PSB Monthly Issue July 2012
July 2012
Everyone following the economy knows how weak the housing and real estate markets have been.
Thankfully in 2011 the overall economic picture brightened, and in the process, a bottom may have been put in on real estate.
There are a number of simple reasons why…
As employment improved throughout the year, demand for durable goods and consumer spending increased.
This trend continued into the first quarter of 2012 with consumer spending rising 2.9%, and unemployment dropping to just 8.1%.
As a result of the pickup in economic activity, the demand for housing and commercial real estate has started to rise.
The problem is construction companies and home builders were forced to slow down new construction during the economic downturn. The market collapsed underneath them, giving them no reason to build out more inventories.
It’s this lack of new construction that has led to a surge in demand for existing space, particularly in commercial space and apartment rentals.
According to the Research Division of the National Association of Realtors, vacancy rates are already falling and the trend is forecast to continue into 2013…
For example, national office vacancy rates in 2011 were 16.6%. Just this past quarter, the rate was down to 16.3%, while the rate is forecast to drop to 15.8% by 2013.
When looking at retail vacancy rates, 2011 was at 12.5%. Just this past quarter, that rate dropped to 11.3%. And by the end of next year, the call is for retail vacancy rates to be down near 10.7%.
While commercial vacancy rates are dropping nicely, it’s the multi-family vacancy ratesthat are really impressive…
You see, the vacancy rate in 2011 for multi-family dwellings was 5.2%. In this past quarter, the rate fell to 4.5%. And by 2013, the forecast vacancy rate for rental units is just 4.3%.
What’s really interesting is these rates account for growth and addition of new units!
It’s pretty clear commercial and multi-family demand will be on the rise for some time.And as demand continues, property owners will need to invest in the restoration, replacement, and maintenance of mechanical systems inside their buildings.
Better still, this demand will cause new buildings to be constructed, and they’ll require entirely new mechanical systems.
That’s where our pick comes in… introducing KSW (NASDAQ: KSW).
Name: KSW Ticker Symbol: KSW Market Cap: $25.8 million Recent Price: $3.85 PSB Rating System 5.0 Stars Raging Revenue: (5.0 stars) Revenues are up by 29.7% from last year at this time, and higher by 12.2% from the last quarter of 2011. Given the projects under management and the recovery of the sector, we should see even bigger revenue in the future. Beautiful Books: (5.0 stars) With a debt to equity ratio of just 0.04, KSW will have no problems running their business. In addition, the company has a massive $2.72 of cash per share on the books. Stellar Structure: (5.0 stars) Insiders own a solid 20.3% stake in the company. In addition, institutions own 17.7%. Clearly, company insiders know they have a good thing here. Valuation Verification: (5.0 stars) Trading at a massive discount to the industry, KSW’s 7.8x P/E provides us with a great buying opportunity. Once the market catches on, this stock is going to skyrocket. Meaningful Milestones: (5.0 stars) KSW just locked up another two projects worth $26 million. No surprise it’s in the high end luxury rental and hotel sector. |
THE GENERAL CONTRACTOR BUSINESS
KSW is a small to mid-sized general contractor operating in the greater New York City area.
KSW sells and installs heating, ventilating and air conditioning (“HVAC”) systems, and process piping systems. Their focus is on institutional, industrial, commercial, high-rise residential, and public works projects.
The company is successful in obtaining projects from private owners and construction companies by utilizing their value engineering and trade management skills. Many of their projects are from repeat customers.
Customers call in KSW to participate in the project while it is still in the design phase, or to assist in bringing a project’s budget in line with the customer’s requirements.
At any given time, KSW has an array of projects underway. These projects fall into the following categories:
- Hospitals
- Hotels
- Apartment Houses/Condos
- Commercial Office Buildings
- Transportation
- Specialty Buildings
- Education
- Courthouses
As you can see, KSW has the ability to work in a wide range of sectors. A few of their current projects include the National September 11 Memorial and Museum, Mt. Sinai Center for Science & Medicine, and the Metro-North GCT Steam Service Repair.
Now that you know what KSW does, let’s take look at the company’s financials.
THE NUMBERS
KSW is growing at an explosive rate…
Revenue in the first quarter of 2012 reached $21.4 million… an increase of nearly 30% from 2011’s $16.5 million for the same quarter. Better still, operating income grew by 138% from $420,000 to $1.1 million over the same time frame!
For a “behind the scenes” type company, that’s pretty impressive growth.
What’s more, KSW’s earnings per share reached $0.11 this past quarter. That’s up from $0.05 in March 2011… a true double in just a year’s time!
In addition to both earnings and revenue growth, the company’s balance sheet is quite healthy.
