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