. Logitech managed to keep a very high level of profitability averaging 33.80% between 2005 and 2016 and even significantly increased its margins during the past 5 years by reporting 44.70% at the end of its last fiscal year and 40.50% in the latest quarter ended on December 31, 2021.

Logitech’s earnings per share (EPS) grew at 28.85% CAGR over the past 5 years, accelerating to 42.95% in the past 3 years. In the past 17 years, only in 2013, Logitech reported yearly negative EPS. On a YoY basis, in the last 3 quarters EPS were just slightly decreasing by 1.56%, while the last quarter saw a clear drop of 44.10% YoY. Although the competitors of Logitech show a drop in EPS in the last quarter, most of them experienced already a significant decline over the last 3 quarters on a YoY basis, Corsair with -18.98%, Rapoo with -33.48%, or Turtle Beach with even -35.46%.

Although Corsair has demonstrated to improve its profitability over time, I expressed my concerns about the company in my article “Corsair: There May Be A Good Reason For Its Actual Valuation”. The company has a relatively high dependency on debt when compared to its peers and the lack of control on its supply chain and manufacturing processes as well as its total dependency on its major shareholder and the reliance on single customers with strong pricing power, are elements I see rather negatively from an investment perspective. Despite significantly improving its return on invested capital over time, Razer’s operating profitability is subject to a higher degree of volatility and the company lost money between 2015 and 2019, before profiting from the increased demand for its products during the past two years. Among its competitors, Logitech has instead demonstrated over an extended period to be able to maintain a high level of profitability by investing its capital consistently with high returns, growing its business significantly with a very robust balance sheet, and at the same time returning consistently value to its shareholders. Those achievements will allow the company to capitalize further on its success and it will also reflect in the share price.

Valuation

I actualized my former published discounted cash flow (DCF) model for Logitech, which extends over 5 years based on 3 different sets of assumptions ranging from a more conservative to a more optimistic view, based on the metrics determining the weighted average cost of capital (WACC) and the terminal value. Although the company confirmed its long-term sales growth assumptions of 8-10%, I still opt for a more cautious forecast in my valuation model.

Since Logitech’s business is based on multiple secular growth vectors, I consider its potential to achieve a higher perpetual growth rate as I may consider for Corsair, which focuses almost exclusively on the gaming industry. Despite this, the perpetual growth rate is still very conservative for a fast-growing company in the technology sector.

The valuation takes now into account higher interest rates, which will undeniably be a reality in many economies worldwide and lead to a higher weighted average cost of capital, as well as slightly adjusted projections of the free cash flow, due in part to short term, but also medium-to-long-term related aspects like supply-chain-related complications, higher sourcing costs, the recent conflict in Europe, increased competition and pricing pressure. The valuation gives now a minimal upside potential of 23.38% and prices the share at $93.79. The most likely scenario, in my opinion, the mid-valuation model, sees the stock at $121.5 or 59.36% higher than its actual price level. While the most optimistic scenario prices the share at $185.19 with a stunning 143.60% upside potential.

The bottom line

In a comparative analysis, among its peers, Logitech is my favorite choice. No other competitor could deliver such consistent and strong results over an extended time. When considered individually, Logitech has positioned itself on multiple very strong growth vectors and is even improving its already high ROIC as well as its gross margin in a long-term perspective. The large cash position and its debt-free balance sheet gives the company the chance to further leverage its expansion capabilities. The company also confirmed its commitment to its sustainable capital allocation strategy with more than $1B in share buybacks and dividends returned to its shareholders. Its strategy to significantly invest in multi-sourcing and capacity agreements is providing a competitive advantage and the company can better mitigate unpredictable supply chain constraints, shortages, delays, or increased logistics costs. The successful execution of its promotional and pricing strategy, combined with sustained marketing and R&D investments has driven its brand awareness and confirmed its leadership position. Logitech is poised to grow further significantly in all its major markets. Gaming is becoming a mass entertainment activity, involving gaming over social networks and live streaming, and Logitech is profiting from both traditional as well as cloud-based gaming, while offering different categories of products for any type of consumer, from casual to enthusiast until professional gamers. The adoption of a worldwide hybrid work environment, as well as the need for upgraded and advanced peripherals not only in the collaborative space, but also for individuals in the strongly growing content creator industry, are secular drivers in which Logitech leads the industry and is determined to further develop its market share.