Wednesday, March 17, 2010

Profits On The Horizon

Nu Horizons (NUHC) is a distributor of hi-tech electronic components. The stock dropped 25% in one day last week when a key supplier, Xilinx, cut Nu Horizons as a distributor in order to streamline Xilinx's distribution network. Xilinx's products accounted for over 30% of Nu Horizons' sales over the last three quarters, so this will have a material impact on Nu Horizons' operations and will hurt Nu Horizons' revenue if the Xilinx's products cannot be quickly replaced. However, the current market price of Nu Horizons is such that this seemingly negative announcement may actually be good news for the stock!

Before writing off the preceding statement as preposterous, consider the following: Nu Horizons trades for just over $60 million, while its net current asset value is over $100 million. Most of its current assets (approximately $225 million worth) are in the form of inventory and receivables, and so this negative announcement may actually be a catalyst for cash generation.

The company's Xilinx inventory is more than $40 million, so as the company either works through it or returns it (with expenses paid for by Xilinx), cash will be generated. If Nu Horizons' sales are reduced because it cannot replace Xilinx's products, further cash will be generated thanks to a reduction in the accounts receivable. Of course, if replacement products cannot be found, the severed relationship between Nu Horizons and Xilinx will reduce Nu Horizons' earnings. But when one is buying assets for a fraction of their worth, it's never a bad thing when those assets are converted to cash.

On the other hand, if the company can replace the Xilinx products quickly and easily, there will be little in the way of cash generation, but revenues and future earnings may also not change materially. In this case, the company will be able to continue to try and grow its profitability, and shareholders buying at this price are still minimizing downside risks, thanks to the discount the company trades at relative to its liquid assets.

Nu Horizons has not exactly been generating excellent returns for shareholders over the last few years; a shrinking of the business (and the cash that is generated along with that) is not necessarily a negative! As solely a distribution business, Nu Horizons should be able to adjust its cost structure to a level commensurate with lower revenues, if need be.

Disclosure: Author has a long position in shares of NUHC


Mike said...

Hey Saj,
Great post, love the site. Just a comment about NUHC. I'm not sure there is a good replacement for Xilinx. Altera is the next biggest player in the market and they sell direct. Actel uses a competitor to NUHC and everyone else is really small. I guess it just seems unlikely to me that this hole in their product mix actually gets filled. So assuming for a minute that they do shrink, I always get nervous when companies come into money from shrinking because cash can very easily be squandered on a poor acquisition when it should rightfully be returned to share holders. Interested in your thoughts.

Saj Karsan said...

Hi Mike,

I agree that what they decide to do with the money is rather important. The good news is that at least this is a catalyst that generates cash (if they do indeed shrink), but yeah we'll have to monitor the situation to see what their plans will be, and that could determine whether it makes sense to be an owner.

segemran said...

Saj, what do you think of the company increase in receivables, meanwhile sales are down? that is not a good sign, although the company doesnt have a history of not collecting his receivables.

and how do you think the impact of the Xilinx problem in this issue will be? besides de potential 40 mill cash generation from the Xilinx inventory.

Saj Karsan said...

Hi Emiliano,

It doesn't appear alarming here yet. Sequentially, sales were up last quarter and A/R did not rise as fast. Also, timings of deliveries can also result in A/R changes that look abnormal, but are ok. I agree that it's something to keep an eye on, however.

It's tough to know how this supplier loss will affect the rest of the business. There is a lot of uncertainty surrounding this business, but that's probably why the stock trades at such a large discount to its assets!

Paul said...

How do you feel about managment selling out a large stake on April 29th? Arthur Nadata sold nearly 30%of his holdings from what I can tell. Thanks!

Saj Karsan said...

Hi Paul,

I think his sales were all part of the plan detailed the day before as part of his departure as CEO. You can read about it here.

Anonymous said...

Congratulations Saj! Arrow electronics buying NUCH for $7.00 a share.

Anonymous said...

Candidate for a value in action!

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