So I want to offer this as an illustration of one way to think about choosing stocks, and spark discussion on how you look at stocks and investing in general. I also want to offer it as a way for people to ask questions about looking at stocks. It would be cool if over time people felt comfortable asking and discussion questions on the topic, here at 2outof4.
What I describe below is typically referred to as "Value Investing". The premise is that you want to buy the stock of a company that is so cheap, that there is a reasonably large margin of safety the stock does not decline much further even if the company reports a bad quarter or negative near-term news. The catch is the company must be a going concern with reasonable prospects of future growth and/or ability to generate a return on its invested capital.
After the close of the market last weekend (2/13-2/15), I thought I found one such Company. One where it looked reasonably cheap, the ongoing business would be stable even if a portion of the company completely stopped functioning, the returns on company invested capital were high, there was good cash flow generation, and management had managed through downturns in the past. The stock had also happened to have dropped in lockstep with a competitor, who had reported its fourth quarter earnings earlier in January. So in a real sense, the stock of the company I was looking at had already been punished in price for poor earnings, which it had not even reported yet, in the fourth quarter. Therefore, if the Company's 4Q08 earnings after the market close on 2/19 were in line with Wall Street analysts expectations and future guidance was not much worse than already lower expectations, I felt the stock had a reasonable chance to actually go up. I knew from my work on the valuation, that it really shouldn't go down much further.
The name of the company in question is Universal Electronics, Inc. (ticker: UEIC). Essentially, it creates all the infrared code and makes remote controls for a number of cable/satellite providers as well as universal remote controls that are sold in retail (mainly in Europe). Granted, not a great business per se in this economic environment, but I had done some research that told me that at a minimum selling remotes to cable/satellite providers was not a business that was going to disappear soon.
What follows is a write-up of some thoughts on the idea. Please feel free to ask questions because there is some jargon and acronyms that may not make sense. I thought I would prefer to let you ask questions instead of explaining all the minutia in this post, although I would be happy to.
"I have been looking at UEIC over the weekend and think it is a good fit as a long idea. I cannot rule out that UEIC pooches the quarter this Thursday, but I want to own a little bit going into results –in case of a less negative-than-expected rally.
UEIC manufacturers remotes controls for OEM, subscription companies, and retail. However, the “Business” segment accounts for 80% of the Company’s revenue, with 70% of the
It seems though, at this valuation, the pooch may be in the numbers. If it is not, then it seems the market is suggesting this company does not make it, despite it weathering a recession in the past and having a seemingly sustainable business within the Business segment. At 0.3x EV/Sales, even if I take the 15 year historical Net Margin % per StockVal of 5.8%, and discount it down to 4%, I still get EV/E of 7.5x on a company where sales and earnings are not expected to blow apart. For reference the average quarterly Net Margin % from March 2001 to June 2003 was 6.8%. In terms of margin of error, the DCF based on terminal FCF of the TTM still gives upside to today’s price on a WACC of 12% (see below)!
UEIC’s market position, potential to grow at home and abroad and experience through prior downturns are the keys to a positive longer term fundamental view. The Company projects that the number of homes that receive digital signals will nearly double to 636 million households or half the world’s TV homes. Accordingly, UEIC has started supplying remotes to Reliance in
3Q08 was a good size miss on sales at Consumer and margin. The Company suggested lower sales and mix as hitting gross margin, but there was likely a little promotion and incentivization, which also hit gross margins. However, sales did increase in 3Q based primarily on digital signal change overs, DVR, VOD and HD change overs all with the subscription broadcast customers. Similarly consumer sales increased due to a new product and a new
In conclusion, this is not a bankruptcy candidate. Margins may come in and UEIC may have to find a base level of business that has a lesser contribution from Consumer. However, It appears to me, the market is pricing in much worse. Just by way of example. If I take TTM sales in the Business segment of $214.4 million and apply the gross margin of 30% and an opex expense rate of 24.9% for the overall business in 3Q08, I calculate net income of $7.9 million. If I use this as a proxy for FCF, assuming D&A and capex cancel each other out, and grow it very slightly I still have upside to today’s price (albeit small and requiring a lowering of my conservatively high WACC above) – that’s assuming consumer goes completely away.
Risks: Retail in Europe plummets, customer concentration, likely need to take inventory scrap reserve up a bit, do a bad deal or merger b/c seem to suggest possibility of an acquisition frequently, certain amount of inventory purchase obligations over the next few years, customers access to credit is huge for these guys, unclear to me how the Company’s library of infrared codes which covers 348kdevice functions and over 3,300 individual consumer electronic equipment brand names is valued on B/S – if at all, supplier concentration, 4Q is biggest quarter, state that most of cost base is currently fixed, US putting off the “digital upgrade”."
-2outof4
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