Hemisphere GPS (HEM.TO) is a Calgary based company that develops GPS navigation systems primarily for the agricultural sector. Formerly known as CSI Wireless, the company took a major turn in 2006 by disposing of its wireless operations to focus on the development and marketing of GPS systems.
In an industry dominated by giants such as Garmin and Trimble Navigation, Hemisphere GPS has carved itself a niche in the agricultural sector that generates 85% of its revenues. The use of GPS guidance systems helps farmers optimize the spraying of pesticides, fertilizer and seeds. Auto-steering systems even allow tractors to evolve by themselves in the fields following pre-programmed route. The sub-inch accuracy of those advanced GPS systems enable farmers to reduce input costs and increase crop yields.
Hemisphere GPS is one of the world’s leading company in this niche market. Thanks to its R&D effort and the acquisition of smaller competitors like Outback and Beeline, the company has a variety of products and over 70 patents. Growth prospects looks bright when considering the still early penetration of GPS guidance systems in agriculture. In North America, less than 40% of farms over 500 acres use GPS guidance and only 20% use auto-steering systems. The adoption of these technologies is even lower in the rest of the world.
In 2010, Hemisphere GPS released its new Outback eDriveX auto-steering system. So far, the product seems to be well received by customers. The company recently signed a distribution agreement with CLAAS Agrosystems in Europe and a OEM partnership with China’s FOTON LOVOL.
First, let’s have a look at the company’s financial data:
The balance sheet is clean with no debt, $8 million in cash and $25 million in working capital. Book value per share was estimated at $1.53 by management on September 30, 2010.
The picture is less rosy when we look at the recent earnings history of Hemisphere GPS. The company earned $6 million ($0.11 per share) in 2008 on $73 million revenues but lost the same amount ($6 million) in 2009 on much lower sales ($54 million). Projected 2010 sales are $59 million which could result in a loss of approximately $5 million.
Without a doubt, the recession dampened the financial results of Hemisphere GPS over the past two years. However, I think their business is starting to turn around. Recent high grain prices have led to big profits for farmers. They are now flush with money and ready to spend again on field equipment. With its diversified range of products, Hemisphere GPS is well positioned to thrive in such agricultural bull market.
Next, let’s have a look at possible financial outcomes:
(In millions)
| Sales | 75 | 100 | 125 | 150 |
|---|---|---|---|---|
| Gross margin | 35 | 47 | 59 | 70 |
| Fixed costs | 35 | 36 | 38 | 40 |
| Net income | 0 | 9 | 17 | 24 |
| PE Ratio | n/a | 15 | 15 | 15 |
| Share price | n/a | 2.25 | 4.25 | 6 |
| Gross margin: | I used a 47% gross margin (2009 gross margin was 48%) |
| Fixed costs: | I consider R&D, G&A, Sales and Marketing and amortization to be relatively fixed costs. |
| Net income: | I used a 20% tax rate. However, the company has tax losses available to be applied against 2011 and probably 2012 income. |
| PE ratio: | I consider 15 has a conservative ratio. A small-cap in a hot sector could fetch a much higher multiple. |
| Share price: | (Net income x PE ratio / 60 million fully diluted share count) |
Since a large part of their expenses are relatively fixed, I think the company has a lot of operating leverage. Any meaningful increase in sales could have a big impact on net income and share price. This is the type of opportunity that growth-oriented investors are looking for.
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All in!
I agree that the fundamentals are very positive, but I think the key catalyst for the stock is an M&A event. The precision agriculture space is ripe for consolidation and Hemisphere GPS has a market leading suite of products. Look for the company’s management to negotiate a deal around mid 2011, probably for a price between $3.50 to $4.50
HEM has been rumored to be a takeover target for years. I agree that it could happen but I prefer to base my investment thesis on improving fundamentals.
[...] This post was mentioned on Twitter by Philippe Rancourt, Philippe Rancourt. Philippe Rancourt said: mon analyse (en anglais) de Hemisphere GPS : http://investlikeanentrepreneur.com/2011/02/02/hemisphere-gps/ [...]
Curious what your take is on the bought deal HEM announced today? Timing seems odd to me.
Strange indeed. The only rationale that I could see for this financing is that they need cash quickly to increase working capital. This would mean they have a lot of orders to fulfill right now…
Tough to see the share price collapse like this ahead of the quarter. Hopefully its just a temporary blip, especially given that Trimble and Raven are performing very well.
Any insight if there is something else happening or do you think its just market noise?
Thanks in advance for your comments
I don’t think something bad is brewing. I guess this kind of drop could happen when a small-cap go up very fast on no news…
Regarding Q4 result, we should not expect too much of it… They will probably post a small loss somewhere between 0.5 an 1 million. Q1 2011 will be more interesting.
Not a good reaction to the quarter. Biggest concern was the gross margins miss (I can live with the defered revenues).
Lets hope that the guidance for 2011 proves to be true. If so the stock is going to head much higher from current levels ($2.50 to $3.50 I suspect).