I Think the Street is Understanding Zagg’s Potential Zip

Zagg Inc. ($ZAGG) surprised the Street in the latest quarter with better-than-expected results. I think this producer of mobile accessories has pretty good long-term growth prospects and the potential to deliver more additional positive surprises going forward. (This is a reprint from my P123 Spotlight blog.)

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Why this Stock is Being Considered

It’s important, before you start to read about or evaluate a stock, to know why the it came under consideration be comfortable soundness of those reasons. Zagg, Inc. (ZAGG), got into my radar as a result of an EPS Surprise screen I created on Portfolio123 that looks among the constituents of a Russell 3000-like universe for companies that experienced a positive EPS surprise in the latest quarter and which ranked highly under criteria relating to Value and Company Quality. ZAGG was one of the passing stocks that ranked in the top 10 under a general analyst-sentiment ranking system I used for the final sort. Details of the approach are described in a 6/8/18 blog post.

Riding Coat-tails on Mobile

Coat-tails businesses are not new. Many have heard of the cliche of making money during the 1800s gold-rush not by hacking away at the ground but by selling pick-axes to the miners, Printers, paper, cables, connectors and so forth rode coat-tails on the personal computer business. Fancy headphones and controllers rode coat-tails on the video game business. Headphones and ear buds rode coat-tails on transistor radios and then Walkmen and then early iPods. We’ve seen it in many places outside of tech (auto accessories, home furnishings, etc., etc., etc.). So it’s easy to wrap our arms around the way ZAGG’s mobile accessories ride coat-tails on cell phones and tablets.

But a coat-tails business isn’t an automatic success. A company can be hitched to a declining business (I’d not likely be bullish on the leading producer of floppy discs, unless the valuation is scaled on the basis of it being a collectibles business). Also, a company can have bad products, bad distribution, or just be overwhelmed by the competitive landslide.

A Growing Business Portfolio

Mobile (cell phones and tablets) are already ubiquitous in the U.S. market. But don’t fall into the trap of assuming this means the accessories business is mature. Cases and screen protectors are not typically transferred from an old handset to a new one, so each replacement purchase, whether of a more expensive or less expensive model, generates new demand.  

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From ZAGG May 2018 Investor Presentation

Among things that can more plausibly be transferred, headphones and battery extenders, we’re a long way from having what we really crave in terms of power, performance, size and heft (we can easily get an all-day battery extender if we’re willing to carry what feels like a brick around with us) so every iteration with something better (more life for less size and weight) generates potential new demand. Actually, I expect portable power, whether through carry-able gizmos, wireless chargers, or cases with built-in battery extenders, a product category that came to ZAGG through its 2016 acquisition of Mophie, will be a big growth driver since it addresses such a huge consumer pain point. 

As to cases and screen protectors, all one needs to do is observe how many cracked screens they see in real life and consider how expensive these phones are getting. We need to protect these devices and do as good a job as we can.  ZAGG is tiny when it comes to cases, but it’s big time in screen protectors.

ZAGG isn’t top dog in every product line it sells. For headphones, for instance, we don’t need to commission a market research study to figure out that Apple’s Beats brand is way ahead of ZAGG’s FROGZ brand. But owning a highly fashionable brand costs a lot, so there’s always room for others. Meanwhile Mophie and Invisible Shield are leaders, And actually, ZAGG is enough of a leader in enough respects to do most of its business through major retailers and wireless carriers , such as with Apple’s iPhone 8 and X launches which involved an Apple-ZAGG collaboration in wireless charring stations.

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From ZAGG May 2018 Investor Presentation

The tablet keyboard market is intriguing. Initially, tablets did not need more than the on-screen keyboards because they were used mainly to consume entertainment content, or so it was thought. Microsoft tried to make the tablet more business friendly through its introduction of Surface, thought hat seems, at least arguably, to have drifted more into the laptop family. iPad, however, has become an incredibly viable business productivity device, especially with the introduction of iOS 11 and the Files app. Today, I can use even my mini iPad 4 (and keyboard case) for at least 90% of my business. My Macbook never leaves my desk and I travel only with iPad, even for business, and do this without even having yet upgraded to iPad PRO. As more in our increasingly mobile workforce discover the convenience of toting the lighter tablets around instead of laptops, we may see really strong demand growth in tablet keyboards.

I think the market is pretty much on to what ZAGG is about in screen protectors and basic battery extenders. However, I suspect the potential in tablet keyboards and fancier forms of battery charging (such as wireless) have the potential to make the earnings surprise theme (the basis for the screen on which I found ZAGG) a recurring one, not so much due to lowball guidance but the good part of the surprise theme; genuinely doing better than expected.

Right now, ZAGG is primarily a domestic company. But in the latest quarter, international sales posted double digit gains. ZAGG would like to be bigger outside the U.S. and success here could be another source of favorable surprise.

