Daktronics, Inc DAKT
July 17, 2001 - 4:25pm EST by
grant387
2001 2002
Price: 9.37 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 170 P/FCF
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT

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Description

Daktronics is a supplier of electronic scoreboards, computer programmable display systems, and large video displays for sport, business and government applications. Aelred Kurtenbach, who is Chairman and CEO to this day, founded the company in 1968.

Daktronics has consistently grown earnings and sales at very high rates over time. They have accomplished this without a high level of debt, but instead funded their growth by reinvesting in their business. From listening to management, this is an extremely well run company based on solid business principles. The company has a current market cap of $170 million.


FINANCIAL RESULTS

Pertinent financial information for the past 5 years is as follows (in 000’s):

1997 1998 1999 2000 2001

Sales 62.640 69,884 95,851 123,350 152,331
Net Income 1,508 3,392 4,220 6,224 8,625
Income per share .09 .20 .24 .34 .46
Long term debt 2,640 1,659 9,503 8,977 12,004
Equity 21.750 25,184 29,501 36,231 45,823

Annual compounded rates of return:

Sales: 24.8%
Net Income: 54.6%
Income per share: 50.3%

Only once during the last 5 years has the increase in net income per share been less than 35%, and in that year it was 20%. As I will discuss later, earnings come in uneven flows, but they certainly do come in. DAKT has shown an acute awareness for running a very trim operation. They focus on maintaining improving margins for their business. Over that past three years, the gross profit margin has increased from 27.3% in 1999 to 27.8% in 2000 and to 29.7% in 2001. Their net income as a percentage of sales has increased from 4.4% in 1999 to 5.0% in 2000 and to 5.7% in 2001.

The company had two for one stock splits in December 1999 and June 2001 and all per share data represent those stock splits.




FORECAST FOR THE FUTURE

According to the latest annual report (their fiscal year ends on the last Saturday of April each year), the company expects to grow revenue at 20% a year and net income at 25% a year. This annual forecast was reiterated in a press release this past week. The company has looked to these growth rates the last few years and has exceeded them by substantial margins.

What is interesting is that the earnings have never come in a consistent linear growth pattern with each quarter increasing over the quarter prior. Rather, the earnings are rather “lumpy” as Charlie Munger might describe them. An example of the last two years of quarterly net income per share is as follows:

1st Quarter 2nd Quarter 3rd Quarter 4th Quarter

2000 0.10 0.13 0.05 0.06
2001 0.11 0.18 0.08 0.09

As the 10K states, “The Company's net sales and profitability historically have fluctuated due to the impact of large product orders, such as display systems for the Olympic Games and major league sport facilities, as well as the seasonality of the sports market.” One thing is tremendously clear and that is that annual earnings have grown at very high rates of return in a consistent manner. The other aspect is that management has no concern whatsoever to “manage earnings” to please Wall Street.

In today’s environment of so much scrutiny over quarterly earnings, a huge opportunity is presenting itself to investors. The company is extremely forthright and seemingly honest about their operations. I would urge you to listen to their latest conference call at http://www.vcall.com/NASApp/VCall/ConsoleFrameset2?ID=75263&brand=vcall&playerID=0&urlID=69769 and listen for yourself. Management has openly stated that earnings will not grow consistently from one quarter to the next in a beautiful sequential pattern. Management does not offer quarterly guidance, but they do have annual goals they set. You get the feeling that they would fit in Warren Buffett’s world very easily, in that they are concerned about long-term growth, not what happens every 90 days. In fact, with a company headquartered out of Brookings, South Dakota, this has Buffett written all over it.


THE OPPORTUNITY

In a July 12th press release, Daktronics stated that earnings for this upcoming quarter will not meet analyst’s expectations. Now keep in mind, Daktronics did not provide quarterly guidance. In fact, the anticipated earnings figures will be significantly below the quarterly estimates that the analysts came up with. (Not sure how many analysts are really covering a $170 million market cap company, three I believe).

Thus, the stock dropped tremendously during the days following this announcement. In fact, on June 28, 2001 the stock traded at $17.35 and today it is trading at $9.37.

What is the most important aspect of the July 12th press release is that management reaffirmed that their long-standing targets of annual sales growth of 20% and annual net income growth of 25% will be expected to be met. The fact is that this company just has lumpy earnings.

Nothing has changed in the operations of the company. No significant sales decline has taken place. Profit margins are not being squeezed. The analysts and the media have shown this recent announcement to be some type of “problem” when in fact, no such problem exists.


VALUATION

DAKT has had its share of good press given to it over the years. They have been mentioned in many periodicals over the past few years and have recently been written about in Motley Fool and been mentioned on numerous financial programs. The company has deserved all of the credit; it really is a wonderful business.

Due to this increased press, the P/E ratio has increased steadily over time and a couple of weeks ago at its high; it was trading at a trailing P/E of 37.7. That’s a number I’d have an incredibly hard time justifying. However, since the price has fallen off the cliff, the trailing P/E is now at 20.4. Given their outstanding historical income growth rate and very high expectations by management in the future, this number is much more reasonable. In fact, I believe DAKT to be a truly outstanding business and can easily justify this P/E ratio. With a 25% increase in earnings per share, the company is trading at a 16.3 P/E ratio for the next twelve months. This is normally a valuation that is higher than I’m accustomed to, but given the fundamentals of this company, it is truly a bargain.

