PSB Monthly Issue May 2014

Sure, most investors understand pipelines are necessary for oil and gas to be distributed. But what about other industries? Don’t most goods and services require an underlying infrastructure to function?

By and large, the companies responsible for building and maintaining an industry’s infrastructure go underappreciated by the investment community.

For instance, most consumers appreciate their Internet connectivity or phone service. But what about the companies that allow that connectivity or service to occur (usually) uninterrupted?

In the case of Internet service, there would be far less connectivity across the world if not for Cisco Systems (CSCO). Of course, Cisco builds the network infrastructure solutions, such as switches and routers, to allow reliable Internet service to function.

That same function is necessary in the power distribution business.

We may use oil, gas, coal, solar, or whatever to generate power. And, you may pay your electrical company for that power. But who builds the equipment enabling performance and reliability in the energy industry?

One such company is American Electric Technologies (NASDAQ: AETI).

THE POWER DELIVERY BUSINESS

AETI is a leading provider of power delivery solutions to the traditional and renewable energy industries. The company’s products and services include custom power distribution equipment, power conversion equipment, power management products and service, and electrical construction.

Due to the diversity of AETI’s products, its customer base is also varied. The company serves traditional oil and gas companies (both off-shore and land-based), production operators, marine vessels, pipelines, and refineries. AETI also has clients in the power generation space including alternative energy markets.

What differentiates AETI from its competitors is its combination of optimized power systems and completeness of its solutions. Basically, the company has the expertise and intellectual property to provide a wide range of top-notch products as well as turn-key solutions.

Moreover, the company has several promising catalysts for growth potential.

First off, global energy demand is expected to grow by 42% in roughly the next 20 years. A big part of that demand could be met by the US shale oil and gas boom – which is an area AETI has a large presence in.

Despite the company’s large customer base in the oil and gas business, there’s still plenty of room for growth. After all, AETI is only reaching 20% of the oil and gas market. What’s more, as the company transitions to more custom products, it stands to increase margins and profits over time.

The company also has joint ventures in place in several key international markets. These include China, Southeast Asia, and Brazil.

THE NUMBERS

AETI’s competitive advantage can be readily seen in the company’s financials.

2013 full-year revenues were $65 million, up 21% from 2012. The company’s core technical product group led the top-line growth. Meanwhile, net income came in at $4.2 million for the year, an impressive 102% increase from the prior year.

Of the $4.2 million in net income, $2.5 million was from domestic operations. That represents a 480% year-over-year increase. Overall, the company’s gross profit percentage climbed from 15% to 18%.

Along with a strong income statement, the company’s balance sheet is also in good shape.

Cash holdings are just over $4 million, but the company has nearly $8 million of credit available. Debt is also minimal at just $500k. Current assets are also a healthy 2.4x current liabilities.

Basically, the company has the necessary cash to fund aggressive organic growth. Plus, management has the money to afford certain strategic acquisitions or mergers should the opportunities arise.

INVESTMENT RISKS

As with any small cap investment, AETI does have a few risks.

A slowdown in global economic growth could lower demand for equipment from international customers and hurt revenues.

An increase in domestic competition could result in a slowdown in revenue growth or a narrowing of margins.

Finally, new regulations in the power distribution industry could increase costs and lower margins in the industry in certain cases.

POTENTIAL RETURN OF 75% OR MORE

AETI has a significant competitive advantage in its industry and solid financials across the board. Nevertheless, investors have mostly ignored the company as an investment opportunity.

That’s good for us, because the shares are trading at just 12.8x projected earnings and 0.8x sales. By way of comparison, the industry trades on average at a much higher 23x earnings and 1.2x sales.

As such, we believe AETI shares will soar once investors realize what a great opportunity the stock provides. In fact, the share price could easily get back to the 52-week high of $11.21 set back in January.

Based on our analysis, we see AETI climbing to $11.25 a share or more. Buy the shares now for potential gains of 75% or higher!

ACTION RECOMMENDATION

BUY American Electric Technologies (NASDAQ: AETI) up to $7.00 per share.

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