PSB Monthly Issue January 2014

We’re going to kick the year off with an opportunity in an industry set for a big 2014. You see, as well as stocks did overall in 2013, not every industry participated.

In fact, agriculture companies actually struggled somewhat.  For example, Deere (DE) was only up 8% for the year (compared to roughly 30% for the overall market). Meanwhile, Caterpillar (CAT) eked out just under 3% gains for the year.

Basically, grains prices came crashing down in 2013 and took their toll on major agricultural equipment companies.

But here’s the thing…

First off, grains prices are set to rebound in 2014 after declining significantly last year. More importantly, investors in companies like DE and CAT are investing in more than just agricultural equipment.

That’s because those companies are just so big.  The fact is, there aren’t many small-cap agricultural equipment companies out there.

And that’s precisely why we like Art’s Way Manufacturing (NASDAQ: ARTW) so much.

THE AGRICULTURAL EQUIPMENT BUSINESS

ARTW is a manufacturer and marketer of specialized agricultural equipment.  The company produces a range of products used by farmers for feed processing, forage blending, land management, and harvesting. The company is also engaged in two other businesses, specialized modular buildings and pressurized vessels.

Agricultural equipment typically makes up 70% or more of the company’s revenues. Most of the products sold my ARTW are niche products and have very few competitors.

Products include animal feed processing equipment, grain drill equipment, hay and forage equipment, stalk shredders, portable grain augers, manure spreaders, grinders, sugar beet harvesters, potato harvesters, land maintenance equipment, reels for combines, silage blowers, and after-market service parts.

As you can see, ARTW has a very diverse set of agricultural equipment, much of it very specialized.  That means the company doesn’t have to rely on any single product or customer for revenue.  And, several products don’t have much in the way of competition.

More importantly, management realized a long time ago that the company wasn’t going to grow by relying on a handful of niche products.  So, over the years, the company has aggressively made small acquisitions of niche product companies in the agricultural industry.

For instance, this year ARTW acquired Ohio Metal Working Products Company for just over $3 million.  The purchased business is the largest domestic manufacturer of standard single point brazed carbide tipped tools.

Additionally, earlier in the year, the company purchased Agro Trend, a division of Rojac Industries out of Canada.  This strategic purchase will increase distribution of ARTW products in Canada, and also adds more exposure to cold weather agricultural equipment, such as snow blowers.

Finally, ARTW isn’t just about diversity in the agricultural equipment space.  The company also has a modular buildings unit, Art’s Way Scientific and a steel tanks and pressure vessels unit, Art’s Way Vessels.

Modular buildings are used for research facilities and laboratories, as well as animal housing, and provide 20% to 30% of the company’s revenues in a typical year.  Steel vessels are used by numerous businesses such as water treatment and refineries and make up about 5% of revenues.

While these divisions aren’t the primary sources of revenue for the company, they can at times provide substantial sales opportunities.  Plus, they lower risk by creating product diversity and add to shareholder value.

THE NUMBERS

While ARTW’s financials haven’t been stellar in 2013, the company remains a model of consistency.  Plus, extenuating circumstances are most of the reasons 2013 numbers don’t look as good as 2012’s.

First off, through the first nine months of 2013, revenues came in at $27 million, a small decline from $29.5 million in the first nine months of 2012.  However, 2012’s numbers were higher than normal due to a large Art’s Way Scientific order (modular buildings) completed during the year.

While modular buildings can result in big projects for ARTW, the timing of the sales is inconsistent and the projects can last for long periods of time. 2013 wasn’t a big year for the company in regard to modular buildings and it’s reflected in the numbers.  That could easily change in 2014.

Net income for the nine months also decreased from $2.1 million to $1.4 million, due once again to a much smaller contribution from Art’s Way Scientific. More importantly, ARTW has been extremely consistent at turning a profit, posting 10 consecutive quarters of positive net income.

From a balance sheet perspective, ARTW is in reasonable shape. The company has $1.4 million in cash compared to $7.8 million in debt.  Current assets are a healthy 4.3x current liabilities.  In other words, there’s nothing to worry about and nothing to keep the company from continuing to make small, strategic acquisitions.

Finally, ARTW does typically pay a cash dividend once a year in November.  The amount of the dividend has been $0.10 per share the last couple years.  While it’s not a large dividend by any means, it’s still an additional perk for shareholders and another sign of the company’s consistency.

INVESTMENT RISKS

As with any investment, ARTW does have a few risks.

A continued decline in the price of grains could reduce demand for agricultural equipment and impact revenue growth.

An unexpected slowdown in the economy could reduce overall demand for durable goods and slow the company’s revenue growth.

Finally, changes in interest rates could make the company’s debt holdings more expensive in the future and increase debt servicing costs.

POTENTIAL RETURN OF 98% OR MORE

Regarding the major price ratios, ARTW is trading at just 12.8x earnings and 0.7x sales.  In comparison, the industry trades at over 17x earnings and 1.1x sales.  As such, the company is clearly undervalued.

In fact, for a micro-cap company that’s generated positive income for 10 straight quarters – and offered a dividend each year – we believe ARTW is a steal.  A return to 2011 highs of $12 per share is a realistic goal for the stock, especially considering the consistent, shrewd acquisitions made by the management team.

Based on our analysis, we see ARTW climbing to $12.00 a share or more.  Buy the shares now for potential gains of 98% or higher!

ACTION RECOMMENDATION

BUY Art’s Way Manufacturing (NASDAQ: ARTW) up to $6.70 per share.

Don’t forget your position sizing and stop-loss rules.