A next big thing? 17 Nov 2004 Marc Gerstein Director of investment research Reuters.com
Zebra Technologies hopes RFID, an intelligent radio-based upgrade from typical bar coding, pans out.
In my 11/13/04 article introducing this week's bottom-up investing theme, the Reuters Select High P/E Ratios screen, I explored the role of expectations in justifying high P/Es. There are many sets of factors that give rise to great expectations, some silly and some substantive. Among the latter, one of Wall Street's favorite scenarios involves a new product category, or a next big thing. One that's been getting some attention lately is RFID, radio frequency identification, the supposed next big thing in retail operations. Zebra Technologies (ZBRA.O), which appeared recently in the High P/E screen is a leading investment play in this area. Are the expectations are reasonably aligned with ZBRA's stock price.
A bona fide big thing
The first danger in investing in stocks whose P/Es are being boosted by next-big-thing expectations is that the thing may not be real, or may not really be such a big deal.
RFID seems like it will be a big deal.
On one level, RFID tags are like bar codes that have become ubiquitous in retailing and are even spreading to other areas (like healthcare). They store lots of information and played a major role in modern retailers having been able to have made the strides they have in operational efficiency, in stocking, purchasing, and so forth.
But with technological progress having become so ordinary, nobody likes to sit still, even when the status quo is pretty good. So forward-thinkers chaff at the fact that bar codes can only be read when in close physical proximity and in direct visual line with the item scanned. Also, the flow of information is strictly one-way, from item to information seeker; you can't write to a bar code label.
RFID overcomes both of those limitations. With this technology, much more information can be obtained with much less physical activity. Information gatherers need no physically go to the locations of the items to be read, and the items need not be positioned in a manner that makes the label visible from any particular orientation. In fact, the label can even be hidden, making it harder for a counterfeiter to know how to imitate the real thing. And since labels can take in information, they can know if removal is being attempted and to send a signal to that effect. For perishables, they can even know if temperature is changing to an unacceptable degree. Hence the reason why they're referred to as being "intelligent."
Here and now, and later
For technophiles, great capabilities are sufficient. For investors, we need to also have a sense of if and when the new gizmos can make a noticeable positive impact on the company involved.
Right now, RFID is a future thing. No company, not even ZBRA, a major player in the field, is relying on it for substantial profitability.
The big fear with such a scenario is that the potential of a business will remain just that, potential, and never become actual. Commentators suggest this is not the likely scenario for RFID. They cite Wal Mart's recent mandate requiring its top 100 suppliers to move to RFID as evidence that we will, eventually, get from here to there. Apparently, similar mandates have come from target, Albertson's, the big UK retailer Tesco, and the U.S. Department of Defense.
Such considerations seem to be a credible indicator in support of the legitimacy of RFID.
ZBRA's numbers
The mandates sound great, but compared to the entirety of the prospective marketplace, they are just a drop in the market. To really make money, we need much more. Hence if we try to rely RFID numbers alone to make a case for ZBRA, we probably won't like what we see.
Fortunately for ZBRA shareholders, we don't absolutely, positively have to bet the farm on RFID. ZBRA is also big in conventional bar code printers. Actually, these account for pretty much all the numbers we see today. Better still, from the vantage point of those who own ZBNRA stock, the numbers are OK; actually, it could even be argued that investment in RFID is dragging the company's results.
Be that as it may, growth rates are OK, margins and returns on capital are terrific, and the cash-heavy debt-free balancer sheet is way better than terrific.
Meanwhile, forward prospects for bar codes (which are seen as most likely to accompany rather than be wiped out by RFID) are pretty good. Merchants are making greater use of them, and the health services industry is just starting to get into it.
As to the stock's valuation, if we had nothing other than conventional bar coding to think about, it might be deemed pricey but not ridiculously so. That, in my view, could be deemed favorable from the vantage point of investors who are inclined to pay up for the next big thing. While ZBRA is not a slam dunk in this regard, investors who pursue this theme could do a heck of a lot worse elsewhere.
I estimate that ZBRA's stock price, which already corrected a bit from its recent all-time high, could be deemed worthwhile if five-year average annual EPS growth comes in at or above 16.5 percent. My future relative (company-to-S&P 50) P/E assumption, 1.182, is below current levels, thus providing something of a comfort factor.
Meanwhile, my growth estimate based purely on a historic number crunch, 17.6 percent, is very close to the 17.1 percent consensus analyst long-term growth expectation. I combined the two numbers fort an overall growth capacity assumption of 17.2 percent, which is modestly above the required growth hurdle.
Market Data 
Markets 
AI
