Saturday, January 24, 2009
Middleby made 8 acquisitions from 2005-2007 and another 6 in 2008, including the crown jewel of TurboChef. Middleby bought TurboChef in the 4th quarter, 2008 in a combined cash/stock deal. Therein lies the rub against Middleby; To come up with the cash portion of the deal, they’ve increased their debt to approx. $257M on a $497.5M line of credit. According to the most recent 10-Q, they are charged the higher of LIBOR + 1.25% or Prime + the Fed Funds rate, which is currently 3.35%. While this is certainly cheap, many feel it is poorly timed given the economic uncertainty and Middleby’s industry, which is highly competitive and sensitive to economic conditions.
However, the annual interest on the $257M debt is only $8.5M, which is covered 8.5 times by Middleby’s $72.5M free cash flow (FCF) for the trailing twelve months (ttm). Cap Ex is light at $5M, meaning Middleby doesn’t require lots of capital to continue operating. On the downside, Middleby’s balance sheet isn’t worth much. With debt to cap at 68%, limited liquidity and the majority of assets comprised of goodwill from their numerous acquisitions, Middleby has a negative tangible net worth. So what you’re buying is really the strength of their brands and their ability to grow earnings. Mr. Bassoul’s track record on this front is very, very good. Also, Middleby has historically utilized debt in their acquisitions and has paid down this debt quickly from free cash flow.
From a valuation perspective, Middleby is trading at 5.2x FCF (ttm), for a free cash flow yield of 19%. Assuming a normal valuation of 9x-10x FCF, which is reasonable for a growth stock, the market is pricing in a 42%-47% drop in FCF from last year. While anything is possible in the current economic climate, it appears that the bad news is priced into the stock. Even if free cash flow is cut in half to $36M, Cap Ex plus the interest payments on their debt adds up to only $13.5M, leading me to believe that Middleby will survive all but a catastrophic meltdown in business spending. The current price of $22 per share presents an attractive entry point for a long term investor, although considering the present market volatility, the price could reasonably fall another 10%-20% in the short term. Those interested in owning Middleby would be wise to establish a position and buy more as the opportunity presented itself. As always, do your own due diligence.
Disclosures: I have no position in any stock mentioned in this article.
Monday, December 15, 2008
So what can be done as an investor? Buying an index of oil exploration, production and servicing companies in an Exchange Traded Fund (ETF) like the Rydex Equal Weight Energy Fund (RYE) is a good place to start. RYE holds an fairly equal weight in 40 companies that would benefit from higher oil prices. Or the more research driven investor could research and buy individual companies, like Petrobras (PBR) or CNOOC (CEO). These giants are the state oil companies of Brazil and China and control substantial reserves. Do your own research and weigh the risks carefully. Though investing in energy and it's future scarcity is likely to be a safe bet.
Tuesday, September 30, 2008
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Friday, September 19, 2008
Monday, September 15, 2008
Considering the fall of Lehman Brothers and Bear Sterns, and the hustle of other Wall Street brokers, banks and AIG to ‘clothe’ themselves with capital to hide their nakedness, the above quote proves itself insightful and timely. The lack of underwriting discipline on the part of a relative few has impacted the lives of millions of people. It is difficult to make a case for not increasing regulation of the entities that will survive the credit contraction. Their inability or unwillingness to accurately weigh the risk of the investments they made calls for increased capital requirements for investment banks and brokers. If they aren’t able to comprehend or care about risk, they should be limited in the damage they can inflict on themselves and others. Milton Friedman would be very disappointed.
Monday, September 8, 2008
Hurco (HURC) is a leading manufacturer of computerized machine tools used in metal cutting in a variety of industries that include aerospace, defense, medical equipment, energy, electronics and automotive. They incorporate a proprietary computer control system for use on a PC system that improves the quality of cutting and ease of use. In addition to producing the machinery and control systems, Hurco also provides software upgrades, parts, service and support to customers. Hurco manufactures their cutting machines in Taiwan, and sells their products in Europe, Asia and North America via direct sales and through independent distributors.
Hurco’s competitive advantage appears to be the computer controlled cutting system they have developed. In machine cutting the setup and accuracy of the process greatly affects efficiency and cost. If Hurco is able to decrease setup time and reduce errors via their proprietary software, it would give them an advantage over their competitors such as Hardinge (HDNG) that don’t have the sophistication of the Hurco product. This is reflected in their return on capital of 24.15%, net margins of 11.1% and 5-year sales growth of 22.7%, all of which are higher than any of their peers. In addition, they have $4.50 per share in cash and no long-term debt.
Hurco is not without it’s challenges. According to the most recent 10-Q, approximately 89% of global demand for machine tools comes from outside the United States, and as a result, Hurco’s sales are heavily concentrated in foreign markets, with 73.6% of sales coming from Europe, compared to 20.8% from the United States and 5.6% from Asia. Because of this, the company earnings are sensitive to foreign currency fluctuations, which have a material impact on earnings based on the relative strength of the dollar versus the British Pound and the Euro. In addition, because of the time it takes to manufacture and ship products from Taiwan, Hurco must schedule production based on sales forecasts for 4-5 months in the future. Therefore, they would be slow to respond to a rapid decrease in orders, resulting in excess inventory and a decline in return on equity.
This may be what happened during the last recession in 2001-2002, when cash flow per share dipped from $1.25 in 2000 to -$0.28 in 2001 and -$1.48 in 2002, before rebounding in 2003 and increasing to $3.24 in 2007. In addition to an economic slowdown, rising prices for steel are also a concern, as they may pressure margins for Hurco and its customers. Such conditions have yet to slow growth, as Hurco managed to grow sales by 37% in the first six months of 2008 versus the same period in 2007. Sales in the United States were flat, but sales in Europe and Asia increased 50%, with currency exchanges resulting in a favorable impact of 17% in Europe and 14% in Asia. Sales of machine tools accounted for 89% of revenue with service fees and parts making up the remaining 11%.
The last five years of the falling dollar have benefited Hurco by making its machining tools less expensive abroad, a trend that is at risk of reversing as the European Central Bank and its British equivalent are being pressured to lower interest rates by slowing economies. The prospect of an economic slowdown has hit shares of Hurco, driving them from a high of $60.44 per share in October 2007 to a recent price of $31.00. This has resulted in a trailing P/E of 8, near the low end of its historical range, and an EV/Ebitda multiple of 4.3 for the last 12 months. This is cheap for a company that tripled earnings from $1.04 in 2003 to $3.24 in 2007. The only analyst covering the stock expects 2008 earnings of $3.58 per share with 2009 earnings growing 12% to $4.00 per share. This would result in a forward P/E of 7.87 and an attractive earnings yield of 12%.
Hurco holds an attractive niche in the machine tool market. In a world that will demand lower costs and greater efficiency as emerging markets grow, Hurco stands to benefit as a provider of quality, cost-saving manufacturing tools. Given the cyclical nature of this business, buying opportunities will present themselves on a frequent basis, as investors respond with fear to economic news and earnings calls. While I believe the current price to be a good entry point, a return to the $25-$28 range is not an unreasonable expectation. It would be wise to enter a position in thirds, the better to take advantage of declines in the share price in these uncertain times. Doing so should provide a good return for the long-term investor.