KSW currently has $14.4 million in cash on hand, and total assets of nearly $47 million. As of March 2012, total liabilities are just $23.5 million… less than half their assets. With a debt to equity ratio of just .04, this company clearly has no major debt concerns.
As an added bonus to their strong balance sheet, management declared a dividend of $0.20 in May. That represents a 5% yield on this penny stock. It’s a great way to return investors some of the $2.72 in cash per share KSW keeps on hand.
INVESTMENT RISKS
As with any investment, KSW does have a few risks.
During any major project, the company can run into unforeseen expenses or problems which can reduce profitability.
Also, there remains the risk of another contraction in the real estate/housing market. This could cause spending on new projects and existing renovations to slow, thereby shrinking the rate of sales growth at KSW.
Finally, any increase in competition for major projects in the New York City area could impact the company.
POTENTIAL RETURN OF 175% OR MORE
KSW is trading at a major discount. For starters, their price to earnings ratio is just 7.8x. That means you can buy KSW for less than 8 times future earnings. If the stock traded up to the industry average P/E of 21.4x, we could see shares of KSW over $6.75!
What’s more, KSW has a price to book ratio of just 1.1x… just 10% more than what the company would be worth if sold off in pieces.
We think KSW deserves a valuation more in-line with the industry. In addition, KSW is throwing off a sweet 5% dividend, their cash on hand is massive, and the company brings in annual revenue of nearly 3x their market cap of $25.8 million.
Based on our analysis, we see the stock trading up to at least $6.75. Grab your shares of KSW now for potential gains of 175% or more!
ACTION RECOMMENDATION
BUY KSW (NASDAQ: KSW) up to $4.10 per share.
Recent price is $3.85.
Use a stop-loss of $2.75 on this position.
Don’t forget your position sizing and stop-loss rules.
The financial industry has been in a massive downtrend since mid-2007. While we’ve seen the sector recover from the lows in 2009, there’s still a lot of room to move higher from these levels.
To get a bird’s eye view of the sector, let’s look at the 9-year chart of the Financials SPDR ETF (XLF)…
As the chart shows, financials have recovered quite nicely. In fact, since 2009, the industry-wide ETF has put in a solid base ranging from $12.50 to $16.00.
But this sector is clearly lagging the overall stock market…
As a comparison, let’s look at the XLF’s performance against the S&P 500 index over the same time frame.
In this light, the financial sector is still down roughly 5%, while the S&P 500 has climbed nearly 27.5%! This shouldn’t be the case, as many of the concerns over the financial meltdown (MBS, CDS scandals) have come to pass. As JP Morgan Chase’s CEO, Jamie Dimon, just told Congress, “All American banks are better capitalized.”
So why are we seeing a continued struggle for financials?
Simply put, it’s Europe.
Unless you’ve been living under a stone, you’re familiar with the European sovereign debt crisis that’s been dragging out for years now. And US banks and financial centers have been questioned over concerns they may be holding too much European sovereign debt.
In the process, bank stocks have remained suppressed… even with improving profitability.
The good news is, matters in Europe are finally starting to improve. Last week, EU leaders took a bold step and announced they’re going to allow EuroZone banks to borrow directly instead of having their countries apply for funds.
This will circumvent the mandate that countries meet certain budgetary constraints prior to borrowing more money. It’s what’s been causing interest rates on debt to rise out of control… most notably in Spain and Italy as of late.
This is just one step in the right direction, but it constitutes a major shift from recent negotiations amongst EU leaders. As we continue to see matters resolve, concern over sovereign debt default will fade away.
As a result, the last major weight on financial stocks should now be lifted, and in the process, banks stocks are set to break higher from current levels.
To participate in the upcoming financial sector rally, we’re going to position ourselves in a strong regional bank… AmeriServ Financial (NASDAQ: ASRV).
Name: AmeriServ Financial Ticker Symbol: ASRV Market Cap: $52.4 million Recent Price: $2.75 PSB Rating System 4.8 Stars Raging Revenue: (4.6 stars) While just up by 6%, ASRV’s revenue growth is in line with the industry averages, and a move in the right direction. Beautiful Books: (4.9 stars) $26 million in cash looks just fine with a debt to equity ratio of only 0.13. Remember, AmeriServ has more assets than liabilities, exactly what we want to see with a strong bank. Stellar Structure: (5.0 stars) Over 44.8% of this stock is held by institutions. In addition, insiders account for 6.7% ownership. It’s obvious the big players know a steal when they see one. Valuation Verification: (4.8 stars) ASRV is trading at a sizable discount. With a P/E of just 10.3 and a pending recovery in the financial sector, we see shares of this company trading up nearly 70%. Meaningful Milestones: (4.8 stars) AmeriServ has opened three new Loan Production Offices. These are located in Altoona and Harrisburg, PA, and Hagerstown, MD. These new offices will add to the growing loan totals in addition to increasing the geographical diversity of the overall portfolio. |
THE REGIONAL BANKING BUSINESS
AmeriServ Financial is a bank holding company that owns a number of entities. These include:
- AmeriServ Financial Bank (the Bank)
- AmeriServ Trust and Financial Services Company (the Trust Company)
- AmeriServ Life Insurance Company (AmeriServ Life)
ASRV Financial Bank currently has 18 locations and 347 employees. The Pennsylvania-based bank operates in Allegheny, Cambria, Centre, Somerset, and Westmoreland counties. This entity runs the company’s general banking business.
