The following is a reprint of my December 20, 2007 RealMoney column
I have long complained that Plantronics’ (PLT) increasing exposure to consumers was nothing but trouble. If lower margins and higher advertising costs weren’t enough, the fact that the consumer part of the business was dragging down overall growth was the icing on the cake.
The company was cleaning up its act earlier this year, and the shares rallied as a result. But an earnings miss in October and a downgrade by JPMorgan (JPM - Annual Report) have robbed stockholders of the entire year’s worth of gains.
Once again, the main culprit is the consumer business – specifically the Audio Entertainment Group (AEG), which was formed through the company’s ill-advised purchase of Altec Lansing. Through the six months ended September 30, that segment’s sales were just $43 million – down from $63 million in the same period last year.
In addition to the AEG, the company continues to struggle with more intense competition in the mobile headset business. One reason for the JPMorgan downgrade was that channel checks indicate the company is losing share of Bluetooth headsets to Motorola (MOT - Annual Report) and Nokia (NOK).
Finally, inventories continue to be far too high for my comfort. They have more than doubled over the past couple of years compared to a cumulative sales increase of just 42%. It isn’t the situation one wants to have in a slowing economy, especially in the face of competitive pressure.
The Good News
There are still a few reasons for optimism, though. For one thing, the drop in AEG revenues means it now accounts for less than 12% of the total business. Even if things continue to deteriorate, the incremental impact will be less likely to weigh on the total company.
Furthermore, the company took action to try and prevent such deterioration. Last month they announced a plan to close and/or consolidate a number of facilities as part of a strategic initiative to lower costs. They are also trying to design fresher products that consumers may actually want to buy, but those aren’t expected until next Christmas.
One good thing that could come of the restructuring in the short term would be a disruption in manufacturing. Though this doesn’t sound good at first blush, it would give the company a chance to work down those inventories.
Not a Bad Value
Shares are trading at less than 17x the consensus estimate for the fiscal year ending in March, and just 14x the estimate for March 2009. Unfortunately, given the recent news it is likely both sets of estimates will come down over the next few weeks.
The 9.9% consensus analyst estimate for 5-year growth is less than the company’s sustainable growth rate based on ROE. This means if growth is less than expected the company should be able to compensate by raising the dividend or buying back shares. On a price to book basis, I think the current multiple of 2.2x could increase. Combined with the growth potential, a valuation expansion could lead to double-digit gains for the stock.
Over the last 12 months Plantronics generated $79 million in free cash flow. If anything, I think this could improve if the company gets a grip on its inventory levels and production capacity. The current FCF/EV yield is fairly attractive at 6.3%, which provides a decent margin of safety while waiting for the growth to materialize.
Although I like the valuation and believe there is cause for optimism, the stock has whipsawed lately due to numerous analyst upgrades and downgrades. Investors willing to take a chance on it would want to pick their price carefully.
Writing puts may also be an effective strategy here. As I write this, the February 25’s are trading at $1.10, offering a potential 4.5% 1-month return on the money risked and an effective purchase price of $23.90 in the event of further market declines.