Monday, February 14, 2011

The Safer and Cheaper ADDvantage

While most stocks are rising in this heated market, there are still a few names that investors are kicking to the curb in favour of the hot numbers. Following the company's earnings release last week, shares of ADDvantage fell 10%+, offering investors an entry point for the stock at a fairly cheap price.

The last time ADDvantage Technologies was discussed on this site, the stock was significantly more expensive, and its business risk was significantly higher. In just a few short months, however, both of these issues have been corrected!

First, the company's stock price has fallen 25% from its December high. The company now trades for just $27 million, despite operating income of $34 million (including $7+ million in fiscal 2010) over the last four years. This company is a steady earner, as operating margin has only fallen below 15% once in the last 8 years. (In 2009, operating margin fell to a still healthy 13.7%.) Considering the strong and steady earnings, the company is also conservatively capitalized, with cash of $10 million against debt of $13 million. (There is a $1 million penalty for prepayment of debt, which is why the company is maintaining both a high cash and debt balance.)

But in the months leading up to December, the worry for value investors about ADDvantage was the upcoming expiry of its contract with Cisco, which supplies 35% of the products ADDvantage sells. But late last year, ADDvantage and Cisco finalized a new agreement whereby ADDvantage is now allowed to sell more Cisco products than it was previously!

As a result of price appreciation last year, ADDvantage is a stock that already currently appears on the Value In Action page, following a stint on the Stock Ideas page. But as a result of its recent price drop, along with the reduction in risk associated with the new Cisco agreement, it returns to the Stock Ideas page anew, as the stock once again appears to trade at a discount to the company's earnings potential.

Disclosure: Author has a long position in shares of AEY and CSCO

11 comments:

Water Investor said...

How comfortable are you that the Cisco reliance won't come back to haunt shareholders? yes, they can sell more Cisco products but could Cisco simply stop ordering if they found a better product?

Saj Karsan said...

Hi Water,

It certainly could, but Cisco is the supplier here, not the customer. So if a better product comes along, it is AEY that could distribute it.

roel said...

Barel,

First off, I really find your thoughts on investing insightful and want to thank you for your time and efforts.

I've started doing some research on AEY.

On their yearly 10Ks, they have a summary of their properties. The Tulsat Broken Arrow, OK properties are a combination of purchased facilities, constructed facilities and leased facilities.

The leased facility is a 56,000sf warehouse which is leased from an entity that is controlled by David Chymiak, Chairman of the board, and Kenneth Chymiak, his brother and president of the board. (The lease expired on Sept 08 and is now on a month to month basis.

This seems to me a potential alarm that the interests of the owners/chairman/president may not be aligned with that of shareholders. In your opinion, should this be a major/minor cause of concern in evaluating the company/stock?

(please see pg 9 of yearly 10K)

Saj Karsan said...

Thanks, Roel!

Yeah this kind of related-party transaction is more common than I'd like in small-caps, and it is a conflict of interest. But it's useful to compare the cost of rent (about 100K/year) with the family's ownership of the company, which is worth many millions. As such, their interests should be mostly aligned with those of shareholders because of their large ownership interest relative to the lease sizes.

niki said...

Good analysis Saj.

I have a question:

It appears that the company switched to some month to month leases recently as against longer term leases; Would that be an indication of any future closures ? and would that indicate any softening in demand ?

jvelasco said...

From their quarter results:

Net refurbished sales decreased $2.4 million, or 47%, to $2.7 million for the six months ended March 31, 2011 from $5.1 million for the same period last year. The decrease in refurbished equipment sales was primarily due to a decrease in sales of digital converter boxes of $1.5 million and the factors discussed above. The decrease in sales of digital converter boxes is primarily due to lower demand in the market and market price erosion.

But on the other hand:

Cost of sales as a percent of revenue was 69% for both the six months ended March 31, 2011 and 2010.

Now I can not understand if they say that refurbished sales dropped almost by half due in big part to price erosion of their set top boxes then how is it possible that their margins are unaffected? If their set top boxes have now a much lower sales price (due to price erosion) but their inventory cost is the same then the profit margins should be smaller but the margin is exactly the same that does not make sense to me. Can someone explain?

Anonymous said...

Hello,

First off, nice find. Looks attractively valued assuming numbers are correct.

I have a few questions if you don't mind.

1) Can you talk about management's background and the board?

2) How big of a threat do you think MSO's buying direct from Cisco / Motorola is?

3) It's understood they must hold inventory, but why in such large quantities? Are they really selling equipment 5-plus years old?

4) Addressable market?

Thanks!

Konrad said...

jvelasco. I'm not sure where you get the price erosion from. Judging by management's comments, there was a decrise in sales, i.e. volume not price. As the cost of sales are variable in this context, I don't find it surprising that there was no impact on margins.

Anonymous, Your comment regarding the direct competition from CISCO and Motorola is valid. The fact is however that theese companies have coexisted for quite some time and seem to serve different market niches. I would also take comfort in the fact that AEY has distribution agreements with the big suppliers

Anonymous said...

Seems you've been off the mark by quite a bit.

In the meantime, you poo-poo'd EVI when it was $1.25 a year ago, it now trades at $1.67 and has since paid out 60 cents/share in dividends. So it effectively trades at $2.27 today - an 80% gainer from when you told value investors to take money off the table.

Any other great ideas you have?

Saj Karsan said...

Hi Anon,

I've been wrong many times. If you look a little further, you'll see I have an entire page dedicated to failures.

But it's worth noting that I didn't tell anyone what to do with their money. I simply said that following the 50% run-up, it may be prudent to sell EVI, which I had previous flagged as being undervalued when it was much cheaper. At the same time as I pointed out the gains, however, I did note that EVI may still be undervalued! Presumably, you thought that to be the case and made your own decision - congrats! Why you would come here offering vitriol thereafter is beyond me, however. While I log my thoughts here, readers are always encouraged to do their own thinking, as I do when read the ideas of others.

juan said...

Hey, Anon, the answer to the question you asked Saj is yes. He has had, and currently has, many other great ideas written up on his website, some of which I have borrowed from him and made quite a bit of money on.

Also, I don't think he's likely to be off the mark with AEY, on which I have quite a bit of money myself. He might have been early, but value investments can't be timed.

You don't seem to understand that last point, and so my advise to you is: read what Saj writes and try to learn.

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