PSB Monthly Issue August 2012
August 2012
It shouldn’t be a surprise to see most industries in the US were radically changed in the latest recession. This could be seen in the widespread economic downturn that started in 2006 and carried on until last year.
The latest recession certainly impacted more industries than you normally hear about… such as housing, finance, and automotive.
One of the many industries to suffer steep losses was the recreational products industry. More specifically, we saw the fitness equipment manufacturers take a big hit.
You see, big brand name fitness equipment companies rely heavily on sales through commercial channels… mostly gyms and schools. But as every corporation big and small looked for ways to cut costs, new equipment was pushed to the backburner.
And it wasn’t only commercial spending that fell off…
As the recession wore on, home fitness equipment makers also witnessed a decline in sales.
According to SGMA Research, from 2009 to 2010, planned consumer fitness equipment purchases fell by 2% from 23% to 21%.
What’s more, total sports equipment sales grew by just 1.39% during the same time frame… far less than the 3.1% analysts projected earlier that year.
The good news is, the industry started to turn positive in late 2010.
In fact, overall wholesale shipments are at three-year highs… with two of five categories at five-year highs. And the most compelling part about this is that sporting goods industry wholesale shipments are outpacing GDP growth to the upside.
Take a look at the graph below to see the trend…
It’s pretty amazing to see how close these two trends follow each other. The great news is GDP is forecast to increase at an even faster pace for the remainder of 2012 and 2013!
With the trend in fitness equipment purchases once again on the rise, now’s our opportunity to get into this industry. And one of the strongest brand names in the business just happens to be in the penny stock space.
Introducing Nautilus (NYSE: NLS)…
THE FITNESS EQUIPMENT BUSINESS
Nautilus is a global fitness products company that provides innovative solutions to help people achieve a healthy lifestyle. NLS has a brand portfolio which includes Nautilus, Bowflex, TreadClimber, Schwinn, Schwinn Fitness, Universal, and CoreBody Reformer.
Many of you may recognize this name and be thinking, “Nautilus is a penny stock? But they’ve been around forever.”
Well, you’re correct, but there’s a lot more to it than that. Let me explain.
You see, the Nautilus equipment company you’re thinking of was launched in the late 60s and 70s by a man named Arthur Jones. In 1999, a relatively new fitness company named Bowflex of America bought out the vast majority of Nautilus. The intent of Bowflex was to expand into commercial fitness clubs.
In essence, Bowflex became Nautilus and took over their company name due to the huge brand recognition.
However, the growth and acquisitions made by Bowflex didn’t stop there. Here’s a timeline highlighting Nautilus’ history…
As you can see above, NLS grew by acquiring a number of fitness brands early on. Unfortunately, just like many other companies, Nautilus was hit hard by the downturn.
Sadly, Nautilus was forced to sell off their commercial division and Pearl Izumi fitness apparel lines. This, as it turns out, is what saved the company from total meltdown. Their decision to focus on direct and retail consumer sales has been the key to their revival.
Name: Nautilus Ticker Symbol: NLS Market Cap: $97.8 million Recent Price: $3.18 PSB Rating System 4.8 Stars Raging Revenue: (4.6 stars) Revenue is already up from the solid 7.1% Nautilus experienced in 2011 to 12% in Q1. NLS is beating the industry average growth of 9.7% Current marketing plans set NLS up for even stronger growth later this year. Beautiful Books: (5.0 stars) With no short-term debt and just $5.6 million in long term debt, the books at NLS are in top shape. In addition, the company has grown cash on hand from $17.4 million at the end of 2011, to over $20 million at the end of the first quarter. Stellar Structure: (4.7 stars) Institutional ownership is good for over a third of the outstanding shares… or 34.8%. Clearly the pros know a winner when they see it. Valuation Verification: (4.9 stars) The forward P/E for Nautilus shares are just 8.3x. Even better, the PEG ratio comes in at just 0.3x. Meaningful Milestones: (4.7 stars) For the first time since 2006, Nautilus achieved annual profitability in 2011. Over the coming months, Nautilus will be moving to a smaller headquarters for further cost savings. |
THE NUMBERS
After spending half a decade in the red, Nautilus is finally back to profitability.
Better still, revenue is on the rise. In the first quarter of 2012, net sales were $51.3 million, which represents an increase of $3.0 million or 6.1%. Breaking it down further, net sales in the company’s direct segment rose by $3.5 million or 11.5%. Most of the sales growth came from continued demand for their TreadClimber product.
While top line growth is critical to a company’s success, their ability to grow the bottom line is even more important. And that’s where NLS is seeing huge gains.
In fact, net income for the first quarter of 2012 was $2.5 million. That’s a jump of 57% from the first quarter of 2011 when the company did just $1.6 million in net income!
