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Analysis Now Includes Spider Graphs

November 25th, 2008 by Jae Jun

I find it much easier to see and understand graphs and lines rather than a row of numbers next to each other. I have to admit that my investing techniques still needs work. So in an effort to iron out some kinks, I will now implement a spider chart (Excel calls it a radar chart) when I analyze companies.

Here is an example. Note the difference between AeroGrow (AERO) (one of my many mistakes) and Coca Cola (KO).

See what I mean? There is a big difference between looking at notes and thinking about the business and actually receiving a visual representation.

Ratings and Metrics Explanation

The scale is from 0 – 5 where 0 is the worst and 5 is the best. Obviously, the bigger the area in the graph, the better.

A brief definition of the metrics used:

  • Best – 5
  • Good – 4
  • Average – 3
  • Below Average – 2
  • Bad – 1
  • Worst – 0

Under Valued: 5 is extremely undervalued and 0 is overvalued. KO has a fair value so it is 3 for average.

High Growth: 5 is high growth and 0 is no growth. I would say KO has an average to below average growth rate.

Low Risk: 5 is close to no risk and 0 is high risk of losing money. Risk could be in the form of one major customer, high debt, high inventory, unpredictable margins.

Well Managed: 5 is excellent company management with 0 being sleazy managers (Enron, Worldcom)

Good Financial Health: 5 is a company that generates excellent cash and strong balance sheet. 0 is a company with huge debt, overly issuing stocks etc.

Strong Moat: 5 is an impentratable moat with 0 being nothing more than a trickle.

(I think there was little confusion with the graphs by a couple of people. These are just my metrics. The whole point of the graph is to remind myself how I saw the company at that point in time. Just because it may be 90% undervalued, doesn’t make it a good investment. All aspects have to be considered and this is just a reminder not an indicator.

So far, I only have 6 metrics but I may add more if I think they are necessary.

Also, the metrics are what you make it. Everyone has a different perception of risk, health, moat etc so the point is to hopefully bring up ideas which could help you in your own analysis.

Take everything I do and say with a grain of salt.)

Disclosure

No positions in stocks mentioned at time of writing.

[tags] aero, ko, stock analysis[/tags]

Tags: aero, ko, Stock Analysis
Posted in Featured, Investment Tools, Valuation Methods | 9 Comments »

AeroGrow: Can’t Finish The Race

July 18th, 2008 by Jae Jun

Fiscal year 2008 came to a close for AeroGrow on March 31, 2008. The conference call was held on June 26 and I think it is a good time to provide an update.

Previously I had written about AeroGrow and pointed out good and bad points, but mostly good. With the stock price lower by approximately 35% from my time of purchase. In this post, I won’t gloss over the increase in revenue or store presence and other obvious matters. This post, I’ll be going over the problems.

Here are some recent points to consider.

Positive Points
  • Revenue increased from $13 million to $38 million compared to prior fiscal year March 31 2007
  • Expanded from a presence of 750 stores in December 2006 to 4300 in December 2007 and 5100 in March 31, 2008
  • Direct business grew from $4.2 to $13.7 million (35.7% of revenue)
  • Sold first million dollars of products Internationally (1.9% of revenue)
  • Gross margins increased from 36% to 40% for the fiscal year
Negative Points
  • Bottom line is isnt improving
  • Management on financial handling
  • Net loss of $3.8 million for the quarter as opposed to an expected loss of $1 million
  • Net loss for the year was $9.8 million. Only slight improvement from $10.4 million the year ago
  • Very small insider buying
Viewing Perspective

The numbers look very impressive, and they are, but that depends on how you look at it.

In a 1km race, if a runner sprinted the first 800m only to realize that he didn’t have any energy left for the last 200m and barely finished, how would you rate that performance? I doubt people would pat the runner on the back for doing a great job.

AeroGrow does so well with income only to disappoint at the finish line. This has become the performance and risk of AeroGrow. The problem lies in AeroGrow, not the AeroGarden.

