Part 1
Part 2
For my final post on Solitron Devices I want to look into two things, the operating performance, and risks involved in the investment.
I took the first two posts to establish the margin of safety from a balance sheet perspective. Solitron Devices is trading at a nice discount to net current asset value. When looking at net-net stocks I prefer to buy companies that are trading at a discount as well as profitable or at least cash flow positive. The reason for this is I don't want the danger of the operating business destroying my margin of safety.
I put together the following spreadsheet breaking down the operating performance for Solitron Devices.
Usually my standards for profitability are not that high when looking at a net-net, but Solitron exceeds those expectations quite easily. A few operational highlights
-Operating margin between 5.4% and 14% for the past six years. Mostly around 9-10%.
-Net margin between 5.6% and 23% with 2011 coming in at 14%.
-Cash flow positive all six years
-Capex is never higher than 30% of CFO
The results mostly speak for themselves. Solitron has been consistently profitable has is able to convert their accounting earnings to cash.
When examining the cash flow statement an important distinction should be made, CFI is high because investments in treasuries are included along with capex. If an investor takes a quick glance at the cash flow statements they could be turned off thinking the company is bleeding money, instead the opposite is true, they're building a cash pile.
I also included in the spreadsheet two free cash flow lines, raw cash flow and adjusted. Raw is CFO minus capex, whereas adjusted I used the average working capital changes across the entire time period.
One thing to consider is that any discussion of free cash flow might not even make sense for Solitron Devices. Free cash flow is the amount of cash that a company could in theory give back to investors or use in share buybacks or dividends. In the case of Solitron if you look at the FCF as computed on my spreadsheet and the amount of Treasury purchases they are very similar amounts. Solitron has been accumulating it's FCF on the balance sheet as Treasury bonds.
The hope is that once the environmental liabilities are exhausted that Solitron will finally start to pay out its cash hoard as dividends, this could be considered a catalyst for a higher share price.
Valuation Scenarios
I've taken a stab at what I think Solitron could be worth under a few different situations.
NCAV: $3.80
Discounted NCAV (liquidation value): $3.03
EPS at 10x: $5.10
EPS at 10x + cash: $8.04
FCF at 10x: $3.53
FCF at 10x + cash: $6.57
Also for the heck of it I did a dividend discount model scenario. I take the amount of treasuries purchased each year as a proxy for dividends that could be paid. I then discount them at the 10yr treasury plus a 4% risk premium giving a value of $4.18 a share.
I personally believe a cash plus operating value is more appropriate method for Solitron Devices putting a possible intrinsic value at between $6.57 and $8.04 both more than double from the current price.
Risks
Even with all the great aspects going for it an investment in Solitron Devices isn't without risk. I've tried to detail what I think the most likely risks are.
-Business could dry up, curiously management has decided to keep a line in their quarterly and annual reports which states that they could possibly operate at break even or at a loss in future quarters. While this line remains the results speak otherwise.
-Current management could retire and be replaced with managers who are intent on using the cash for empire building squandering the margin of safety.
-The company is very small with a market cap of $7m giving limited liquidity and visibility in the marketplace.
-The company could be subject to a takeover or buyout without giving appropriate value to the shares.
-Defense spending could be hit by major cuts, defense contractors and the government are a large source of business.
Even with the risks detailed I think an investor is on safe footing buying Solitron Devices, a true rare net-net in the US market.
Disclosure: Long and actively working to increase my position.
Thank you for sharing….this is a great post it gives a lot of information….
ReplyDeleteA couple of risks worth considering:
ReplyDelete1) If treasuries are long term (20 or 10 years) they can take a serious hit with inflation bonds could fall hard.
2) Defense spending can get severely reduced if USA gets into sovereign debt troubles.
3) I do not know much about the business but I would find out if they can get wiped out due to competition. Semiconductors are a commodity in many areas.
I find the analysis very good with respect the numbers but qualitatively I still have a small idea of how the business operates (but at least it gives much more information than the analysis done to Japanese stocks). Anyways there are sec fillings so a lot can be learned maybe from them, definitely worth taking a look, so it was nice to learn about the existence of this company!
Regarding Japanese stocks mentioned in this blog: their financial statements are super attractive but it stops there, I cannot find almost any qualitative info about the net-net Japanese stocks mentioned. I could translate their fillings from the Tokyo stock exchange but the information is mostly financial in nature, only numbers and nothing about the nature of the business or its dynamics, almost no information about: how they make money, competitors, risks, suppliers, customers, hardly any news sources, no conference calls, etc.
Given that it is so difficult to learn about the business because they basically say nothing about it in their official disclosures (they basically just disclose the financial statements) I would invest there by diversifying a lot in several companies but I honestly would prefer much more to dig deep in the business before buying a significant amount, otherwise I rather pass.