Friday, February 3, 2012

Virco Manufacturing Gets Smoked

Virco Manufacturing's market cap has fallen from $50 million a few months ago to about $24 million today, giving it a P/B ratio of under 0.6. The company manufactures and distributes desks, tables, chairs and other furniture for the education sector. It is the largest such manufacturer for the preschool through grade 12 market in the US, and offers a range of services from installation to classroom design capabilities.

As state budgets have been hit hard since the recession, funding for schools has suffered. In turn, this has resulted in lower revenues for Virco, which has seen its sales decline steadily since 2008. Costs have not come down to the same extent as have revenues, as the company generated $12 million in operating income in 2008 but has lost $8 million in the last 12 months.

But that might be about to change. Following the busy summer season (which is when most sales to schools take place, in anticipation of the September start to the school year), Virco has taken action to cut costs in a serious way. Headcount is down 20% from the beginning of the year, as last quarter's results (a $3 million loss) include $4 million of expenses related to the job reductions.

As a result, the company may be in a position to post a profit in the next year, as long as revenues hold the line. To that end, the company's backlog for next year is up from last year at this time, though it is still early to draw any substantial conclusions. With a current price to sales ratio of just 0.15, however, it likely won't take much in the way of profits for current shareholders to benefit.

But an investment in Virco is far from easy money, as there are a number of risks. First, the company has a defined benefit plan that is underfunded by about $15 million. Second, 40% of the company's revenue is sold through a single contract (but to different customers). It doesn't expire until 2014, and the company believes that it can still sell to the same customers even without the contract, but there is a risk that it could lose some customers if the contract is not renewed.

But perhaps most important of all, the current management team doesn't seem to be particularly good. The company's founder, an astute and successful entrepreneur, left management of the company to his son. But things haven't gone so well lately. The company's book value has fallen from $90 million ten years ago to just $41 million today, with only about $15 million of that being due to buybacks and dividends. Sales are also 25% lower today than they were 10 years ago, and return on capital has been substandard.

It's also unlikely that someone can come in and clean up the mess. The family of the founder controls 40% of the company's shares, so it's unlikely that an unsolicited offer would be accepted.

Virco's shares haven't been this cheap since about 1993! Unfortunately, the company may deserve this valuation based on its record since the founder's retirement.

Disclosure: No position

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