Hammond Power Solutions

Global equity markets have rebounded significantly from their lows almost 2 years ago. For the most part, my portfolio has been composed of “cheap” businesses whose future depended on an economic rebound.  I have been successful at using this strategy. As the economy continues to recover, there are less and less bargains in plain sight. I am comfortable paying a fair price for a good business, although I love when my companies get cheaper.

Enter Hammond Power Solutions (HPS.A on TSX), they build  dry type transformers. Though these transformers are not as cool as the ones I am used to, think Optimus Prime and the Autobots, they have been a good business for HPS to be in. There is no drug awaiting FDA approval, no two guys with a bobcat in a field trying to find gold, and no new sexy product about to be unveiled. Just building transformers and earning good returns on capital while doing it.

From their website:

“Hammond Power Solutions Inc. is the largest manufacturer of dry-type transformers in North America. We engineer and manufacture a wide range of custom transformers that are exported globally in electrical equipment and systems. We support solid industries such as oil and gas, mining, steel, waste and water treatment, and wind power-generation.”

Since 2001 revenues have grown at around 11%. Sounds great, but profits have kept up as well, going from 1.8 million in operating earnings to over 16 million today (and those are likely trough earnings). The share price has done quite well over the last 10 years, going from under $1.00 to over $10.00 today. Hammond used to trade at a discount to assets, but I think it is best to focus on earnings and cash flow for this company.

Hammond Power’s products have many applications and are quite diverse throughout the entire industry. Demand is from new infrastructure being built for things like: mining and renewable energy, as well as replacement demand for aging infrastructure. Though growth in North America isn’t as quick as some of the Emerging Markets, the industry in seeing growth the same or higher than GDP and should continue for the foreseeable future. Being the largest manufacturer of dry-type transformers, HPS should participate in the industry tailwinds.

Operational Check

The company has managed to keep the CCC under 60 for most of the last 10 years. ROIC (pre-tax) has been over 20% for the last 5 years and ROE has been at least 15%. Gross and EBITDA have averaged 28% and 12% over the last 5 years. Low debt load (debt to equity of 0.06) and a current ratio of almost 3.

Valuation

  • HPS has $1.02 in excess cash, and yes I think it is “real” excess cash that shareholders are likely to benefit from.
  • EV/EBITDA is at 5.75 (remember we are probably at trough earnings).
  • Net cash P/E is just under 10, excluding forex charges.
  • Price to maintenance FCF is just under 9.
  • DCF with a 10% growth rate puts fair value at $16.85.
  • EPV at $16.51.
  • Graham formula has fair value at $17.15.
  • Price to book at 1.5, and price to tangible book at 2.5.

Other notes

  • HPS pays an annual dividend of $0.13, giving a yield of 1.24%.
  • There is no real sales concentration risk.
  • Around 60% of revenue comes from the United States.
  • Around 70% of employees are unionized, but there has never been a stoppage of work.
  • There are some expansion plans is place for the next 12-18 months. The target is $500 million in revenue in 5 years.
  • The CEO (Will Hammond) owns around 32% of the company.

Given that fair value is at least 50% higher than the share price and management interests are aligned with shareholders, I think HPS.A deserves a spot in the portfolio. Though not dirt cheap, a fair price is fine with me.

Dean

Disclosure: The author is long shares of HPS.A at time of writing.

Hammond’s Website

Latest Quarter

3 Comments

Filed under Company Analysis

3 responses to “Hammond Power Solutions

  1. I found your blog by googling this company.

    Overall, I agree on HPS. I love that they’re #1 in dry-type transformers and are pressing their advantage by expanding sales and distribution and using R&D to develop new products. I like that the company is still controlled by the founding family, as this is a sign that the business is so good that they’ve never had to beg for outside capital. I think that they’ve got good returns on capital and opportunities for decent growth. My estimate of value is about 20 CAD, and a buy below 12.50. It’s illiquid, but I think that I will be happy to hold it for a long time. After all, any company with a name that boring almost has to be a keeper.

    How did you find it? I used a Canada focussed magic formula screen.

    All best,

    CR

  2. Hi CR,

    I found HPS.A on a cheap P/E screen from GlobeInvestor.
    I agree that HPS has some decent tailwinds and has moved from an asset story (back in 2004) to an earnings story today. Revenue growth should average mid to high single digits. The company no longer trades at a discount to assets and it shouldn’t. Pretax ROIC has been at least 20% over the last 6 years (depending on exactly what you use for the IC demonimator you will get slightly different numbers).
    Boring, profitable, and cheap, I’ll take it.
    Thanks for the comment.
    Where did you find the magic formula screen for Canadian stocks?

    Dean

    • Hello Dean,

      >Where did you find the magic formula screen for Canadian stocks?
      I made it in CapitalIQ – I don’t know whether there’s a free way to do it, since I haven’t had to look for one. HPS wasn’t at the top of the list, but it was the first company that I thought I could take a stab at.

      Happy hunting,

      CR

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s