Another quick and dirty look at a net-net.
I discovered SVT when looking through the Grahamian Value site.
- Price – $7.35
- Shares – 2,397
- MC – 17.6mil
- EV – 22.6mil
Servotronics, Inc. designs, manufactures, and markets control components and consumer products in the United States and internationally. The company operates in two segments, Advanced Technology Group (ATG) and Consumer Products Group (CPG). The ATG segment provides servo-control components to the commercial aerospace, aircraft, and government related industries; and medical and industrial markets. This segment’s principal components include torque motors, electromagnetic actuators, hydraulic and pneumatic valves, and related devices that convert an electrical current into a mechanical force or movement, and other products. It also offers metallic seals of various cross-sectional configurations to close tolerances from standard and special alloy steels. This segment markets and sells its products to the United States Government, government prime contractors, government subcontractors, commercial manufacturers, and end-users. The CPG segment provides cutlery products, including steak, carving, bread, butcher, and paring knives for household use, as well as for use in restaurants, institutions, and the private industry; fixed and folding knives for hunting, fishing, and camping; and machetes, bayonets, axes, strap cutters, and other tools primarily for military and rescue/first-responder use, as well as for commercial markets. It also offers various specialty tools, putty knives, linoleum sheet cutters, field knives, scalpels, and micro-spatulas; and plastic and metal fabrication, as well as engineering, design, and OEM/white-label manufacturing services to customers in the consumer and commercial industries. This segment markets its products through its sales resources and independent manufacturers’ representatives to big box, hardware, supermarket, variety, department, discount, gift, drug, outdoor, and sporting stores, as well as through electronic commerce. Servotronics, Inc. was founded in 1959 and is headquartered in Elma, New York.
The two segments are very different and can be analyzed independently.
Selling anything on an airplane requires tough to obtain certifications and the relationships are very valuable. Especially if those relationships carry across multiple types of aircraft.
As you can see the ATG segment has grown from it’s base of less than 6 mil quarterly revenue to well over 12 mil before covid. This part of the business is consistently profitable (before covid).
There is some customer concentration risk in the ATG part of the business which is typical of these small parts suppliers in aerospace. This also leads to some lumpiness that can create some opportunity as many orders are delayed not canceled.
Covid has hit this part of the business hard. The last quarter was the first operating loss in 10 years.
The company designs and manufactures are variety of knives with a variety of applications. Below is the subsidiary’s website.
I don’t know anything about knives, but the business looks really competitive. I’m not sure of the brand value that this company carries.
they have been losing money consistently in this segment of the business.
Couple to lower expectations of the business with the increase in current assets gives you a net-net. Net-nets obviously have low expectations built into them. The low valuation takes some of the risk of future execution off table as they really can continue to do what they are doing and you can sell for a profit once some confidence returns. Many will argue net-nets are not fantastic businesses. This is completely valid. But there are examples of great businesses today starting out as a net-net that have been transformed into something substantially bigger and better. A good example is Sangoma Technologies, which several years ago was a lumpy product business trading at less than net cash.
Below is the current assets of the consolidated business.
One of the risks I look for in net-nets is the obsolescence risk of inventory. Some quantifiable ratios coupled with qualitative guesswork can reduce this risk.
As we have seen with SVT, the ATG part of the business was growing well. With this growth comes the increase in inventory. It’s worth looking at the Cash Conversion Cycle and overall Working Capital to look for some potential concerns.
Inventory and working capital have grown relative to sales but they are still not what I would call worrisome. Given that ATG has been hit hard from covid lockdowns I feel relatively comfortable with using the current inventory value in my margin of safety. There is currently 25mil of inventory carried on the balance sheet. As well there is 12 mil in PPE carried on the balance sheet which can give an additional margin of safety if we puchase based on a discount to assets.
Split the business?
The obvious thing to an outsider would to split/sell/spin-out/divest the CGP business. Though this is easy said than done, it likely would unlock substantial value.
If we use our imagination and covid lockdowns don’t continue to drag on for longer than the next 2-3 quarters and the aerospace business returns to pre covid levels of profitability of 6-8mil EBIT annually, I don’t think 8-10x EBIT is unrealistic. This leaves a value of 48-80 mil in the ATG business with no incremental growth. That’s at least double the current market cap of SVT.
Valuing the CPG business is harder. What do you think a (non Saas) business that has yet to produce earnings is worth? There are about 10 mil in identifiable assets carried on the balance sheet. This is without considering any liabilities. CPG did 8.2 mil in revenue in the TTM and 6.7 mil in 2019. There has been increased interest in the CPG products recently and the loss in the last two quarters has been the smallest in several years .
Really the value to be unlocked is just getting SVT to be valued based on the aerospace business alone. One could argue that diversification in business lines reduces the risk overall to the entity. I’m not sure that’s fair given CPG has not earned a profit in many years and we (up until 2020) experienced an economy that is growing with minimal inflation.
This is where things are uncertain. What’s the likelihood of the spin/sell/divest catalyst? I have no idea.
The current CEO is also the chair of the board. He controls (personally and from his father’s trust) controls 21% of the shares. He is also the President and CEO of the company’s knife subsidiary (Ontario Knife Company). He’s been with the company since 1993.
The rest of the board controls less than 1%. Harvey Houtkin and FMR LLC control about 20%. The Employee Stock Ownership (ESOP) Trust has another 20%. The participants in the ESOP have the right to vote on the share that have been allocated, while company representatives vote the unallocated shares. 84% of the ESOP shares have been allocated.
SVT is an interesting set-up. Expectations are low, but even with a return to a post covid world there may not be a massive amount of upside in the shares. Even if the economy reopens sooner rather than later, there are no guarantees when the ATG business will return. Of course there is a debt with SVT that adds some risk (although I think that is minimal).
SVT may be a good candidate for a net-net basket.
Anyone else look at SVT recently?
*the author does not have a position in SVT at time or writing.