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Happy Holidays for gadget stocks
This years gift theme is digital, and that's good news for investors in Kodak, SanDisk, M-Systems and three big game makers.
By Robert Walberg
The holiday shopping season may have just started, but its already shaping up to be another strong year for consumer electronic devices. That creates opportunities for investors.
Like many of you, I spent the day after Thanksgiving, as well as much of the weekend, scouring the malls for deals on DVDs, cell phones, digital cameras, digital music players, video games and video-game systems. I even took a peek at some flat-panel television sets.
At $1,500 to $4,500, those sets are still too rich for my liking. But many consumer electronics devices cost less than $300, the sweet spot that results in mass sales.
Nowhere is this more evident than in the digital-camera market. Consumers slow to make the switch to digital, myself included, are rushing to snap up four to five megapixel cameras for around $250.
Two years ago, you could barely touch a two megapixel camera for that price. The dramatic price drop is convincing the laggards to finally make the transition. And its prompting the early adopters of this technology to upgrade or simply add a second camera.
Canon (CAJ, news, msgs) wins most of the accolades for best cameras in the consumer reviews, but I saw a lot more Eastman Kodak (EK, news, msgs) cameras flying off the shelves than any other brand. The reason was simple -- price. Kodak technology might not be as advanced, and its styling is certainly less attractive than the Olympus or Sony (SNE, news, msgs) models. For about $150, however, consumers could get a four megapixel Kodak camera with three-times optical zoom. An additional $50 to $70 gets you an upgrade to Kodaks five megapixel camera, with a docking station tossed in for free.
A price advantage
Generally speaking, that put Kodak cameras about $50 below the competition. The price advantage helps to explain how Kodak has quickly gained market share on leader Sony, moving into a virtual tie for the top spot.
Kodak will have to do more than offer discounted prices to win customers over the long term, but management finally seems committed to the digital age and is taking steps to accelerate the transition. The company is also working aggressively to pay down debt and bolster its financials.
These steps, combined with the strong sales effort, explain why the stock is up 28% this year. At nearly 13 times estimated 2004 earnings of $2.54 a share, Kodak still offers reasonable value in this fast-growing segment of the consumer electronics market, especially if it can continue to deliver positive earnings surprises -- as it has done in each of the last five quarters.
Another way to play the growth in digital cameras, as well as cell phones and digital music players, is with flash memory companies. Two standout companies in the flash industry are SanDisk (SNDK, news, msgs) and M-Systems Flash Disk Pioneers (FLSH, news, msgs).
Related news and commentary on MSN Money
SanDisk is the industry leader, and its primary business is selling flash cards, or small data storage devices. As resolution in digital cameras grows, so does the demand for memory, which is good news for SanDisk. The company is also positioned to exploit the surge in demand for digital-music devices. As more and more of these units store an ever larger number of song titles the need for memory increases. Apples (AAPL, news, msgs) iPod, the leader in this area, still uses a hard drive, but expectations are that it will convert to flash at some point.
More memory, please
The cell-phone market is also booming, as phones become more like computers and demand more memory.
SanDisk has started selling its own consumer devices, most notably the SanDisk Photo Album, which lets people view digital photos on TVs, and an MP3 digital music player, prominently displayed at Best Buy (BBY, news, msgs) stores. Its a small business at the moment, but one with interesting growth potential.
Despite its exciting growth prospects, SanDisks stock took a 27% beating in mid-October after the company missed its sales and earnings targets due largely to pricing and margin pressures. However, with well over $7 per share in cash (less debt), operating profit margins of 24% and a return on equity of 19%, SanDisk is a nice long-term buy at only 18 times projected earnings for 2004 and 2005. And the price-to-earnings ratio drops to much more compelling 12 after backing out the cash.
A smaller -- but equally attractive -- play in the flash industry is M-Systems. The company, with a market capitalization of $570 million, targets the universal serial bus (USB) flash drive market with its DiskOnKey and the multimedia mobile handset market with its Mobile DiskOnChip. Bolstered by strong growth prospects and an attractive valuation, the stock has jumped more than 40% off its mid-summer low. The stock remains attractively priced for growth-oriented investors at nearly 28 and 19 times 2004 and 2005 estimated earnings, respectively -- and with a long-term projected growth rate of 22.3%. A break above key resistance at $17.50 a share would position the stock for an intermediate-term run at the $20 to $22 area.
Do you want to play a game?
Another solid investment option in the consumer electronics industry is in the video-gaming marketplace. Due to the drop in console prices and the introduction of several new, popular game titles such as "Halo2," "Grand Theft Auto: San Andreas," "Tony Hawks Underground 2" and "Spider-Man 2," the video gaming business is enjoying explosive growth. Three attractively priced stocks in this area are Electronics Boutique (ELBO, news, msgs), Activision (ATVI, news, msgs) and ATI Technologies (ATYT, news, msgs).
Electronics Boutique, or EB Games, is a retailer that sells games and gaming systems. Earnings last quarter exploded and theres no reason to think that sales or earnings growth will slow considerably any time soon. Though the stock has had a nice run, its still reasonably priced at about 17 times this year's estimated earnings of $2.29 a share. It also trades at 0.5 times trailing 12-month sales. Investors should also note that the company has $3 per share in cash, no debt and a return on equity of 19%.
Activision creates video games. Among its popular titles are Tony Hawk games, "Call of Duty," "Lemony Snicket: A Series of Unfortunate Events," "DreamWorks Shark Tale," "Shrek 2" and "Spider-Man 2." Its broad array of titles, competitive profit margins and discounted valuations make it a top play in this area. It also explains why the stock has been one of the best performers in the industry this year and why its knocking on the door of a multi-year high.
Despite the stock's rise, theres plenty of room for additional growth given that it sports a P/E to growth ratio, or PEG, of 1.19, well below the industry average of 1.8. Activision also is free of debt and sitting on more than $4 per share in cash.
Gaining on a competitor
ATI Technologies provides graphics processing products for video game consoles, digital televisions, desktop/notebook PCs and other consumer electronic devices. Two things to like about the company are its product diversity and its recent market share gains versus competitor Nvidia (NVDA, news, msgs).
Investors will also like the fact that despite being up nearly 30% this year, the stock trades at a discount to its estimated long-term growth rate of 22%. Industry-leading profit margins and return on equity, combined with a strong balance sheet, simply add to the stocks appeal. Assuming the company hits its targets, a move to the $23 to $25 area should be no trouble over the next six to 12 months.
Whether you prefer to play the original equipment manufacturers like Kodak, the parts suppliers like SanDisk and ATI Technologies, or the retailers like Electronics Boutique, or some combination, you'll definitely want to increase your exposure to the fast-growing consumer electronics industry this holiday season.
At the time of publication, Robert Walberg neither owned nor controlled shares in any equities mentioned in this column.
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