Instead of an investment thesis
In this article, I revisit my purchase thesis on Coda Octopus Group (NASDAQ: CODA) Inventory. I continue to believe in the company’s potential to monetize its technology and expand its customer base. However, given the current economic environment and recent financial results, I feel compelled to rate the stock as a “reserve” – in my view, it becomes a “buy” at around $3 per share.
I first discovered Coda Octopus Group in August 2021 when the stock was trading at $9.41. Since then, despite my bullish conclusions, quotes have almost halved (my thesis turned out to be twice as bad as the market):
To understand what went wrong, I suggest paying attention to what the company actually does and its unique selling proposition.
Coda Octopus was founded in 1994 in Orlando, Florida. The company operates in the marine products and engineering sectors and has offices in Florida, Utah, United Kingdom, Australia and Denmark.
The Marine Technology Business segment sells technology solutions for the underwater and underwater markets – primarily real-time 3D volumetric imaging sonars, which are the only ones of their kind capable of generating up to 40 million measurement points. 3D data and provide the ability to detect multiple target submarines in real time with a single sensor. As fellow SA Confoundedinterest rightly noted in their November CODA article, this business segment is the most important and innovative – it is the one we need to pay attention to if we are to understand the potential future business growth. In the second quarter of 2022this segment accounted for 70% of total revenue and 41.8% of gross margin.
Another line of business – Marine Engineering Business – operates a consulting business model, so it can be assumed that its main costs consist of salaries and travel expenses (this fact explains the high gross margin). However, in the second quarter of 2022, it was this segment that let the company down:
These results were a one-time event – when reviewing operating losses from their non-core segment, management advised that the Marine Engineering Business should post much stronger results in Q3 and Q4.
Anyway, in recent years, management has been actively developing the “Marine Technology Business” segment – the company’s underwater imaging sonar technology has some potential if we consider possible applications – both commercially and to meet the defense needs of different countries:
The amount spent by the company on R&D expenses is evidenced by the dynamics of the ratio of this expense item to revenues over the past few years:
Basically, CODA has returned to the stage of vigorous scientific and technical activity after a long period to bring to market as soon as possible the Diver Augmented Vision Display System (DAVD), the PIPE Echoscope, and a new patented solution for real-time 3D Cable Tracking. In the years to come, these investments should bear fruit, both in terms of expanding the addressable market and developing the existing market.
I think CODA, because of its unique technology that other companies don’t have, can quickly achieve its goals if everything goes the way it has for the past few years – growing its customer base, improving its product/service line , and therefore develop TAM and SAM (the key components of any fast-growing micro-cap business).
What’s the catch then? Why “Hold”?
To be honest, buying growth companies in the current macro conditions is quite a risky thing to do. Many projects the CODA team has been involved in are finishing slower than expected, which undoubtedly has an impact on order intake. This is reflected in the dynamics of deferred income and receivables in the last quarter:
The management of CODA itself speaks of the current problems of the company’s customers:
In the current quarter [Q2 2022] our overall quote percentage rate was higher than the previous quarter [Q1 2022]. However, we are experiencing a much slower closing rate, including projects moving forward. We believe this reflects the difficult environment, in particular the supply chain issues that persist globally, as well as the continued constraints caused by the pandemic, particularly in Asia, which is an important market for our solutions. .
Source: Based on the latest 10-Q from CODA
Also, in my opinion, the valuation of the company is still too high to reflect the current market situation. I justified my opinion below – after a bad quarter, the P/E multiple (TTM) fell from ~12X to ~19X as the share price did not react strongly to the drop in EPS. After that, the market started to adjust the P/E ratio higher – it now sits at ~16X. Meanwhile, the stock has corrected around 12% – if the market continues to decline to 12X, the stock should fall to $3.5-$3.6 by the next report (September 15, 2022). The bottom could turn out to be even lower – the market quite frequently overreacts, so that shouldn’t be overlooked either.
On the other hand, the forward EV/EBITDA multiple is already at an all-time low – if the market moves positively, CODA could rally without falling further.
I believe in the long-term future of the company – as the addressable market grows and the innovation base grows, Coda Octopus has every chance of doubling or tripling its market capitalization (the market capitalization is only about $53 million).
In the medium term, however, CODA could face operational difficulties – if talk of an impending recession is true, the company’s customers are likely to further delay the implementation of their new projects. In this case, CODA’s valuation multiples are expected to fall further – both through a decline in share price and a medium-term decline in earnings. Therefore, I remain an internally bullish, but I do not recommend that potential new investors open positions at current prices – better to wait until the stock has fallen by around a third.
I’d love to read your thoughts in the comments section below!