The price to sales ratio has now fallen to 1.11, which is an outstanding value given this business. Running discounted cash flow figures provides an intrinsic value significantly higher than its current market value. This is an outstanding business trading at a reasonable (or arguably inexpensive) price and is a classic Phil Fisher company.


OTHER CONSIDERATIONS

The following will provide additional background on this company that I’ve included as part of my research. I do like to examine a number of both qualitative and quantitative criteria when analyzing a company. Thus, for those that don’t want to read a bunch of words, this would be the place to stop. I’ve included some excerpts from their latest 10K, as I believe they provide a good education on the business. The link to the 10K is http://www.sec.gov/Archives/edgar/data/915779/000089710101500406/0000897101-01-500406.txt (you can’t get the entire copy on edgaronline.com.)


Market and Competition

The markets for DAKT break down into essentially three main customers:

(1) SPORTS (66% of sales), consisting of Elementary and secondary schools, colleges and universities, recreation centers, YMCAs, major and minor league sports teams and facilities, Olympic games, national and international sports federations, civic arenas and convention centers, pari-mutuel gaming and motor racing;
(2) BUSINESS (20% of sales), consisting of banks, auto dealers, shopping malls, casinos, retail stores, hotels, motels and other businesses; and
(3) GOVERNMENT/TRANSPORTATION (14% of sales), consisting of legislatures and assemblies, departments of transportation, financial exchanges, aviation, and transit.


They really compete in a very fragmented, niche market. Daktronics has created a very high brand awareness in their market and are continuing to expand upon that. Over time, DAKT has become a leader in this market

As the 10K points out, “Most of the manufacturers of computer programmable displays that are used to show alphanumeric data and graphics do not manufacture large screen video displays. Conversely the large video manufacturers do not manufacture computer programmable displays. Daktronics, however, manufactures both computer programmable displays and large video displays. This places Daktronics in a uniquely beneficial position to serve venues that have both requirements such as the typical large sports venue. Daktronics, through the use of its proprietary Venus(R) 7000 software, also has the unique capability of time sharing a large screen such as in a large stadium or arena between the video display functions previously provided by the large video display and the information and animation display functions previously provided by computer programmable display. Having all these functions integrated into one ultra large display system gives the venue owner significant flexibility in managing the information and entertainment presentations that has not been available previously. It is the opinion of the Company's management that the advent of digital television will further stimulate the ease and value of combining these video and information presentations into a single display system.”

The company goes on to state, “Many of the Company's competitors compete in only one or a few of the market niches served by the Company. There are generally more competitors in markets that require less complicated information display systems, such as the high school scoreboard market and the commercial market for time and temperature or message displays used by banks and small retail stores. As the needs of a customer increase and the display systems become more complex, there are fewer competitors. Nevertheless, competition may be intense even within markets that require more complex display systems. Some of the Company's primary competitors are Mitsubishi, Tokyo, Japan; White Way Sign and Maintenance Company, Chicago, Illinois; Nevco, Inc., Greenville, Illinois; Trans-Lux Corporation, Norwalk, Connecticut; and MultiMedia of Rancho Cordova, California.”



CONCERNS INTO THE FUTURE

That the slowing economy will prevent new stadiums from being built
This is the beauty of this company. Should new sports complexes not be built at the pace they have in the past, DAKT does a very significant amount of business in upgrading existing stadiums. Sort of like a Home Depot effect, if one can’t afford to build a new home, they will certainly continue to remodel.

They run out of new markets
After studying this company, completely the opposite seems to ring true. There is virtually no foreseeable limit to the potential for this company. An example is that they recently sold displays to a number of McDonald’s franchises. These have been very well received and they have only touched the tip of the iceberg in the fast food industry displays that exist. They just contracted with two large soccer stadiums in England to provide displays. The international market has barely been tapped at this point.


Inventories rose 42% during the past year
Upon taking a look at the inventory increase, it does not seem to cause an alarm, given their large rise in sales and earnings over that past year. The increase in inventories is broken down as follows:
2001 2000
-------------------------------
Inventories:
Raw materials $ 9,610 7,403
Work-in-process 2,439 1,341
Finished goods 7,670 5,105
-------------------------------
$ 19,719 $ 13,849
=======================

The CEO is about to semi-retire
Two years ago, the founder and CEO announced that he would be planning on taking on a diminished (part-time) role in 2001. At that point, they began forming a succession plan and in the latest conference call, the CEO assured everyone that that plan is ready to go and he will soon be working fewer hours. Although, he made it very clear that he was not walking away entirely. It is obvious that this is a well-run company and no big decisions are made in a hap hazard way. He has clearly taken the time to make this transition seamless and will do so with the company’s best interests in mind.


SUMMARY

DAKT is an outstanding company with a strong history. It is a leader in its market and continues to strive to attain high levels of growth in sales and income going forward. The stock has seen a recently plunge of 46% for no logical reason. The market is providing us with an opportunity to purchase shares of a great small company at a discount to its intrinsic value.

Catalyst

1) Daktronics has performed exceptionally well the last number of years
2) Significant recent favorable press assisted the stock price in rising substantially over the past few months
3) A recent press release has been incredibly misunderstood by the market and the price of the stock has fallen 46% in the last weeks
4) The opportunity exists to purchase an outstanding business at a reasonable (or arguably inexpensive) valuation
5) A classic Mr. Market story
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