With high brand recognition, we could see these results continue to improve as the company streamlines their efforts and the economy continues to improve.
What’s even more impressive about NLS is their balance sheet.
For perspective, let’s take a look back at their books in 2007. Back then, Nautilus had just $7.9 million in cash and over $79 million in short-term debt.
At the end of this past quarter, NLS now has $20.4 million in cash and no outstanding borrowings. I’d say that’s a major turnaround and shows investors that management knows how to get the books in great shape!
INVESTMENT RISKS
As with any investment, NLS does have a few risks.
As we’ve pointed out, the fitness industry trends are pretty closely tied to GDP growth. If the US economy falters, Nautilus may struggle to grow sales.
As you’re aware, the fitness industry is extremely competitive. While NLS has one of the strongest brands in the business, the “next great thing” could come along and steal market share.
Finally, the company may see profit margins slide if they experience significant changes in production costs.
POTENTIAL RETURN OF 300% OR MORE
NLS is trading at a major discount. For starters, their forward price to earnings ratio is just 8.4x. That means you can buy NLS for roughly 8 times future earnings. As a comparison, the industry average P/E is 21.0x, 250% greater than the company’s current share price.
What’s more, Nautilus has a PEG ratio of just 0.3x, compared to an industry average PEG ratio of 1.6x. That’s cheap growth, no matter what the rest of the industry is doing. If NLS traded in line with the industry average, we could see shares rise by more than 533%!
We think NLS deserves a valuation more in-line with the industry. Given the company’s superior brand name recognition, excellent product mix, and return to profitability… now’s a great time to buy shares at a major discount.
Based on our analysis, we see the stock trading up to at least $9.00, with a near term target of $6.25. Grab your shares of NLS now for potential gains of 300% or more!
ACTION RECOMMENDATION
BUY Nautilus (NYSE: NLS) up to $3.35 per share.
Recent price is $3.18.
Use a stop-loss of $2.25 on this position.
Don’t forget your position sizing and stop-loss rules.
Unless you’ve decided to live in a cave somewhere, you have electronics in your life. I’ll bet more than you’re even aware of!
Think about it… our culture has transformed so rapidly over the past decade alone, that we now have electronic and computer interactions all around us. Just over ten years ago, smartphones didn’t exist… they were just beginning to merge mobile phones and PDAs.
Does anyone remember PDAs?
Now, we don’t just have the iPhone, but instead hundreds of other options to choose from. Sadly, many times you can’t get people to stop endlessly staring at them. For better or worse, they’ve no doubt significantly changed our culture.
Take this level of evolution and multiply it by the hundreds, if not thousands of other devices we routinely use that are electronic in nature. Televisions, computers, phones, printers, video games, mp3 players, electronic automation systems, and on and on…
Heck, even cars are now rolling electronic wonders!
The bottom line is the integration of electronics in the modern world is here to stay. And the number of companies involved in the manufacturing and sales of these devices will continue to grow.
The industry, however, has been in flux lately…
We’ve seen electronic equipment orders and production fluctuate wildly with the changing economy. In addition, natural disasters over the past few years have severely impacted production of electronics in places like Thailand and Japan.
Take a look at the chart below to see for yourself…
As you can clearly see, electronics markets bounced back in 2010 from the 2008-2009 recession. But unfortunately, Japan saw a fairly large drop in production due to the tsunami/earthquakes in 2011.
Fortunately, production and orders of electronics are once again on the rise. And with GDP growth set to expand into 2013 and beyond, we could see this industry grow at even greater multiples.
One segment of the electronics industry that will benefit from this growth is the electronics manufacturing services (EMS) business. These types of companies fulfill any portion of larger technology companies needs, from single components, all the way up to complete manufacturing.
EMS companies are in excellent position as they can benefit from more than just one type of product. If smartphone component revenue falls off, then the industrial or medical technology revenues could pick up… and so on and so forth.
It’s these types of companies we want to own as the electronics industry expands.
One company that’s in perfect position is SMTC (NASDAQ: SMTX).
Name: SMTC Ticker Symbol: SMTX Market Cap: $47.1 million Recent Price: $2.92 PSB Rating System 4.8 Stars Raging Revenue: (5.0 stars) SMTC is putting up double digit revenue growth in the neighborhood of 29%. Opportunities are endless for a company in this industry to keep that level of growth up. Beautiful Books: (4.5 stars) The debt to equity ratio of 0.91 isn’t ideal for a company, but is the norm for a high growth company like SMTC. In addition, cash flow from operations far exceeds interest payments on debt. Stellar Structure: (4.6 stars) Just 1.5% of shares are held by insiders. However, over 30.3% of this stock is held by institutions. It’s obvious the big players know a steal when they see it. Valuation Verification: (5.0 stars) Undervalued by virtually every industry comparison, SMTC has the potential to clear return over 450% if it trades in line with the industry average valuations. Meaningful Milestones: (4.8 stars) SMTC just bought out their Chinese joint venture partner, Alco Electronics, to expand their manufacturing capacity in China. This gives SMTC even more ability to grow their top line. |
THE ELECTRONICS MANUFACTURING BUSINESS
SMTC is a global Electronics Manufacturing Services (EMS) provider, delivering contract manufacturing services to both mid-tier original equipment manufacturers (“OEM’s”) and emerging technology companies. The company works within the industrial, medical, computing, and communications markets.