AmeriServ Life is a captive insurance company. This insurance arm engages in underwriting as reinsurer of credit, life, and disability insurance within AmeriServ’s market area.
There are three main reasons to buy AmeriServ Financial now.
First off, ASRV doesn’t have exposure to European debt. The company is a smaller regional bank… not a big money center bank such as Bank of America (BAC).
When buying shares of ASRV, we’re purchasing a micro cap bank that can participate in the upside of the financial sector, without the associated risks of owning a larger institution.
As we discussed earlier, recent decision by EU leaders bode well for the long term survival of member countries and their banks. And that will translate into a financial sector rally.
Second, AmeriServ recently announced an increase in the common stock repurchase program. The company upped the number of shares they can buy back to 1,007,000. That represents 5% of the outstanding shares.
As part of this expanded buyback program, the Company said it had also reached an agreement to repurchase a large block of 1,045,000 shares of its common stock at $2.47 per share.
Finally, even in the face of a weak national economy, ASRV increased their outstanding loans last quarter… marking four straight quarterly of gains. What’s more, deposit totals closed the first quarter of 2012 at the second highest level ever recorded by the company.
With a strong macro theme in place, a strengthening balance sheet, and excellent internal growth, AmeriServ looks well position to rally from here.
Now, let’s examine the company’s financials…
THE NUMBERS
Revenue for the first quarter of 2012 came in at $13.8 million. That’s an improvement of nearly 6% over the same quarter in 2011. While that kind of revenue growth may not appear eye popping, it is in line with the industry… and an improvement for ASRV.
What’s important to investors is the bottom line, and that’s where AmeriServ is really excelling. Net income for the first quarter this year rose to $1.57 million or $0.06 per share. That’s a gain of $38% over the same quarter in 2011.
While the company’s performance looks great, their balance sheet is even better…
Currently, AmeriServ is holding $26 million in cash. That equates to roughly $0.96 in cash per share. In addition, the company has over $967 million in total assets, and just $855 million in liabilities. Overall, ASRV a debt to equity ratio of just 0.13.
Clearly, AmeriServ has a very strong balance sheet. And with the stock buyback program rolled out by management, total outstanding shares have fallen from 21.2 million in March of last year to just 19.4 million now.
Moving on, let’s take a look at some risks…
INVESTMENT RISKS
While AmeriServ has improved loan quality and reduced troubled debt, any significant deterioration in the US economy could lead to loan losses. Obviously, this would impact the bottom line.
Another risk comes from local competition. Banking is a very competitive industry, so ASRV needs to focus on retaining clients and continue attracting new customers.
Lastly, matters in Europe could revert and deteriorate. This could drag the overall market lower and banking stocks in particular.
POTENTIAL RETURNS OF 70% OR MORE
Right now, shares of ASRV are mispriced by the market. That’s where we’ll take advantage and turn a sweet profit.
For starters, ASRV is trading for just 10.3x current earnings. The industry average P/E is up near 14.3x. If AmeriServ trades up to the industry P/E, we could see shares trade up over 38%. That would put ASRV up over $3.80 a share.
And remember, the entire financial sector is lagging the S&P 500 by more than 32%. If matters in Europe continue to clear, financial stocks, including ASRV, should trade back in line with the rest of the S&P.
Our analysis shows investors could see ASRV climb over $4.65! Now’s the time to pick up share of AmeriServ Financial and look for gains of 70% or more!
ACTION RECOMMENDATION
BUY AmeriServ Financial (NASDAQ: ASRV) up to $3.00 per share.
Recent price is $2.75.
Use a stop-loss of $2.00 on this position.
Don’t forget your position sizing and stop-loss rules.
In June, many of our positions recovered most of May’s losses. While a handful of positions remain lagging the market, we’re going to hang onto all our positions for now. In fact, a couple of our stocks have traded up and over their buy up to price.
Those stocks are listed below…
- Move Aceto (NASDAQ: ACET) from Buy to Hold.
- Move Sun Healthcare Group (NASDAQ: SUNH) from Buy to Hold.
Category: PSB Monthly Issues
