Saturday, July 12, 2008

Value In Action: Hammond Power Solutions

Recently, a Globe and Mail article extolled the virtues of Hammond Power Solutions (TSE: HPS). The stock has a market cap of only $140 million, but caught The Globe's eye since the stock is up 12 times over since 2004. In April of 2008, Cormark Securities initiated coverage of this company, giving it a buy recommendation, and sending the stock price soaring over 10% that day on high volume.

But the stock went from $1 to $12 in the last four years, and the buy recommendation comes now? While the stock might still be a buy, it would seem most of the value in this stock has already been realized, since the stock has appreciated far more than have the earnings. But could someone really have seen this price appreciation coming? Maybe not all of it, but if we look at Hammond as it stood in 2004, we see evidence of an obscure stock trading at a large discount to its intrinsic value, which is something we don't see now!

On Dec 31st, 2004, HPS had a market cap under $13 million, yet it had a book value of $19 million. This alone doesn't tell you much, as the company could have a large amount of assets tied up in equipment which has a fair value far lower than book value, and/or could have large amounts of debt threatening its solvency.

But a closer look at the assets in 2004 reveals that the company's accounts receivable and inventory are enough to cover all of its liabilities. In addition, the company has capital assets of $11 million, a large part of which include land and buildings that the company has been carrying at book value for several years. Furthermore, the company has additional investments in stocks, loans and real estate which are not required for operations (one of which they sold for a gain in 2008).

In 2004, HPS traded at a P/E of less than 10. While it has a similar P/E today, you can no longer buy its assets at a discount. In fact, you would be paying almost 3 times book value if you bought the stock today. Does this mean you would be overpaying? Not necessarily, as the company may have relationships with customers, suppliers, technical know-how and real-estate that is understated by its book value. However, there is little in the way of a margin of safety at today's price. We prefer to buy companies when they are trading at clear discounts to their intrinsic values, like this company was in 2004.

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