SMTC is based in Canada and has been a publicly traded company since 2000. They have global operations in Canada, USA, Mexico, and China.
As we covered earlier, SMTC has grown as a number of OEM and tech startups have found significant cost savings and improved cash flow by outsourcing their production. That makes it a win-win for EMS companies like SMTC.
What’s truly exciting is the projections are for the EMS industry to grow from an estimated $120 billion in 2012, to nearly $126.9 billion in 2013. If that isn’t impressive enough, SMTC found EMS companies have just a 9% penetration of the total available market in electronics manufacturing.
That gives companies like SMTC huge growth opportunities…
With a global footprint and supply chain management, SMTC can meet their client’s needs by providing a number of services including:
- Design and Engineering
- PCB Assembly & Testing
- Fabrication and System Integration
- Global Supply Chain and Fulfillment Services
Basically, SMTC does any portion of your manufacturing of electronics chips and boards, all the way up to full production of your product, and even handles post production needs such as warranty repairs.
Now, let’s examine the company’s financials…
THE NUMBERS
Revenue for the first quarter of 2012 came in at $72.5 million. That’s an improvement of nearly 29% over the same quarter in 2011. This also was the highest quarterly revenue generated by the company since 2006, and the first time sequential quarterly revenue exceeded $70 million since 2003.
Clearly, SMTC is growing the top line nicely…
What’s important to investors is the bottom line, and SMTC blew away net income growth as well. For the first quarter of 2012, the company recorded $2.4 million in net income. Compare that to the prior year’s $700,000 Q1 revenue, and we’re seeing earnings growth of over 225%!
While the company is performing exceptionally well, their balance sheet is stable for a high growth player…
Currently, SMTX has $2 million in cash. However, their net working capital increased by $12.9 million mainly due to increases in accounts receivable and inventory, along with a drop in accounts payable.
Even though SMTC carries a debt to equity ratio of 0.91, the cash generated from operations is more than 6.7x greater than their interest payments. This is common for companies in high growth industries, and not a significant concern. The bottom line is, SMTX is moving their balance sheet in the right direction.
Moving on, let’s take a look at some risks…
INVESTMENT RISKS
While SMTC operates in a diversified industry, the loss of any major clients could significantly impact revenues.
Another risk is changes in economic conditions. If the economy turns for the worse in coming months and years, SMTC is at risk of seeing business decline.
Lastly, regulatory changes in any of the countries in which SMTC operates could impact profitability. Added environmental requirements fall into this category as well.
POTENTIAL RETURNS OF 450% OR MORE
Right now, shares of SMTC are massively mispriced by the market. That’s where we can turn a huge profit.
For starters, SMTC is trading for just 4.3x future earnings. The industry average P/E is up at 19.5x. If shares trade up to the industry P/E, we could see SMTC climb by a whopping 450%. That would put SMTC up near $13.25 a share!
While the P/E ratio is just one valuation metric, their price to sales ratio is also extremely low compared to the industry… 0.20x versus the industry average 3.2x.
Between the double digit revenue growth, triple digit earnings growth, and undervaluation by the market, we see shares trading north of $10… and should be valued closer to $13.25.
Now’s the time to pick up shares of SMTC for gains of 450% or more!
ACTION RECOMMENDATION
BUY SMTC (NASDAQ: SMTX) up to $3.30 per share.
Recent price is $2.92.
Use a stop-loss of $2.00 on this position.
Don’t forget your position sizing and stop-loss rules.
The major equity markets have been quite rocky as of late. Volatility has crept up and the the inaction by central banks has caused recent gains to evaporate. In regards to our portfolio, we’ve seen the majority of stocks pull back slightly.
Two exceptions to this are Jinko Solar (JKS) and Metalico (MEA).
It appears that both of these stocks are under short attack at the moment. And while we should sell these stocks based on their price action, there’s simply no fundamental reason for them to be trading at such a loss.
The good news is we’ll see earnings out from both companies this month. So we’re going to continue holding until we see the financial results of operations from both firms.
There’s nothing like great earnings to create a massive short covering, and get the share price back in the black. For now, let’s continue hanging on to all the stocks in our portfolio.
Category: PSB Monthly Issues
