OK, I am going to kick us off with my first proposal for the AfterSVNT blog. Justaguy and I have discussed it a little bit in the comments to a prior post.
My pick is Sparton Corp., a more than 100-year old manufacturing company trading at about the $5.75 level with 10 million shares outstanding and about a $58 million market cap.
This company currently is virtually debt free and had about $30 million of cash on its balance sheet at June 30th. In addition, the company has a piece of unused real estate in New Mexico for sale, with an original asking price about $6.5 million. In 10FQ4 (June 30th) the company took a charge to write down the property to its net realizable value. There are four manufacturing facilities: one in OH, two in FL, and one in Vietnam. In addition, there are tax loss carryforwards that can shelter about $15 million of future pretax income from taxes. This loss carryforward is not yet assigned any balance sheet value because the company has not yet experienced a long enough period of consistent profitability. However, the company's restricted cash is likely to become available to it as its profitability will qualify those funds (earmarked for future environmental remediation spending)
There are three divisions, with by far the most important (on an operating profit basis) being the Defense & Security Segment (DSS). This division makes "sonobuoys," disposable electronic devices used to track the comings and goings of submarines. These devices are deployed from anti-submarine warfare aircraft and helicopters, used once, and never recovered. There are two manufacturers, but they operate as a joint venture and split annual two-year orders from the US Navy. Typically, there also are orders from friendly foreign navies. It is supposed that China's ongoing construction of a modern submarine fleet is likely to result in an increase in orders over the next 5 to 10 years at least from foreign navies. This timeframe is a bit far out for me, investment-wise, but comforting nonetheless.
A second segment produces medical devices, primarily on a contract design/manufacturing basis, while the third is a contract electronics manufacturing operation (think Flextronics or Sanmina but much, much smaller).
The company suffered a lengthy period of mismanagement beginning in the late 1990s, after the departure of the management team that had taken control of the company shortly after the end of World War 2. In 2008, agitation by investors that included hedge fund Lawndale Capital Management (current owner of 9.5% of the stock, 968,616 share according to Bloomberg) resulted in the appointment of a new, outside CEO practically at the height of the post-Lehman financial crisis. A new management team began to take action in early 2009, effectively saving the company from a bankruptcy filing that many believe was only weeks, if not months away. Only successful negotiation with a large number of third parties including bankers, customers, and the Defense Department provided Sparton with the cash needed to regain a semblance of financial health. Since that time, a classic financial and operational turnaround has increasingly become evident.
The turnaround included major cost cutting, the liquidation of excess inventory, collection of excessive levels of Accounts Receivable, and the "firing" of unprofitable customers. Basically, the new management team did everything they could to stem the bleeding and right the ship. That included shutting down multiple underutilized manufacturing facilities including the former Headquarters facility in the company's home town of Jackson, MI and one in Canada. Employees also were let go and the company's cost structure was rationalized. Cash raised was used to eliminate debt and to raise the company's cash position.
More recently, improved profitability has been at least in part a result of significantly improved rejection rates at the sonobuoy operation, as scrap and rework costs were cut sharply.
As of now, the company has posted 4 consecutive profitable quarters despite the lower sales base that resulted from letting customers go. Offsetting the lower sales is the cost cutting as well as the elimination of unprofitable revenue. In the current quarter (11FQ1) SPA completed the acquisition of Delphi Medical Systems for approximately $8 million. In addition to $10 million of inventories, SPA acquired 2 facilities. The deal includes a potentially favorable inventory valuation adjustment, and should quickly (though not immediately) be additive to earnings and cash flow. The operations acquired add to the company's customer base and should result in about $32 million in sales that go into the Medical division (not the EMS division as stated in an earlier version of this article.)
With $2.25 a share in cash (after subtracting out the $8 million acquisition, but not including the restricted cash balance), and a solid core defense segment, I believe SPA is in a position to generate nearly $1 a share in cash flow (about $10 million) in its FY2011 (ends June 30th).
Management indicated on the most recent conference call that the company would increase its spending on R&D and would pursue acquisitions that promise rapid incremental profitability using a combination of existing cash and ongoing free cash flow. In a recent conference presentation, management announced a target of $500 million of revenue for its FY 2015. This is an ambitious growth rate of better than 20% CAGR for revenues over 5 years.
If Sparton were to be successful in achieving its objective of $500 million in annual revenue and could earn a relatively modest 5% net income margin after taxes without increasing the share base appreciably, earnings could approach $2.50/share. There is quite a bit of blue sky between that objective and the company's present condition, but a stretch goal such as that surely is designed at least in part to be inspirational.
Trading in the stock is thin, about 22,500 shares per day on average over the past three months, and this is not a day trading opportunity. Care needs to be taken in accumulating a position, and I recommend that investors build their position over time as they learn more and grow more comfortable with the company and its prospects.
