Hemisphere GPS HEM
June 25, 2007 - 1:20pm EST by
issambres839
2007 2008
Price: 2.74 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 134 P/FCF
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT

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Description

With agriculture prices soaring and farmer’s incomes exploding, Hemisphere GPS represents a cheap “pure play” investment on the agriculture economy. Hemisphere GPS is poised to grow earnings at over 80% compounded annually for the next two to three years and yet trades at less than 12 times my 2008 earnings estimate. Hemisphere has finished their restructuring with a new dynamic CEO with almost a year under his belt, and has introduced a market altering new product. In the next 12 to 18 months, Hemisphere could climb over C$6 a share based on the company earning $0.21 per share in 2008 and $0.33 per share in 2009.

Formerly Known as CSI Wireless
 
I first recommended Hemisphere last year when it was called CSI Wireless (Hemisphere recently changed its name) and it was trading for liquidation value at C$1.50 per share. The company was a mess with two out of its three divisions losing money and having just fired its CEO.
 
A year later the company has shed its money losing businesses, hired a new, impressive CEO (Steven Koles) and refocused the company around its precision agriculture (GPS for the farm) business. This investment case is no longer one of survival but one of normalized margins, an impressive new product lineup and capitalizing on a scorching hot farm economy. But first, let’s refresh what precision agriculture is.
 
GPS for the farm, otherwise known as Precision Agriculture
 
Precision Agriculture uses GPS to plant, fertilize and harvest fields with pin point accuracy. Instead of using traditional foam markers or guessing, farmers utilizing precision agricultural devices can save time and money with exact usages of fertilizer and fuel. Farmers can also work longer hours in any one day due to relying on GPS and not eyesight. This allows farmers to have a quicker harvest. The newest devices actually steer the tractor or vehicle for you according to the GPS layout of your field.
 
Precision Agriculture did not exist ten years ago. Today, approximately 20% to 25% of U.S. farms use some form of GPS device in their farming. With today’s high fuel prices and high fertilizer prices, it is not hard to see why Precision Agriculture has taken off. Payback can be as little as one year with some crops. Prices on products go from about a few thousand up to $40K for the high end systems. The average price for precision agriculture systems is $8,585 according to Frost & Sullivan (a consultancy group).
 
A recent study by Caledonia Solutions found that one out of every four commercial corn producers already owned a guidance system and ownership should grow another 50% in 2008. What is interesting is that corn prices were about $1 lower when this report was issued in late 2006.
 
Check out the following excerpt from AEFP (Alberta Environmental Farm Plan) Journal, which explains how and why GPS is so helpful and valuable to farmers:
 
“Outfitting the tractor with a Global Positioning System (GPS) has helped Tony Pliva reduce herbicide and other inputs used on his Southern Alberta farm. By reducing the amount of overlap on each equipment pass, he estimates he's saving about 6.5 acres worth of inputs on each quarter section.
 
Although it varies with the crop, the Drumheller-area farmer says that translates into an overall input savings of between $5,000 and $10,000 per year.
 
"It's surprising when you make the comparison," says Pliva, who crops about 2,800 acres of grains and oilseeds. "Without the GPS, during field spraying, I was overlapping about 100 feet over a quarter-section. And over the whole farm that adds up."
 
A quick calculation shows that a 100-foot spray overlap on a quarter section—a half mile-long field—equals about 6.5 acres and over 17 or 18 quarters, which totals about 112 acres of overlap. Although crop inputs will vary, if seed, fertilizer and chemical range between $50 and $100 per acre, that adds up to $5,000 to $10,000 per year.
 
The Outback GPS (A Hemisphere product) unit costs about $6,600. Considering the value it brings to his operation, Pliva estimates that the system will be paid off within a couple of years. "And reducing the inputs is also good for the environment," he says.”
 
Hemisphere sells a range of Precision Ag products
 
Hemisphere sells products for three separate markets: Ground Agriculture, Air Agriculture and Precision Marine. Ground Ag represented 75% of 2006 revenue, Precision Marine represented 15% and Air Ag represented 10%. Product pricing ranges from as little as $1700 to $8000. Products include guidance products that tell you when and where to drop seed and fertilizer to the company’s eDrive that actually steers the tractor for you.
 
In the North American aftermarket for precision agriculture market, Hemisphere has 50% market share based upon units sold and components in underlying products. For example, all of Raven Industries (NASDAQ: RAVN) precision agriculture products have Hemisphere’s Crescent chips inside. One of Raven’s subsidiaries makes GPS equipment.
 