Invert, Always Invert

I’ve been reminded the importance of bottom up thinking when researching companies. Unfortunately, a question that I did not ask myself and fully investigate was “what is wrong with the company?” or “why is it the way it is?”. Had I told myself that the answer was “I’m not sure”, it would be safe to say that I would have kept waiting and monitoring the company on the sideline.

So, what is wrong with the picture? Simply, I see it as the lack of discipline in capital expenditure and experience within the management team. This was the risk I outlined in my previous posts and one which played out.

“For the quarter and year-ended March 31, 2008, the story is a consistent one. We easily beat our expectations on the top line but missed them on the bottom line.”

This above statement shows that management wasn’t expecting much from their bottom line to begin with. In fact, it doesn’t sound promising at all if management themselves call it a “consistent” story.

Future Steps to Improve The Business?

During the conference call, the CEO briefly went over 3 issues from the previous quarter conference call.

  1. “The first step we took was the establishment of our P&L centers, with changes in accountability and expectations for the organization, including building the cost accounting systems I talked about earlier.”
  2. “Number two is our new distribution center…We’ll open the center in Indianapolis and expect to save about $1 million in shipping costs and gain 1.5 points of gross margin this year as a result of this change.”
  3. “Number three is that we’ve taken significant steps to right-size our organization. We cut our head count by 28% since the first of the year…he changes we’ve made will make us a far more efficient company..”

Unfortunately, this wasn’t the information I was hoping for. There were no explanations, elaborations or deadlines on how the above was going to be acheived. I was a little surprised that deeper probing questions weren’t raised during the Q&A section. I wanted to know things like how saving $1 million in shipping would prevent or benefit the company when they are still losing around $10 million or as it is stated in the 2008 annual report in the risk section;

“As of March 31, 2008, our losses from operations have resulted in an accumulated deficit of $39,628,084. There is no assurance that we will ever attain profitability.”

Insider Buying

During the conference call, the CEO mentioned that insider buying would begin on July 2. Since then I’ve been monitoring every SEC filing (I have the RSS set up for AeroGrow). What I see isn’t a whole lot of activity. The max number of shares purchased by each individual is 5000. I’m not sure whether there is a rule or  limit, but 5000 shares at around $2 doesn’t show a whole lot of conviction in the company. Besides Walker Jack Jonas who has purchased 20,000 shares during this time, the new CEO has only committed to 5,000 shares.

If a CEO of the company, who I assume is getting paid in the 6 figure range, commits around $10,000, his $10,000 is equivalent to my $1,000. i.e. a small portion of his portfolio.

Opinion

I could be coming across as stubborn, but considering it’s a small portion of my portfolio and I have been aware of the risk to some extent, I’ll be holding onto my shares.

I don’t agree with the “dump AeroGrow” call but if the company does not break even or is profitable by 2009, I will definitely reconsider my position.

Disclaimer

I am long AeroGrow.

Tags: aero, aerogarden, aerogrow, Stock Analysis, valuation
Posted in Stock Analysis | 4 Comments »

Fisher’s 15 Point Checklist: AeroGrow (AERO)

May 10th, 2008 by Jae Jun

As with all companies, a thorough understanding is required in order to maximize returns and keep your cool even when the stock price falls. But how do we go about understanding? Not everyone is in the position to do for themselves much of what is needed to get the most from their investments. That is where the 15 point checklist by Philip Fisher comes in handy. It acts as a guide to your investment research. The following is my scuttlebutt for AeroGrow. You may also read my first valuation report on AeroGrow.

1. Does the company have the products or services with sufficient market potential to make possible a sizable increase in sales for at least several years?

AeroGarden is the first user friendly, fool proof, kitchen top appliance out in the market. There is a significant market potential for the product and demand can be seen by growth in sales and distribution. If the product was not appealing or didn’t have the market potential, distributors such as Macy’s, Target, William Sonoma, Sears, JC Penney, Bed Bath Beyond, Amazon and many more would not want to waste valuable shelf space for such a product. The sales may not be maintained for 10-20 years, but an increase for at least “several years” is highly probable.