In sum, I think SPA is now a solid, profitable company with a large cash cushion and a new management team that has made near miraculous progress in getting the company back on track after a long period of decline. if SPA can achieve $1 a share in cash flow, I can easily see this as an $8 stock. That makes it more and more attractive as it drops below the $5.50 level (which would equate to 50% upside). This $1 per share in cash flow is essentially the same level of profitability that I figured about a year ago when I first began looking at Sparton after having had it "on the back burner" for more than 10 years.
I know more, but this is certainly sufficient for now.
Jay (aka AA)
Good summary. I assume they've cut costs to the bone as part of the restructuring. You mentioned 'firing customers' -- can you elaborate more? With the profitability how will the continue to grow revs going forward? I need to look more into the Co. background but it sure seems like they have upside potential. $8 would seem to be resistance looking at a longer term chart
ReplyDeleteHow did you build up any kind of position? Spread (now) is 12 cents and volume 1100 shares after almost an hour and a half. Guessing there are about 10 million shares outstanding
ReplyDeleteThe company used the term "disengagement." Basically, when new management came in, they discovered that a number of significant customers had business priced at levels so low that they were unprofitable! One of the customers actually is a friend of mine who works for a company that is one of the 30 Dow Jones Industrials at the present time. The "disengagement" from that company (and SPA management has been open about who it is (HON) took quite some time.
ReplyDeleteThis "disengagement process is the reason that the revenue base in the Electronics segment has declined so much, but also the reason that the segment operating/gross margins have recovered.
I think the company is at an inflection point here. The hard slog of the turnaround has been completed, and management recently ventured to make its first acquisition, adding a business with about $32 million in revenue in the Medical segment for approximately the cost of the inventory that they purchased. They said it would be immediately additive to ongoing earnings/cash flow.
It is not a blue chip, and it certainly is thinly traded, but those things can present advantages as well.
My position is roughly a quarter of a day's trading volume. That's a better question for a guy like Lawndale who has a really big position. For the most part I use the "basket" method of putting orders in under the current market level and waiting for the seller to come to me. I also do flip a smallish position back and forth when I need some excitement. Sometimes the market makers/specialists leave the spread too wide and I'll put myself on both sides. Being a microcap with limited volume does add a wrinkle to the process, but the advantage is having information that other people don't pay attention to through the research process.
ReplyDeleteThe P-8 Poseidon plane discussed below will be an enhanced replacement for the current P-3 Orion that deploys Sparton’s sonobuoys.
ReplyDelete“The contract announced Friday is for the first six production aircraft out of a total of 117 that the U.S. Navy said they'll need through about 2025. The first P-8 planes are due to be deployed in 2013. Boeing is also assembling the first P-8 for the Indian Navy, which ordered eight of the jets. The Australian Navy is working closely with the U.S. Navy on the program and is also expected to order the P-8.”
Presumably the Indians and Aussies will need Sparton sonobuoys too.
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The Seattle Times
Business / Technology
Originally published January 24, 2011 at 5:54 PM | Page modified January 24, 2011 at 8:41 PM
http://seattletimes.nwsource.com/html/businesstechnology/2014027699_poseidon25.html
Navy inks $1.6B contract for initial P-8 Poseidon production planes
The U.S. Navy on Friday formally approved a $1.6 billion follow-on contract to Boeing to produce the initial production versions of its P-8 Poseidon anti-submarine airplane, a militarized version of the Renton-built 737 airliner.
By Dominic Gates
Seattle Times aerospace reporter
The U.S. Navy on Friday formally approved a $1.6 billion follow-on contract to Boeing to produce the initial production versions of its P-8 Poseidon anti-submarine airplane, a militarized version of the Renton-built 737 airliner.
When Boeing won the Poseidon contract in 2004, the initial $3.9 billion development phase of the program required it to develop and build five flight test airplanes and two ground test airplanes. A sixth flight test plane was later added to the contract.
The P-8 first flew in 2009 and so far three flight test planes have been transferred for tests at Naval Air Station Patuxent River, Md.
The fourth test airplane is having its military systems installed at a new P-8 line inside the old Thompson site building across Marginal Way from Boeing Field. The fifth test airplane arrived at Boeing Field from Renton on Saturday and will this week transfer to the Thompson site. The sixth flight test airplane is under assembly in Renton.
The first ground test airplane completed the static tests required for certification this month. In September, that plane will be refurbished and converted for use in live-fire target practice at Naval Air Warfare Center, China Lake, Calif.
Boeing is also assembling the first P-8 for the Indian Navy, which ordered eight of the jets. The Australian Navy is working closely with the U.S. Navy on the program and is also expected to order the P-8.
The contract announced Friday is for the first six production aircraft out of a total of 117 that the U.S. Navy said they'll need through about 2025. The first P-8 planes are due to be deployed in 2013.
The U.S. Navy contract is worth $15 billion if Congress eventually authorizes funds for all 117 production airplanes. Boeing estimates that spare parts and maintenance plus foreign contracts could pump up the total value of the P-8 program to as much as $40 billion over two decades.
More than 1,000 Boeing employees work on the Poseidon program in Seattle and Renton.
Dominic Gates: 206-464-2963 or dgates@seattletimes.com