On 4/13/2012, we coded Key Tronic Corporation (NASDAQ:KTCC) as a GeoBargain @ $11.40 (please go here to see 4/13/2012 premium email alert)
Company Description: Key Tronic provides a mix of manufacturing services for outsourced Original Equipment Manufacturing (OEM) products. The company’s electronic manufacturing services (EMS) include: Product design, surface mount technologies (SMT) and pin through hole capability for printed circuit board assembly, tool making, precision plastic molding, liquid injection molding, automated tape winding, prototype design and full product assembly.
Year End: June
Data Ended 4/16/2012
- Price = $11.31
- Fully-Taxed Trailing EPS = $0.39
- Fully-Taxed 2012 EPS Estimates = $0.85
- Fully-Taxed 2013 EPS Estimates = $1.24
- P/E based on Fully-Taxed Trailing EPS = 29
- P/E based on 2012 GeoTeam Fully-Taxed estimate = 13.3
- P/E based on 2013 GeoTeam Fully-Taxed estimate = 9.1
Criteria Check List
KTCC Meets 6 out of 10 of our most important requirements for growth and risk-based quantitative data.
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Requirement
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Comments
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Recent 52-week High (generally within 3 months)
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Yes
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Strong EPS Growth Rate
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As of 2nd Qtr 2012; Company Guidance
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Yes
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> 30% EPS Growth Rate
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- 2nd Qtr. 2012 EPS increased 76%
- Per company guidance 2nd EPS will more than quadruple to at least $0.30.
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Yes
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GeoPowerRanking (GPR); Number of consecutive quarters that EPS is expected to grow at least 20 to 30%.
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4; The company may be entering a new EPS growth cycle.
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10% Revenue Growth
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- 2nd Qtr. 2012 revenue increased 38%.
- Per company guidance 3rd Qtr revenue will grow at least 45%
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Geo Minimum Operating Cash Flow and Balance Sheet Requirements
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As of 2nd Qtr 2012
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Yes
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Positive Cash Flow
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$4.9 Million as of 2nd Qtr. 2012
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No
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Long Term Debt to Equity Ratio less than 20%
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22%
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Yes
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Current Ratio is at least 2:1
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2.2:1
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Yes
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Days in receivables < 90. This shows that the company converts its account receivables to cash within 90 days. (measure of liquidity)
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55.4
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Return on Equity is at least 15%
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18% run rate
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Minimum Pre-tax Operating Margins of 8%
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3.2% as of 2nd Qtr. 2012
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Preferably Under 50 Million Shares (Fully Diluted)
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10.5 Million shares as of 2nd Qtr. 2012
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High Insider Ownership (generally greater than 15%)
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12.8% (Yahoo)
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Limited Institutional Ownership (generally less than 20%)
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24.8% (Yahoo)
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P/E Divided by Growth Rate (PEG Ratio) is Less Than 1.
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0.44 (Assuming the company meets its 2012 3rd EPS guidance)
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Reasons for Optimism
- Customer Base Broadens. The type of customers and size of orders that KTCC can bid on is partly determined by its revenue level. At an annual run rate of nearly $400 million (compared to a previous run rate of around $240 million), the company is now approaching a new revenue threshold that will enable it to bid on more and bigger contracts from new and existing customers. At the end of its December 2012 second quarter KTCC’s customer base stood at 40, an increase of 20% from its June 2011 fourth quarter. With less than 1% of the potential global market, plenty of growth opportunities exist for KTCC.
- Best-in-Class Margins. The average operating margin of KTCC’s competitors is about 2.5%. While, KTCC’s current operating margins stand at around 3%, the company’s goal it to attain operating margins of 5% to 7%. This gap between current and desired margins should lead earnings to grow faster than sales. The fact that KTCC has ample excess manufacturing capacity should also offer operating leverage.
- Favorable Industry Trends. The EMS industry is forecast to grow around 10% for the next several years. The trend of KTCC’s customers to increase their reliance on outsourcing is the key growth driver for the EMS industry. Borrowing commentary from our Smtc Corporation (NASDAQ:SMTX) GeoNugget which plays in the same industry of KTCC...
“ample growth opportunities exists in the EMS industry as OEM'S increase outsourcing activities. Ultimately, many companies want to outsource manufacturing to focus on customer service, product engineering and design.”
KTCC expects to grow its topline faster than the industry average. Furthermore, KTCC’s unique specialized product offering gives it a competitive advantage. For example, KTCC’s tool making and precision plastic molding services are offered by only a handful of other EMS players.
- No Dilution Risk. The company has been very specific that it can fund its growth without diluting shareholder ownership:
“We believe that projected cash from operations, funds available under the revolving credit facility and leasing capabilities will be sufficient to meet our working and fixed capital requirements for the foreseeable future.”
- Diamond in the Rough. KTCC currently trades at a trailing P/E of 29 and forward P/E of 13.3 on our 2012 June ending EPS estimates of $0.85. We believe that investors may be using KTCC’s rich trailing P/E as a valuation barometer and are significantly underplaying KTCC’s growth drivers. After five straight quarterly revenue outings ranging between $62 million and $70 million, the company saw its Fiscal 2012 December revenues reach $84 million. EPS rose 76% to $0.30 (fully taxed around $0.19). We presume that investors may be skeptical about the quarter’s performance since the previous four had exhibited negative or flat EPS growth.
However, the company had been absorbing costs as it ramped up new programs to meet customer needs. These costs should be less of a hindrance at KTCC’s new revenues levels. Furthermore, investors have seemed to ignore the fact that the 2012 second quarter was not an aberration. The company has issued bullish guidance for its March 2012 third quarter where it expects revenues to balloon to over $90 million and EPS to more than quadruple to at least $0.30. The EPS guidance is more revealing when one considers that this EPS guidance assumes a full tax rate compared to minimal tax rates in previous quarters. We believe that KTCC could command a premium multiple once investors realize that the 2012 second quarter was not a fluke, that the company’s margins are best-in-class and that opportunities abound for aggressive customer wins. After the company reports its fiscal 2012 third quarter financial results on May 1, 2012 (after market close), its trailing EPS should be about $0.64. Applying a P/E of 25 to $0.64 yields a near-term valuation scenario of $16.00.
GeoTeam overall subjective/confidence comfort level: Pertains to the ability of a company to achieve solid and consistent EPS growth over the next several quarters (from 1 to 10): 10
Potential Valuation Scenarios if the company can achieve its EPS growth goals
Short-Term Potential value based on fully taxed trailing EPS (Assuming the company meets its 2012 3rd EPS guidance)
P/E 25 $0.64 = $16.00
Short-term Potential value based on 2013 fully taxed EPS Estimates
P/E 15 $1.24 = $18.60
Caveats:
- Customer Concentration
- KTCC operates in a low margin industry which could limit P/E expansion
Additional factors to consider in analysis
- Effective Internal Controls: Yes
- Needs to raise capital: No
Foot notes:
1Valuation scenarios are not intended to be investment advice, but are scenarios based on some commonly used investment guidelines. They are provided to aid investors in making their own investment decisions.
2Our analysis is based on Quantitative and Qualitative factors. Even if a company does not meet the majority of our quantitative requirements, strong qualitative factors can still influence our optimism for a given story. Furthermore, gaining alpha in a market entails finding companies before the masses do, which means that there is value added when one can identify stocks that may currently have weaker quantitative data, but will soon improve. The GeoTeam typically considers EPS Growth, Revenue Growth and PEG Ratio as the most important quantitative attributes that affect short term valuation.
