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Profits Amid The Rubble

November 25, 2012 | About:
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Gordon Pape

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No one likes to profit from the misery of others but experienced investors know that even the worst disasters can bring opportunities. So when super storm Sandy battered the north-east recently, contributing editor Glenn Rogers went searching for companies that might benefit in some way. Here's what he found.

Glenn Rogers writes:

The now infamous super storm Sandy continues to be a brutal curse for the north-eastern part of the United States particularly New Jersey and New York. Thousands of people have been dislocated and some areas are still without power three weeks later. Over 200,000 cars were destroyed along with thousands of homes, which will take months if not years to rebuild, while various state and federal agencies try to work out who's going to pay for all this and which of the many infrastructure problems will be tackled first.

Some investors have been wondering what stocks will benefit from a disaster of this magnitude. Many of the obvious plays like Home Depot (HD) and its counterpart Lowes (LOW) have already been picked over as have a number of the storage companies and the life and casualty insurance companies.

I know it's counterintuitive but I added to my positions in Chubb (CB) and Allstate (ALL) because generally what happens is that the insurance companies get knocked down initially and then bounce back later because they're able to jack up rates to recover those initial claims. After that, the higher rates are the equivalent of printing money.

I looked for a stock initially to try to play the used car markets in the area since 200,000 destroyed units, most of which would be fully insured, will need to be replaced. That has to happen fairly quickly so people can get back to work. But most of the publicly-traded dealerships like CarMax (KMX), Auto Nation (AN), and Sonic for some reason don't have much of a presence in the North-east. That may have something to do with quirky consumer laws in New Jersey and New York that make it less desirable for them to set up shop.

So I continued looking for other potential winners in the wreckage and have come up with a relatively little-known small-cap stock called Generac Holdings (NDQ: GNRC) which is based in Wisconsin. And as you can surmise from the name, it is in the business of making generators for industrial, commercial, and consumer use. The stock is not completely unknown because it spiked up right after the storm but the market subsequently corrected and the share price has pulled back from its highs.

If Sandy had come ashore in a poor part of America you wouldn't have expected much of a jump in generator orders since they are expensive, heavy duty, and designed to fully power your home in the event of a natural disaster. These units are different from the portable ones with which most people are familiar, the ones that enable you to keep your fridge going. Most of Generac's equipment is powered by natural gas and is wired right into a house's electrical system so the power instantly kicks into gear and the homeowners who had the foresight to install one go on about their business while their neighbours freeze in the dark.

I have a number of friends in the tri-state area and I'm surprised how many of them had already installed units after the last storm. There is a lot of money in the region where Sandy came ashore and you can bet that there will be a significant surge in orders for Generac's products, particularly since the power companies have had great difficulty getting people back online in anything approaching a timely manner.

Even before the storm, Generac was doing well. In 2011, they had a record year with $792 million in net sales (figures in U.S. dollars). That was a 34% increase from the prior year. Plus, the company feels it has considerable opportunity to grow since currently it has only 2.5% penetration of U.S. households. Every 1% of additional penetration represents approximately $2 billion in market opportunity. Said another way, 97.5% of the homes in the U.S. do not have a backup generator whereas 40% of the homes selling for between $3 and $5 million in Greenwich, Connecticut do have such equipment. Of course, not everyone can afford to protect their home with a backup generator but is certainly likely that more than 2.5% of the population can.

Currently the company has 70% of the market share so they are well positioned to continue to dominate in the segment. The U.S. electrical grid is in terrible shape and given the continuing trend towards wilder weather it is likely that more homeowners and commercial/industrial users will turn to backup power sources to protect their businesses and families.

Late last year the company completed its first major acquisition when it acquired Magnum Power Products, a firm that makes light towers, pumps, and mobile generators. The acquisition was funded by using cash on the balance sheet and was expected to be accretive immediately.

The company generated $158 million of free cash flow last year because of high gross margins and a favorable tax position. This allows Generac to continue to develop new products and to look at additional acquisitions. The company also reduced its outstanding debt by nearly $60 million in 2011.

Another hopeful prospect for the business is that in 2011 only 1% of its shipments were to countries outside North America. There clearly is demand globally and Generac has begun to expand its sales offices into Latin America, Europe, the Middle East, and the Asia-Pacific region. The recent acquisition of Magnum will help jumpstart this effort since 10% of its sales are outside North America and its products are sold in over 50 countries. This should help Generac develop an international dealer presence more quickly than it could have done its own.

Finally, there is another factor that could help extend the value of the company's shares. That stems from the fact that the company is controlled by a private equity firm, CCMP capital, which owns a 59% stake. CCMP took the company public in 2006 after a leveraged buy-out at $13 a share and many people think it is likely that they will sell the rest of their stock before long since that's what private equity firms do. So the stock could get a surprise lift from a future take-out.

The shares closed on Nasdaq on Friday at $35.29. The stock does not pay a dividend so this is strictly a capital gains play. Because it is a small-cap company, we rate it as higher risk.

Action now: Buy with a target of $40.

About the author:

Gordon Pape
GuruFocus - Stock Picks and Market Insight of Gurus

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