Hemisphere’s strategy is to offer more software based solutions than hardware and to offer cost effective solutions to a farmer. It operates in the low to mid-end portion of the market. While there are some products and solutions that cost $30,000 to $40,000, Hemisphere’s goal is to try to find a lower cost solution and get more mass market adoption. And that is where Baseline HD comes in.
 
 
 
 
Baseline HD is about to shakeup the Precision Ag market
 
If you wanted GPS guidance on your tractor plus auto steering with “sub-inch” accuracy (the best accuracy technology allows now), common solutions cost you upwards of $30,000. Hemisphere’s new Baseline HD solution will cost you less than $15,000 while providing the same accuracy. I believe that this product single-handedly could change Hemisphere and dramatically alter the competitive landscape.
 
To get sub-inch accuracy in GPS farming currently requires something called dual RTK (Real Time Kinematics). RTK positioning provides much higher differential positioning accuracy by observing a given signal's carrier phases. The difference with BaselineHD is that it uses single RTK, something that wasn’t thought possible. This also allows less components and a much lower price point.
 
Consider the market potential just in Hemisphere’s customer base. Hemisphere has sold about 30,000 S2 guidance drives. (An S2 costs $2800). Now an S2 provides one meter accuracy. By spending $8000 more and adding the Baseline HD, your S2 can now provide sub-inch accuracy. And if you talk to farmers, the difference between one meter accuracy and 1.5 centimeters accuracy is night and day. And the more accurate you are the more money you save and the more efficient your farm is.
 
Hemisphere has sold over 1000 units so far of the Baseline HD, but if you forget about market growth and just focus on the S2 user base, you get around $250 million revenue opportunity (Hemisphere did $46 million in revenue in 2006) and that is without the eDrive, which sells for $4000 and would add another opportunity of $120 million.
 
Check out this testimonial I found from another article:
 
Dave Mitchell, a grower and BaseLineHD user near Bakersfield, Calif., recently stated, "While preparing my field to plant carrots, I've found that BaseLineHD with eDrive is saving me at least 18 inches of overlap per pass. The cost savings are incredible and the return on investment is easy to see immediately. The high accuracy of BaseLineHD permits me to plow, disc, rip, list, and plant all my crops including carrots, potatoes, black eyed beans, garlic, and wheat. And because of the self contained battery and compact size of the BaseLineHD base station, it's very easy to take with me from field to field, a great feature in this area because our properties are spread out."
 
The Farming Economy is Hot, and will only get stronger
 
Wheat, corn and soybean prices are at multi year highs due to 30 year lows in worldwide inventories, increasing demand from Asia and surging ethanol demands. The price for agricultural land has doubled in many parts of the country despite farmers planting crops fence post to fence post. And the fundamental drivers of price are actually just as bullish if not more so now then they were last year.
 
Worldwide inventories are not going to be replenished anytime soon thanks to surging demand from Asia and less exports from the U.S. due to the demand for ethanol. Further, due to massive water problems in Asia and increased urbanization agricultural production and inventories are suffering. Asia is the big key for ag prices and may be the reason that prices continue to rise. Also, considering that a cow eats as much as ten times the grain as a human; when meat consumption increases, so paradoxically does grain consumption.
 
You can also see the surge in the farm economy by just taking a gander at the stock prices of companies that sell into the farm economy: Deere (NYSE: DE), Catepillar (NYSE: CAT), CF Industries (NYSE: CF) and Potash (NYSE: POT). All of these companies are at or near all time highs. There are very few pure play agriculture equity investment opportunities and most of them are very large corporations. (This is another reason why Hemisphere is so attractive.)
 
Precision Ag should grow faster than the farm economy as well
 
Only 20% to 25% of farmers have GPS guidance systems in North America and less than 5% have auto steering. Adoption is growing every year, especially as the cost of the products comes to down to levels that approach mass market appeal. Hemisphere is a big part of bringing the price down and should drive adoption of GPS technology.
 
Further, the surging fortunes of farmers should increase purchases as well. Consider the comments the CEO of competitor Trimble Navigation (NASDAQ: TRMB) made last year. “We (Trimble) see a wave of new money coming into the primary customers for Precision Ag equipment (row crop farmers) resulting from alternative fuel demand in North America and Europe starting next year and it should last for 2-3 years, this should be very positive for our business.”
 
Analysts are estimating industry growth at around 10-15% long term, but I think it could be more like 20% for the industry and that certain companies such as Hemisphere could grow much faster due to product offerings and great technology at attractive price points.
 
Restructuring is finished, but the best is yet to come.
 
With the restructuring substantially complete, the company is now free cash flow positive and has a solid balance sheet with no debt.
 