2. Does the management have a determination to continue to develop products or processes that will still further increase total sales potentials when the growth potentials of currently attractive product lines have largely been exploited?

Management clearly has determination. Just go to their investors website and read their reports and listen to the conference calls. From the very beginning, the AeroGarden wasn’t created for the sole purpose of being a kitchen appliance. The company and management created the AeroGarden so that a recurring revenue stream occurs with it. With each sale of an AeroGarden, the consumer must also use the company’s proprietary seed pod kit or the deluxe kit for those that want to germinate their own seeds. Accessories such as hood extensions, pumps and even halogen light bulbs have a proprietary connector to spur additional revenue growth.

Although the AeroGarden is the main product of the company, differentiations of the AeroGarden are being sold that aims at different demographics to reach a broader market and to increase sales potential. Such products include a variety of windowsill/tabletop/wall attached pods priced from $29 to $99 expected to launch in 2009.

3. How effective are the company’s research and development efforts in relation to its size?

From the information below (click for larger version), R&D expenses have been pretty consistent. Percentage wise, the values aren’t as consistent but that is due to the size of the company. The increased revenue in 2007 with the same R&D expense gives a low ratio, but in relation to the company size, I don’t believe they are overspending.

We will have to wait for more quarterly figures to see whether AeroGrow is investing in R&D for future products to drive growth. If R&D expenses dry up after the AeroGarden, it could be a warning sign that the company isn’t looking out for the future.

4. Does the company have an above average sales organization?

As I previously mentioned in the other post, AeroGrow’s distribution strategy and reach is excellent. Their sales occur through retail, electronic (web, telemarketing), print (numerous catalogs) and internationally.

It’s interesting to note that many people have bought more than one AeroGarden. This person has five.

5. Does the company have a worthwhile profit margin?

The current gross margin for the quarter came out to be 38.9%. That is a very respectable margin which should leave plenty of profits for both the distributors and AeroGrow. Compared to companies like Jarden or Whirlpool with gross margins of 27% and 18% respectively, AeroGrow has a very profitable margin.

6. What is the company doing to maintain or improve profit margins?

Basically, as much as the past profit margins are good, the future margins are the most important to the investor. There are many things that can reduce the profit margin. Competitors, rising prices in commodities, energy and food are the noteworthy. Thankfully, I don’t believe any of these would greatly affect the margins for AeroGrow. Being the first to market, AeroGrow has kept the AeroGarden at a reasonable price, but the seed kits and accessories provide a huge margin.

As AeroGrow grows and creates an economy of scale, margins should be increased by maximizing capacity and efficiency.

7. Does the company have outstanding labor and personnel relations?

With the company being so young and not enough media attention or information, it is difficult to say whether the employees are being treated fairly by their employer but we do know that AeroGrow provides medical, dental, vision and 401k benefits to its employees.

8. Does the company have outstanding executive relations?

Having the right atmosphere among executive personnel is vital. As small time investors, the only type of resource we have access to are the conference calls and SEC filings. Since I don’t have enough information to form an opinion, I’ll jot a few things that we should look for by paraphrasing some points from Common Stocks and Uncommon Profits.

Since the company is still at the beginning stages of its venture, executives should have confidence in their CEO and chairman. This means that from the lowest levels up there is a feeling that promotion is based on ability. There is no ruling family in this company where the son/daughter is promoted over people.

Salary adjustments should be reviewed regularly (at least yearly) and in line with industry and local standards. The DEF14 filing should provide all this, but AeroGrow does not have any available at this point in time.

9. Does the company have depth to its management?

Go to AeroGrow’s website and visit the management/governance section. It seems like AeroGrow has a diverse management team tackling all necessary business aspects. One thing I like especially like is that the founder does not try to control everything. Michael Bissonnette gave up his role as CEO so that he could concentrate on what he could do to help the company and not on how he should run the company. It shows that Mr Bissonnette trusts his management team and also delegates his authority to each individual. Real delegation of authority empowers management to utilize their individual given talents to produce results.

