At a glance, the results from their first 3Qs don’t look that impressive. Revenues are up 2% YoY, and operating income has actually gone down 15% due to an increase in COGS.
However, I think this hides in a way the underlying strength of the business. Revenues for the third quarter alone were up 26%+, and operating income was up 65%+ due to a huge increase in gross margins.
So what’s going on here? Basically, the company’s first quarter last year was unusually strong as one of their customers stockpiled inventory. That’s making their year over year comparison look rougher than they really are.
But the company is 1) still (very) profitable 2) growing and 3) has a huge cash balance.
Let’s drill down a bit into 3 and then 2.
The company’s cash balance + marketable securities are up to $9.66m, or $12.45 per share. This for a profitable company trading at just over $13 per share!!!!
The question then becomes- how good is the business that you’re buying for that last $0.70 (~$550k)??
And it turns out it’s a pretty good one! ROIC is consistently >25% with strong margins, and the company is starting to show signs of good growth.
The company included this quote in their most recent 10-Q
So orders are flat year over year, backlog is up, and we have sales guidance.
Compared to the third quarter of Fiscal Year 2011, sales are up 26%. During the third quarter of 2012, the company booked $1,197,000 in new orders compared to $1,949,000 in new orders booked for the second quarter of 2012 and $1,190,000 in new orders booked during the third quarter of 2011. Our backlog of unshipped orders was approximately $2,538,000 at the end of third quarter, down approximately 18% from $3,103,000 at the end of the second quarter of 2012 and up 64% from the $1,545,000 backlog at the end of the third quarter of 2011. We currently expect fourth quarter sales to be approximately $1,600,000.
Last year, the company included sales guidance in their 3Q 10-Q as well. They guided towards $1.1m in sales and ended up doing ~$1.2m.
So, based on the company’s guidance (which may prove too conservative), sales should growth 33% year over year. Profits should actually increase by more than that year over year because the company notes that they get a modest bit of operating leverage from increases in sales.
But even if we don’t model in any operating leverage, we can get a good approximation of what the business is going to earn. Using their sales forecast, revenue for the full year should come in at $6.4m. Assuming constant margins from the first 3Qs (a bit over 15%), operating income should come in at $985k, or ~$1.25 per share. If you assumed a normal tax rate of 35%, the business is generating $0.81 in EPS.
In other words, OPST is selling for a P/E of less than 1x after adjusting for cash.
I’ve said it before, but I think the right valuation for OPST is to value the business at 10x operating income, add in the value for their cash and securities, and use that as your “fair value” target. Perhaps you apply some form of discount to the cash because, even though management is not doing anything outrageous with it, it also appears they don’t have plans to distribute any time soon.
If you used that method, you would come up w/ a fair value for the operating business of $12.50 per share and a fair value for the cash of $12.45 to arrive at a target price of ~$25. Even if you used an 8x multiple for the business and applied a 40% discount to the cash, you’d get an op. business value of $10 and a cash value of ~$7.50 for a target price of $17.50.
In other words, no matter how you slide it, I think there’s a pretty strong margin of safety in OPST shares at today’s prices.
Disclosure: Long OPST