Monday, October 4, 2010

Secular Or Cyclical?

When a company's current earnings are low or negative, and the near-term industry outlook is negative or uncertain, Mr. Market will generally pummel the stock. But when said company has the ability to outlast a downturn, this pummeling of the stock price can result in a great opportunity for the long-term oriented, value investor. One stock currently being beaten down due to its earnings situation and near-term outlook is Baldwin Technologies (BLD).

Baldwin produces equipment for the newsprint industry. The preceding statement implies a double whammy of explanations for why the company's current earnings are low to negative:

1) Companies cut back on capital equipment during recessions, hence Baldwin's revenues will have taken a hit as newspaper companies cut large-scale expenditures

2) As a maker of capital equipment, Baldwin likely has a number of fixed costs that cannot be easily reduced when revenues fall

However, cyclical stocks present opportunities as sentiment often becomes far too negative. After all, this is a company whose stock trades for just $19 million, but which earned exactly that amount (combined) in the three years prior to this recession! Furthermore, the company has the ability to outlast this recession (i.e. its debt levels are not onerous), which is of the utmost importance for cyclical companies.

However, this company is not without risks. For one thing, there is a third "whammy" not listed above: the newspaper industry is in secular decline. As such, some of the decline in revenue may not simply be cyclical dips that will eventually return, but rather a secular or permanent dip. Determining the terminal value of a company in secular decline is not easy, and adds to the investment's risk.

Furthermore, this company has a number of non-cancelable operating lease obligations it must make good on, further reducing its flexibility should the secular declines arrive with more ferocity than expected.

Trading at a large discount to its pre-recession earnings, Baldwin has the potential to be a value investment. However, investors should be sure to understand this company's risks before taking the plunge.

Disclosure: None


Greg Leman said...

Is it not possible that this company is having trouble because newspapers are a dieing breed? They have more problems than just the recession.

Anonymous said...

saj already outlined that concern.

Ankit Gupta said...

For what it's worth, I do believe there will be a floor on newspaper industry revenues. It's not going to 0 like some might lead you to believe, but it definitely won't be what it was years ago.

If there is more consolidation and competition decreases, it should be a pretty good industry.

Anonymous said...

Most of their revenue is from overseas. I don't think that the newspaper industry is shrinking in Japan or India.