10. How good are the company’s cost analysis and accounting controls?

There is both good and bad to this section.

The good. AeroGrow only registers sales into its books once a product has been shipped unlike many companies that count sales as products that have been ordered.

The bad. AeroGrow needs to get a better handle on their expense and operation costs. They need to watch their cash stash and be able to convert profits into free cash.

11. Are there other aspects of the business, somewhat peculiar to the industry involved, which will give the investor important clues as to how outstanding the company may be in relation to its competition?

Being the first to market, patent rights (if you read and understand them) possibly give AeroGrow exclusive rights to the easiest or cheapest way of making the product. Patent position for small companies is critical because you don’t want bigger companies with the cash and scale to imitate the product. “However, it is the constant leadership in engineering, not patents, that is the fundamental source of protection.”

12. Does the company have a short range or long range outlook in regards to profits?

Being the size that it is, AeroGrow must focus on the short term to generate profits and cash to continue running its business as well as a long range outlook. A method of long range outlook is the seed kit business model as well as researching additional seed kits, products and expanding into international countries.

13. In the foreseeable future, will the growth of the company require sufficient equity financing so that the larger number of shares then outstanding will largely cancel the existing stockholders’ benefit from this anticipated growth?

With the current growth and demand, AeroGrow definitely has the ability to provide growth and returns from its cash and financing.

14. Does the management talk freely to investors about its affairs when things are going well but “clam up” when troubles and disappointments occur?

Listening to the conference calls reveals that the chairman and CEO are both open and honest about what is happening within the company. They are candid in explaining their difficulties.

I just read this humorous discussion on Yahoo about management which you will definitely find useful.

15. Does the company have a management of unquestionable integrity?

This is yet to be proven.

if there is a serious question of the lack of a strong management sense of trusteeship for stockholders, the investor should never seriously consider participating in such an enterprise – Philip Fisher

Summing Up

One thing to note is that Philip Fisher was a pure growth stock investor and running through the checklist for AeroGrow seems to confirm this. Of the 15 points, there aren’t too many negatives but since most of the points are related to growth, this is to be expected.

It seems like AeroGrow scores 11/15 where 3 of the points is neutral. Looking back at the 15 points, AeroGrow has the potential for huge gains in both the market and stock price. However, keeping an eye on management’s integrity and how they handle different business scenarios for good and bad times will be interesting as the company continues it growth.

Tags: 15 point checklist, aero, aerogarden, aerogrow, fisher, Stock Analysis
Posted in Stock Analysis | 8 Comments »

AeroGrow (AERO) Valuation

May 3rd, 2008 by Jae Jun

Living in an apartment in Seattle doesn’t offer much opportunity to grow your own small plants or herbs. The endless cloudy days and the small square footage doesn’t help the cause either. I don’t like gardening and planting but I do want to be able to eat (if possible organic) fresh salads, herbs and other vegetation without having to visit the grocery store so often. So I’ve recently become greatly interested by Aerogrow, a company that has a product line that seems to solve the dilemma for people like myself.

Business Summary

A startup company that manufactures and markets the Aerogarden line of indoor gardens for consumer markets worldwide. The Aerogarden is a dirt free, fool proof indoor plant growing device that utilizes Aeroponic technology created by NASA. Aerponic allows the plants to grow at twice the speeds compared to dirt growth. Here is a video of a comparison between growth speeds for Aerogarden and dirt. Aerogarden also allow the fully grown plants to be transferred to a pot and dirt since the roots hang down in the air and water.

This product is targeted towards three demographics.

  1. Chefs / wannabes
  2. Use of fresh flowers / Decor
  3. Gardeners / wannabes

The target consumer can be either one of the three or all three.