Surprises, by their very nature, are not predictable so I don’t think this theme alone could support an investment case. That’s why it’s important to consider other issues, particularly Value and Quality.

The Numbers

Table 1 shows that fundamentally, ZAGG is pretty solid and features strong finances, good margins, good turnover, and good returns on assets and equity. (Note that ZAGG’s weak 5-year numbers reflect heavy write-offs in connection with the 2016 Mophie acquisition, not bad operations.)

Table 1

Medians
Industry S&P 500
Total Debt 2 Equity 0.16 0.53 1.40
LT Debt 2 Equity 0.16 0.39 1.06
Interest Coverage TTM 25.26 4.54 7.37
% Gross Margin TTM 34.78 23.86 42.23
% Operating Margin TTM 9.81 6.98 17.32
Inventory Turnover TTM 4.82 2.90 5.40
Asset Turnover TTM 1.85 1.13 0.52
% Ret. On Assets TTM 10.45 4.81 9.80
% Ret. On Assets 5Y Avg. 2.94 4.39 9.57
% Ret. On Equity TTM 22.82 9.51 15.24
% Ret. On Equity 5Y Avg. 4.72 10.08 14.17

Ratios computed using Compustat data and Portfolio123 formulae.

In Table 2, we see that ZAGG is a pretty good cash-flow generator. The only year among those shown in which it did not have a large surplus was 2016, when it acquired Mophie.

Table 2

The key Inflows: Important Outflows Surplus
Cash Fr. Oper. Dividend CapEx Acquisitions
2012 17 0 3 0 14
2013 36 0 3 0 33
2014 26 0 4 0 22
2015 25 0 5 0 24
2016 33 0 9 75 -51
2017 34 0 6 0 28
TTM 56 0 6 0 50

In $ mill. Data from S&P Compustat via Portfolio123.com and reflects Compustat standardization protocols

In Table 3, we see that ZAGG’s valuation metrics are OK in most respects. This is fine. I’m not suggesting ZAGG as a value play.  All we’re looking for in this primarily Surprise-Sentiment oriented investment case is that value not be exorbitant in light of quality and growth potential, and I believe ZAGG satisfies in this regard.

Table 3

ZAGG Medians
Industry S&P 500
PE using Est CurYr EPS 11.79 12.72 17.65
PE using Est Next Y EPS 10.88 9.97 16.12
PEG Ratio 1.87 0.77 1.67
Price/Sales 0.86 0.81 2.60
Price/Book 3.37 1.65 3.29

Ratios computed using Compustat data and Portfolio123 formulae.

Actually, Table 4 suggests one important way in which ZAGG’s value may be better than OK. I calculate PEG as P/E based on the current-year EPS estimate divided by the projected long-term EPS growth rate. (Since we invest for future growth, and since past performance does not assure anything about the future, I think it’s wrong to use a historic growth rate for this calculation, as many do.) Therefore, PEG should be evaluated in light of the credibility of the growth forecast.

Assessing growth projections is typically more art than science. But one interesting thing we can do is look at whether the growth projection calls for a company to deliver more than it has shown itself capable of delivering in the past. Most of the time, the growth projection calls for just that; better days in the future than anything the company has ever experienced. It’s a Wall Street thing: This is an optimistic business (and why it’s usually more important to value stocks relative to one another than to any absolute standard).

Table 4 shows, however, that the growth-rate forecast for ZAGG is pretty conservative. Unlike  the median of expectations for the industry and the S&P 500, ZAGG is projected to deliver much less growth than it has in the past in terms of Sales growth. (I prefer to compare future expectations to historic Sales trends since, unlike EPS, this number is less apt to be distorted by unusual items.)

Table 4

ZAGG Medians
Industry S&P 500
Projected EPS Gr Rate % 6.3 16.4 11.0
Projected EPS Growth Rate as % of Historic Rate of . . . 
3 Yr Sales% Growth Rate 26.5 119.5 185.1
5 Yr Sales% Growth Rate 43.8 102.2 191.1
10 Yr Sales% Growth Rate 10.8 348.9 182.4

Ratios computed using Compustat data and Portfolio123 formulae.

Conclusion

Strictly speaking, ZAGG is in the Household Durables Industry (the Consumer Discretionary Sector). That makes sense since its products do share many of the low rice point, and basic essentials nature of the group. Yet the company’s growth prospects are more tech like; not mature washed-up tech but real genuine growth tech. The stock has had some big swings and may have more going forward as product news ebbs and flows. But I like the overall business here, not tied to any specific mobile product but to the category as a whole, and I like the way ZAGG adds low-cost functionality and protection to the increasingly high tech and high cost products. I think this is a sound idea fro growth-oriented accounts.

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