Is This Nasdaq Debutant A Buy After Sharp Sell-off On Day 2 Of Listing?

The machine vision company's shares tumbled on their second trading day last Friday, as it searches for a formula to jumpstart its stalling growth

Key Takeaways:

• Lianhe Sowell's shares rose on their trading debut last Thursday, but tumbled the next day amid a broader market selloff on fears of a global trade war
• The machine vision company's recent rapid revenue growth came to a sudden halt in its latest reporting period

Talk about bad timing.

Machine vision company Lianhe Sowell International Group Ltd. (LHSW.US) made its U.S. trading debut into some of the worst headwinds in years, launching its newly Nasdaq-listed stock last Thursday. The shares seemed to defy the tanking markets around it, briefly more than doubling from their IPO price of $4 before closing up by a respectable 7.3% at $4.29.

But then reality caught up with the company on its second trading day last Friday, as the broader market continued to tank on concerns about coming chaos from Donald Trump's newly announced tariffs on most U.S. trading partners. Lianhe Sowell's shares led that charge downward by plunging 32% their second day to end at $2.92.

It's no huge surprise that this company's stock has been so volatile, as it's quite small and its float was also small, equal to just 3.8% of its outstanding shares. What's more, Lianhe Sowell's' astonishing growth that may have impressed investors when it first filed to list in May last year suddenly stopped in the six months to last September, the first half of the company's fiscal year, according to its latest updated prospectus.

Lianhe Sowell's story looks both encouraging but also has factors that could limit its potential. Unlike other companies machine vision companies, which are largely reliant government customers, Lianhe Sowell sells its machines and software to other companies. That's an important difference, as governments across China are reining in their spending lately due to their large debt loads.

By comparison, the manufacturers that make up Lianhe Sowell's customer base may actually be ramping up spending as Beijing offers incentives to upgrade their facilities as a form of economic stimulus. The company makes products that can be used by manufacturers for things like identifying defective products on assembly lines and automatically capturing the identification numbers on containers entering and leaving a port.

That said, Lianhe Sowell's biggest drawback is the high degree of customization needed for its products, which means it's harder to scale up its operation.

As we've already noted, Lianhe Sowell is quite small, which is reflected in the relatively modest $8 million it raised in its IPO. The company had just 30 full-time employees at the end of March last year, though we should note that figure was up by 50% from the 20 it had just a year before and just 16 in March 2022. Presumably it may try to beef up its workforce even more with its modest IPO proceeds, which it plans to use to build up the business.

Even after the Friday share selloff, Lianhe Sowell's stock still trades at a relatively high price-to-earnings (P/E) ratio of 61, which isn't unusual for this kind of newly listed Chinese company on Wall Street. Its price-to-sales (P/S) ratio is a little more realistic at 4.14, well behind the 12.8 for much larger peer SenseTime (0020.HK) and 30.8 for CloudWalk (688327.SH), another machine vision company.

Stalled growth

While Lianhe Sowell is much smaller than SenseTime and CloudWalk, it underwent a brief period of explosive growth starting in its fiscal year through March 2023 as it rolled out new products and picked up customers. The company's revenue shot up to $13.1 million in the 12 months through March 2023 from just $950,000 the previous year. That growth then continued in the next fiscal year, with revenue nearly tripling year-on-year to $36.6 million in the 12 months to March 2024.

But then the growth suddenly ground to a halt. Lianhe Sowell said its revenue in the six months to September last year totaled $16.9 million, up by less than 1% from $16.8 million a year earlier. It didn't provide a clear reason for the sudden slowdown, but a closer look at its prospectus shows the company is limited by its ability to only serve a small group of customers at any given time.

Its customer turnover is also quite large, indicating most of its customers purchase the company's products and then fail to return for more. That's not too unusual for such a small company like Lianhe Sowell, whose product portfolio is quite small and thus has limited products to sell to its customers. But it also deprives it of repeat business, which is important for any growing company.

Lianhe Sowell's prospectus shows it derived 85% of its revenue from just six customers in the six months to September 2024, with the top three supplying about 70% of the total. What's more, two of the company's top customers in the year-ago period, which supplied a combined 30% of its revenue for that time, were no longer major customers a year later. This shows Lianhe Sowell is attracting major new customers, which is always a good sign, but only fast enough to replace customers it is losing.

All this means the company may have a good product, but needs to boost its team to serve more companies from its large potential customer base if it wants to continue growing. It probably needs to standardize its products more also if it wants to achieve the scale it needs to make it into the big leagues.

Reflecting the current awkwardness in its growth phase, Lianhe Sowell's gross margin in the six months to last September fell by nearly 2 percentage points to 21.2% from 22.9% a year earlier – the opposite of what you would expect from a growing company. The company attributed the decline to its efforts to obtain more customers for its newer software business, which grew 16% in the six-month period to make up 22% of its revenue from 19% a year earlier. By comparison, sales for its older hardware business fell 3% during the six months.

Despite all of its issues, Lianhe Sowell is profitable, though its net income fell to $1.25 million in the six months through last September from $1.58 million a year earlier. At the end of the day, buyers of the company's stock should probably expect more volatility in its first few trading months, especially as the global trade war heats up. They should also watch closely to see if Lianhe Sowell can restart its growth by boosting its team and standardizing its products. If it can, the company could offer some strong potential over the next few years.