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This is written with serious investors in mind, though sometimes they're just drafts in progress. I'm a former reporter, private investigator and institutional equity analyst who digs deep to find niche undervalued and undiscovered securities. I manage money for individuals, institutions and family offices via my business Long Cast Advisers. This blog is part decision-diary, part investment observations and part general musings about Philadelphia sports. It should not be viewed as a solicitation for business or a recommendation to buy or sell securities.

Thursday, July 7, 2016

How to not chase a stock ($TAYD)

While doing work on my last post, I came across Taylor Devices $TAYD on a screen for companies that - similar to $ARIS - have been generating cash and reinvesting it at high rates.

$TAYD is a $61M mkt cap / $55M EV company that makes products that solves problems caused by recoil, sway and / or vibration. These are generally called "dampers" or "shock absorbers" or "snubbers" and they make all kinds of them for two general types of applications: Construction and Aerospace / Defense.

In the construction side of the business, which is now about 60% of revenues, their dampers - including fluid viscous dampers - offset the sway of buildings, bridges and other structures where wind and / or earthquakes effect such things. One of the most recent / high profile applications is in the 432 Park Ave residential tower that blights rises over the NYC skyline like an oligarch's middle finger a tall reed of grass in the center of Manhattan.

On the aerospace / defense side the company sells components of military equipment to stabilize or isolate weapons and radars, personnel or equipment, like on the seats of naval craft or in the hold of the space shuttle.

An interesting tidbit around the history of the company is that it has deep roots providing fluid viscous dampers for the military (ie in the housing of MX missile silos so they would survive a nuclear blast) and then transitioned into the construction side after the end of the cold war, as per this short quote from an article in the January 2008 issue of the Journal of Structural Engineering:

"A major reason for the relatively rapid pace of implementation of viscous fluid dampers is their long history of successful application in the military. Shortly after the Cold War ended in 1990, the technology behind the type of fluid damper that is most commonly used today (i.e., dampers with fluidic control orifices) was declassified and made available for civilian use ( Lee and Taylor 2001). Applying the well-developed fluid damping technology to civil structures was relatively straightforward to the extent that, within a short time after the first research projects were completed on the application of fluid dampers to a steelframed building (Constantinou and Symans 1993a) and an isolated bridge structure ( Tsopelas et al. 1994), such dampers were specified for a civilian project; the base-isolated Arrowhead Regional Medical Center in Colton, Calif. Asher et al. 1996."

In short, this is a business with a long history making a high value product in an unusual niche; just the kind I like to invest in.

Through FY2015 ending May 31, 2015, the company sold $31M worth of these products generating profit of $2.2M, reflecting a net profit margin of 7.1%, impressive.

Even more impressive is that through the first 9-mos of fiscal 2016, the company generated $27M in sales - nearly matching the prior year with a quarter to spare - with net income margins above 10% for 1Q and 2Q and ~14% for 3Q. (The FY16 year end has closed but company won't report until August).

And most impressive of all is that 10-years ago, this company was levered 3x EBITDA, had $86K in the bank and did 1/2 the revenues as they do today, with 92 employees ($130k / emp). Today, they have $7M in net cash, twice the revenues and a stock trading at 3x backlog, with only 112 employees ($275k sales / emp).

How the company turned around its business was a function - like all success stories - of many things happening at once but a few things stand out:
1. wider acceptance and regulatory approval of fluid viscous dampers in earthquake prone areas
2. expanded production facilities with better equipment that improved turn times
3. larger production facilities to accommodate larger products
4. better tax management, (ie lower tax rate), which means IMHO that mgmt is actively working hard to generate higher returns.

Some of the improvement is structural but some benefits from a cyclical real estate / infrastructure tailwind. Such is the nature of all industrial businesses.

And it is the nature of the stock market - especially in smaller niches of the market - to occasionally be imperfect on valuing stocks. To mine eyes, after digging into the company's business and financials, the valuation appears to reflect a mistake by the market, erring towards a rather common mistake of a stock responding to earnings growth rather than the order book.

In short, the stock appears to be violating the old adage regarding investing in industrial long-cycle businesses to "buy in the order cycle / sell into the delivery cycle".

It does not take long for an investor to observe that backlog is declining, avg project sizes are declining, and that book to bill ratio is 0.5x, meaning the company is burning backlog at twice the rate they are bringing in new business.

For those more inclined to visual displays of data, here is a graph of TAYD's backlog activity layered on top of sales activity. It is quite easy to see how the two generally move in the same direction sales lagged one period.

Here is a graph of TAYD's sales and net income. Again, quite easy to infer a relationship between the two, except in the most recent period.

Why would it be that Net Income would suddenly diverge from declining sales? I'd hazard a guess that on large fixed price projects the company can harvest awards on completion, as is the case with many construction related businesses.  And with backlog coming down, one can infer that several large projects have recently completed.

Here is a graph of TAYD's Net Income layered over "price to backlog" a valuation methodology typically used for companies that generate income off of backlog. You can see how investors reward the company with a higher multiple during periods of strong earnings

And finally, here's a chart of the median quarterly price of the stock layered on backlog.

It is certainly possible that the market knows about some orders on the horizon that will boost backlog or potentially future opportunities for sustained margin expansion.

It is possible that the company has been "re-rated higher" b/c of its prior capacity expansion, with another capacity expansion currently under way, that will enable the company to build even larger product and capture more share of the market.

But it is not possible for the company to generate strong results without strong orders, and the orders of late have been lagging.

At $60M market cap, this remains, to the wider market, an "undiscovered gem" and perhaps even a good idea for a long term investment. I don't yet understand enough the competitive landscape to make that decision. But I do know that if the pull of orders tugs earnings down, and momentum buyers flee, there will likely be another bite at this apple at lower prices for patient investors.

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