But the best is yet to come. Why? There is a lag between the surging agriculture prices in the past nine months and farmers having cash in their pockets. If you talk to farmers they generally spend what’s in their front pockets. And there are many farmers who have hedged out production at much lower prices. The past twenty years have been very difficult for farmers. Just because there has been one really good year doesn’t mean that farmers are going to rush out and start spending money. The longer that higher prices last, the more that spending is going to increase. Hemisphere will tell you that the company doesn’t feel that its customers have fully benefited from these higher grain prices and that the real spend will come in 2008-2009.
 
Beyond the farm economy and market driven benefits flowing to Hemisphere, the company has taken several initiatives that will show up over the next year.
 
Hemisphere has rid itself of the middle man in purchasing printed circuit boards (PCB) and is now buying them straight from China.
 
The company is now focusing on cost in the design phase. For example, for the S3, (the next generation guidance system) the design process is focused around making the product cheaper to make, thereby lowering the final manufacturing cost to Hemisphere.
 
Also, the CEO has introduced twelve month forecasting with a focus on long leads and a flow of delivery and inventory management to lower the cost and improve the efficiency of the company’s manufacturing process.
 
Finally, the company introduced the BaselineHD in February in the middle of the buying season. We really won’t see an impact from this new product until 2008. This is yet another tailwind for 2008.
 
International Opportunity
 
Internationally the company has made changes to their distribution network and is more optimistic about their international opportunities than before. This should be a big boost for the company as Australian and South American revenue streams come in the Hemisphere’s typically weaker second half. In 2006, 70% of the company’s revenue came from the first two quarters. This should moderate as international revenue comes on strong.
 
2008-2009 should see sharply higher earnings
 
While, the company is still in recovery mode this year (fiscal 2007) it should grow revenue 31% to around C$60 million and should see its margins recover to 7% from losses last year. Earnings per share should be about C$0.10 per share this year.
 
Next year, Hemisphere should grow sales 25% to C$75 million in fiscal 2008 and operating margins should recover to 14%, bringing EPS to C$0.21 per share. And in 2009, I estimate C$90 million in sales and 18% operating margins which the company should earn C$0.33 per share.
 
Remember that historically the company has done 20-25% operating margins and that their competitors have 20% to 30% operating margins. I believe there is a lot of conservatism in these numbers as it assumes market growth, despite its obviously superior BaselineHD product. These numbers also assume a slow resumption of historical operating margins.
 
It’s important to note that Hemisphere has C$40 million in NOLs. I estimate that they won’t start paying taxes until 2010, unless business is better than expected. The value of this NOL is about C$0.80 a share and present value is probably C$0.35 per share.
 
Comparables and Competition
 
Hemisphere GPS’ chief competitors are Trimble Navigation (NASDAQ: TRMB) and a private company, Novarient. Other comparables include Novatel (NASDAQ: NGPS) and Raven Industries (NASDAQ: RAVN).
 
The largest GPS company is actually Deere (NYSE: DE) subsidiary, ComNAV. They sell only on John Deere tractors and to John Deere customers and do not participate in the aftermarket. They do about $400 million in revenue.
 
The average multiple of these comparables is 18 times next year’s earnings. Please note that Novatel actually looks really cheap at 12 times next year and drags down the average. However, Novatel is only growing earnings at 10% or less and there are worries in the market place about its customers reducing orders from Novatel, so investors are worrying if the 2008 estimates are too high right now.
 
Valuation
 
If I put an 18 multiple on C$0.21 in earnings for 2008 and I add in C$0.30 a share in cash, Hemisphere should trade at C$4.08 a share. If you apply that same multiple to 2009 earnings and add in the cash you get C$6.24 per share. At its current price, Hemisphere trades at less than 12 times next year’s earnings despite excellent earnings growth.
 
I would also add that Hemisphere is an excellent acquisition opportunity and a larger company could remove a lot of public company expense and corporate overlap with an acquisition. Further, there could be a bidding war as this is a hot space and Hemisphere has an excellent market share position, distribution network and brand name.
 
Summary
 
With so few agricultural equities, especially small cap equities, to invest in, Hemisphere GPS offers not only a chance to invest in a growing sector and a great macro backdrop, but in a company in which normalized margins are triple what they currently are seeing. As expectations for 2008-2009 rises, so will the stock price.

Catalyst

-Q2 earnings report
-Guidance for back half of the year
-New OEM partner
-Realization of how good 2008-2009 will be
-Continued Strong Grain Prices
-Consolidation in the Precision Ag space
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