At first, Aerogrow may seem to be a one product company, but the company has been able to differentiate its product into different categories and now has over 10 products in its lineup ranging from $99 to $229.

Growth Strategy

Growth is where I see Aerogrow shine. Aerogrow has created a revenue strategy where the Aerogarden is like the razor/razorblade strategy for Gillette. The Aerogarden is the razor and the seed kits and accessories are the razor blades. People can’t just use any normal seeds on this machine since the seeds are contained inside a spongey material so each Aerogarden offers the potential lifetime sales of seed kits, light bulbs, accessories and additional gardens.

So far Aerogarden’s are placed in four channels of distribution.

  1. Retail – Macys, William Sonoma, Sears, Target, JCPenney, Bed Bath & Beyond, Amazon, Home Shopping networks and many more. For 2008 Aerogrow is targeting other retailers such as Kohls, Sams Club, Costco, Staples and Lowe’s.
  2. Electronic – Web, TV, Telemarketing
  3. Print – Catalogs
  4. International – UK, Japan, Germany, Austria, Switzerland, South Korea, Mexico, Australia, France, Italy, Iceland

The potential retail channels that could be opened is quite outstanding and Aerogrow is maximizing its first to market advantage. The number of stores the Aerogarden is being sold has grown from 750 in 2006 to 4,300 in 2007 to 8,600 in 2008.

Aerogarden has been gaining huge traction in the market, news as well as on TV. It has been featured on The Today Show, Ellen and Tyra Banks talk shows.

Competitive Position

Aerogrow does have a competitive position, but it isn’t one that would last for years and years. It has the advantage of being the first unique consumer orientated product in the market with 11 patents pending to prevent simple direct copies, but if sales continue to occur at its current rate, there will definitely be a swarm of competitors flooding the market. This is not to say there are no similar products. In fact there is, but they are all large, ugly and sort of industrial. The Aerogarden is truly the first good looking, kitchen top and user friendly appliance.

Aerogrow spent about 2.5 years in R&D before marketing the product and kept tweaking the product with tests performed by random “non techie” people with no gardening expertise until the product became fool proof. This company isn’t just trying to sell it to anyone that moves. They are focused on creating a market and establishing themselves firmly.

Its array of products from a small “Prehistoric Garden” and “Flower Fairy Garden” Aerogarden to the Pro version that can grow full sized tomatoes can target all sorts of demographics but it doesn’t end with tomatoes.
Aerogarden’s large number of seed kits include the following with more being researched and tested at Aerogrow. The following are the food seed kits.

  • The Salsa Garden – (Cherry Tomatoes and Zesty Jalapeños for salsa/sauces)
  • The Holiday Herb Kit – (Parsley, Sage, Oregano and Thyme)
  • The Salad Bar Series – (4 seed kits of mixed salad greens: Romaine, Arugula, Baby Greens and Mesclun Mix)
  • The Herb Chef Pack – (Two-season pack, 14 “mix ‘n match” seed pods for creating customized culinary gardens)
  • Salad Chef Packs – (Two-season pack, 20+ varieties of salad greens including arugula, baby greens, romaine, mesclun and butter lettuces).
  • The Strawberry Patch™ – (Strawberries)
Risks

Consumer goods are cyclical and seasonal and there is a possibility that the Aerogarden could turn out to be a one hit wonder like numerous failed kitchen appliances. On the other hand, it could potentially become the future household staple like the blender, toaster, rice cooker etc.

Being a startup with inconsistent cash generation, I have no doubt Aerogrow will be highly volatile in the short term. The company is growing at an incredibly fast speed and is using a lot of resources to invest in its business but the big risk is whether management can execute their business plan as well as having enough cash to fund operations. More information in the financial section.

While listening to the conference call, I felt that management wasn’t as experienced as I hoped and it did seem like management and business processes are still being figured out and tweaked. One thing they mentioned was that a longer than expected upgrade in IT and accounting systems blanketed transparency in accounting and spending which led to a disappointing amount of money being overspent.

