Rallying Since March, Is Dolby Laboratories Stock Headed Back Down?

Dolby Laboratories stock (NYSE: DLB) is up more than 30% since the beginning of this year, and at the current price around $92 per share, we believe that Dolby Laboratories stock has over 15% potential downside.

Why is that? Our belief stems from the fact that DLB stock has doubled from its low in March this year, while the S&P has moved a little over 60% in comparison. Further, after posting weak Q4 2020 numbers, and with demand struggling to rise to pre-Covid levels, we believe Dolby stock could head lower. Our dashboard What Factors Drove 49% Change In Dolby Laboratories Stock Between 2018 And Now? provides the key numbers behind our thinking, and we explain more below.

Dolby Laboratories specializes in audio noise reduction and audio encoding/compression, licensing its technology to consumer electronics manufacturers. Dolby’s price rise since 2018 came due to a 13% rise in revenue per share, driven by a 10% rise in revenue combined with a 3% drop in the outstanding share count.

Further, DLB’s P/S (price-to-sales) ratio shrank from 6.1x in 2018 to 5.6x in 2019, but has since jumped to 8x, riding the rally in technology stocks. We believe that given Dolby’s weak Q4 ’20 performance, there is a possible downside risk for the P/S multiple.

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So what’s the likely trigger and timing to this downside?

The global spread of coronavirus and the resulting lockdowns have led to a drop in demand for medium to large scale sound systems. These systems are mainly used in large events and theaters, both of which have been affected heavily due to the pandemic. This has led to a drop in demand for Dolby’s products, which is evident from their Q4 2020 results, where revenue came in at $1.16 billion vs $1.24 billion in 2019. Specifically, products and services revenue dropped almost 40% from $134 million to $83 million over this period. Further, as operating expenses didn’t drop at the same rate, operating margins fell to 18.8% in FY’20 vs 20.7% in FY ’19. Despite a lower effective tax rate, EPS came in lower at $2.30 vs $2.51 in 2019.

Going forward, we expect revenues to stay weak in the near to medium term, and if the company is not able to control expenses, we believe the stock will see its P/S multiple decline from the current level of 8x to around 7x, which combined with a reduction in revenues and margins could result in the stock price shrinking to as low as $75, a downside of more than 15% from the current price near $92.

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