Tuesday, September 7, 2010

Contraction Expansion

SIFCO (SIF) engages in various metalwork processes primarily for the aerospace industry. The stock is down almost 40% from the market's peak in April, and therefore looks cheap across a few value metrics. Even when a company's numbers look good however, investors must dig under the surface to uncover any risks that may be present. SIFCO does have some business risks that could give investors pause.

SIFCO trades for just $54 million despite having a net cash position of $25 million and 2009 net income of $8 million, making it seem incredibly cheap. Of course, 2010 income will be lower than it was last year, as the company has worked through much of its backlog and revenue continues to out-pace new orders.

But while the company now operates well under capacity, it appears to be undertaking an expansion strategy! When capacity utilization is low, one expects companies to allow capacities to fall or actively shrink capacity to reduce fixed costs. But in this case, the company will spend approximately $6 million this year on capital expenditures to expand its ACM group (for a description of the company's industry and segments, see this article), versus 2009 company-wide depreciation of under $2 million. Revenues are down in the ACM group, and operating income is about half of what it was last year, suggesting the expansion is ill-timed. However, due to the company's large cash reserves, it can afford to think long-term; perhaps management is seizing some sort of opportunity, but that is not clear.

A risk that we have previously discussed on this site is customer concentration. Technically, SIFCO's customer concentration is not that bad, with about two customers each representing about 15% of revenues. However, almost 40% of the company's revenue is due to military wartime demand, even if there are various companies in-between SIFCO and the military. It's never likely that a "peace scare" will be upon us anytime soon, however, the risk to this company is rather high under such a scenario.

Finally, it's worth noting that while the company has no debt "officially", its "other liabilities" do contain $5 million worth of pension shortfalls on its defined-benefit plan. This is essentially borrowed money which shareholders will have to cover (barring an incredible surge in the pension asset portfolio).

SIFCO appears to have a lot going for it, from a price vs value point of view. However, the company's expansion strategy when demand for its services are low, along with its heavy reliance on military projects increases its risk for value investors.

Disclosure: None

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