Another risk, but less obvious is that people are using the Aerogarden to grow marijuana at home. I’m not sure, but there could be protests or complaints about the product making it easier to grow drugs…

Management

The founder and chairman, Michael Bissonnette, is an entrepreneur with experience in creating other successful businesses. He has admitted that he has a large amount of his wealth invested so he is determined to see it become a success and it seems like he is on the right track. However, that doesn’t guarantee success.

The CEO is new to the company and other members of management are all quite young. I wouldn’t call them the most experienced team such as the Coke’s, Nike’s, and Microsoft. But considering their company size, they do seem to have the necessary team and expertise with diversity in their skills. With small cap companies and especially micro cap companies, it is absolutely vital for shareholders that management is honest and ethical. I’ll continually monitor this topic.

Financial Health

The company has been enjoying rapid revenue growth on a year over year basis and it is expected to continue. Revenue came in at $14.6 million compared to $4.9 million the prior year, but as much as the top line is impressive, the operating expenses due to media spending and expanding its distribution caused a per share loss of $0.13 versus $0.30 loss of last year. Raking in $14.6 million but still having such a large loss is clearly an area where attention must be paid. If money is burnt this fast AeroGrow could be in trouble but for now, AeroGrow can fund operations from the cash it raised in additional stock issuance. Maintaining enough cash and getting a hold on operations is something to watch out for and management is addressing this issue.

Gross margins were 38.9% compared to 32.4% the prior year but came in 1% less than expected due to a free shipment promotion intended to increase holiday sales, but management is making strategic moves to increase gross margin by around 3-4%.

The company has no long term debt and has enough assets to cover its short term liabilities. Its current and quick ratio is 1.58 and 1.06 respectively. Considering that a somewhat similar company, Jarden, is a 20+ year old established company and has a current and quick ratio of 1.99 and 1.11, AeroGrow’s liquidity is respectful.

With the company expected to make a profit in 2009, earnings are being estimated in the $0.25 – $0.30 per share range.

With the company being young and not enough information to perform a DCF, I’ll use a simple Monish Pabrai’s multiple method of using a multiple of 10x cash flow for a business with no growth but consistent cash flow and a multiple of 12-15x cash flow plus excess capital for growing companies. AeroGrow is a rapid growth company and so I will use 15x. Other stable slower companies are at the 11-13x multiples so 15x seems low and conservative considering AeroGrow’s growth. This gives an intrinsic value in the range of $4.32 to $5.07. Analysts are estimating the intrinsic value to be between $9-$10 but I think that is too lofty with too much expectation.

With a current price drop to $2.50 just 2 days ago on April 30 and now trading at $2.69, it is hovering close to a 50% margin of safety.

Opinion

This company breaks many rules that I stick to. Specificially, it breaks the no startup, consistent cash flow, consistent growth and strong CROIC rule. However, what I find attractive is that there is a real consumer following and demand for the product. During the December holiday period, rather than sales slowing down, sales were up and in high demand which led to the 201% increase in revenue over the prior year. Also, the additional distribution growth and potential international presence is great. With countries such as UK, Japan and South Korea, where a large population live in dense urban areas and highrises, owning a garden is not realistic. People that want fresh flowers, plants, fruit or herbs but don’t want the hassle of dealing with mess and dirt and failures will definitely want something like this.

The company operates in a small niche markets which will make it undesirable for the big companies to get in and its early technology advantage and patents create a short to mid term moat for the hungry copycats wanting a piece of the riches.

Check out these fascinating blogs of people using their Aerogarden to grow lettuce, strawberries and herbs or even marijuana.

With young companies, I find it best to follow and emphasize Philip Fishers “Scuttlebutt” approach from Common Stocks and Uncommon Profits.

I’ll do a 15 point checklist on AeroGrow later on in the week.

Disclosure: I own shares of AeroGrow.

Tags: aero, aerogrow, Stock Analysis
Posted in Stock Analysis | 13 Comments »