Wednesday, March 3, 2010

Paving The Way To Success

In general, makers of capital equipment see highly cyclical demand from their customers, as the will/ability of companies to finance expensive purchases during recessions disappears. Further adding to the already-pressured earnings situation for companies that manufacture heavy-duty capital goods is the fact that a large component of their costs are fixed, at least in the short-term. But often, this combination of negative factors in the short-term can result in a beaten down stock price, where upside potential is strong and downside risk is low in the long-term.

As an example, consider Gencor (GENC), a manufacturer of heavy-duty equipment for the highway construction industry. As one might expect, Gencor's revenue has taken a hit, and the fixed-cost nature of its business has resulted in several consecutive quarterly losses. But while the company has lost under $3 million in the last five quarters combined, it holds cash of $65 million against no debt, and it trades for just $68 million.

In addition, the company has another $32 million in inventory and accounts receivable against total liabilities of just $10 million. Inventory on the balance sheet is understated due to the fact that the company uses LIFO as its inventory method. (For further discussion of this issue, see the post on L.S. Starrett.)

This situation is eerily similar to that of Hardinge a few short months ago. One major difference, however, is that the catalyst that ended up bringing up Hardinge's price is not possible here. Management controls the company without actually owning a majority of the company's shares, due to a dual-class share structure. This is not an ideal situation for shareholders, and one of the problems with this is that it effectively prevents any hostile takeover attempts. As such, it is entirely possible that the price of the stock won't move up until the economy picks up steam, which could be a while. But for value investors who simply focus on purchasing businesses at discounts to their intrinsic values, Gencor appears to be an attractive candidate.

Disclosure: Author has a long position in shares of Gencor


Beri said...

watch out, cash flows have been boosted by distributions from stakes in investees being liquidated, the underlying business' cashflow profile has been pathetic at best.

editor said...

I have concerns with Gencor as well. It's not too interesting if you normalize the earnings and exclude investee income. Obviously the investment portfolio holds a lot of value but I doubt management will distribute it any time soon. And with the share structure that's in place they don't have to.