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Stock of the Day (Archive)
Nov 05, 1997
This Bike Maker Gets Vertical, Dude!
The stock chart for Cannondale looks like a bumpy trail ride, with much
of this year on a downhill track. The bike industry has been struggling
with a slowdown in sales growth, coupled with a proliferation of
products and excess inventory. Cannondale is in better shape than most
bike makers, though, because it makes primarily high-end models, the
segment of the market with the best growth and the widest margins.
Indeed, because Cannondale (NASDAQ:BIKE - news) is a premium
brand and it uses proprietary components, its bikes grab a 20%-50%
premium in price. Only five of its 50-plus models sell for less than $600.
The company has a strong presence in both the road and mountain bike
markets, used by some of the top riders in each sport.
In addition to distinctive bikes, Cannondale has a distinctive business
strategy. The phrase "Get vertical" might have some meaning for
Cannondale's mountain bike customers, but it also has some meaning
on the corporate level. The company has made a dramatic push toward
vertical integration, that is manufacturing components in-house
instead of relying on outside suppliers as most bike makers do. By last
year, 90% of all parts in the typical Cannondale bike are made in-house.
When a company makes its own parts, it takes much more control over
its own destiny. That means complete control over their design and no
supply problems for hot-selling parts that many bike makers now
experience. The downside with making your own proprietary parts is if
you have a production problem, there is no alternative source to which
you can turn, resulting in painful product delays.
So far, the strategy has paid off, and it's helped Cannondale's profit
margins widen nicely compared to the competition. Gross margins are
in the 35% neighborhood versus 25% for most other bike
manufacturers. Last week Cannondale reported a 37% increase in net
income from the same period a year ago, slightly better than expected,
on sales growth of 11%. Some analysts have expressed concern about the
sluggish growth in sales, but if not for the effects of a strong U.S. dollar
on foreign revenues, sales would have been up 21% in the latest quarter.
Nonetheless, the stock has basically gone sideways for more than a year,
and the only significant buying interest in the stock came from the
company itself -- in September Cannondale announced a 1 million
share buyback. There are only 8.7 million shares outstanding, and the
float (the number of shares not held by management or otherwise tied
up) is just 4.5 million.
The sideways action in the stock and the continued growth in sales and
earnings has created a situation that value investors may want to
investigate further. The Price to Sales Ratio (PSR) is 1.22. The
Price/Earnings (P/E) ratio stands at 15.1 using trailing twelve month
earnings, or 11.6 using calendar 1998 estimates. According to the First
Call survey of earnings estimates, Cannondale is expected to grow 22%
in fiscal year 1998 and 20% a year on average over the next five years,
so the P/E is barely half the expected growth rate. That's pretty rare
these days, even in the wake of the recent market correction.
Cannondale's industry is in a bit of a tough period, but its valuation alone
makes it a compelling stock to keep an eye on. The fact that it is a
premium brand with expanding margins adds to the story. Of course,
the companies reliance on overseas sales means foreign currency
exposure could be a problem, so the Asian crisis will have to be watched
closely. It will also be interesting to see how Cannondale's vertical
integration strategy works out, since this is an issue that is getting
hashed out in other industries like computer disk drives. |
