RF Industries RFIL
June 16, 2009 - 10:41am EST by
surf1680
2009 2010
Price: 4.00 EPS $0.30 $0.35
Shares Out. (in M): 3 P/E 12.0x 11.0x
Market Cap (in $M): 12 P/FCF 13.0x 13.0x
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 9 TEV/EBIT 5.0x 5.0x

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Description

 

 

RF Industries is a connector company in a competitive, low tech industry.  It's a compelling buy because it trades below working capital, has a stable earnings history, conservative management, and it's revenues didn't shrink as much as the competition during the recent economic crunch.  It appears in multiple "value" screens, and not just for cheapness.   At today's share price, all you are paying for is their cash and a diversified collection of useful connectors at below wholesale prices.  You can sell these connectors back to Mr. Market at a premium when Mr. Market realizes, once again, that the connector industry is here to stay. 

 

From Wikipedia, "An RF connector is an electrical connector designed to work at radio frequencies in the multi-megahertz range. RF connectors are typically used with coaxial cables and are designed to maintain the shielding that the coaxial design offers. Better models also minimize the change in transmission line impedance at the connection. Mechanically they provide a fastening mechanism (thread, bayonet, braces, push pull) and springs for a low ohmic electric contact while sparing the gold surface thus allowing above 1000 reconnects and reducing the insertion force. Research activity in the area of radio-frequency (RF) circuit design has surged in the last decade in direct response to the enormous market demand for inexpensive, high data rate wireless transceivers."

 

Long term trends in their favor.

Connectors are getting more expensive, more specific and more complicated.  Price and sophistication of connectors will likely continue to increase, at the same time, the availability of older connectors needs to be maintained.  The trend is reinforced by FCC requirements.  Different types of connectors, even for the same type of signal, are being required for different uses.  The idea behind this is that it shouldn't easy for a consumer to plug a large television antenna into a wifi base station (even though it may dramatically improve the performance of the wifi base station).  At the same time, engineers like to differentiate product designs by specifying unique connector types. 

New product lines come out, old product lines are orphaned.  Clever companies like RFIL quietly fill the gap to manufacture and maintain the old inventories.  RFIL has developed a reputation in the industry for this.

USA is "undercovered" by 3G and Wimax.  Wireless expansion will grow.  The connectors and wiring harnesses RFIL provides will be needed as wireless networks grow.   Wireless providers (the actual end-user for RFIL's products) have been able to maintain their pricing power in this recession.  Even more impressive is how they compete based on network coverage.  As long as this remains the case, the outlook for network growth should be strong.


Several important value screen points are being met:

-Trading at 12x unleveraged earnings vs. recent past when it traded at over 20x earnings

-Trades at a historically large discount to book value and working capital

-The share price has suffered from 3 years of declining annual returns.  Investors are exhausted and have likely given up hope.

-Insider purchases.  Management owns 12%.  Small, open market purchases were made during recent stock dip at current price and at lower prices.

-No analyst coverage.  Too small and no investment banking needs.

 

The most compelling reason to buy this stock revolves around a study of the share price relative to their tangible book value.  At this price you buy the company for inventory and cash, or .76x book value.  Over the last 12 years they've traded at an average of 1.8x book value.  Their business model hasn't changed much over the last decade.  They've always been profitable.  The mix of their assets and capital structure has remained consistent over time.  If you focus on just their 2 hardest assets, cash and inventory, they are trading for less than their total, which hasn't happened (using historical average share price).

 


current

2008

2007

2006

2005

2004

2003

2002

2001

2000

1999

1998

1997

1996

share price

3.95

6.01

6.50

6.18

5.91

7.53

3.58

2.36

2.98

5.13

1.86

2.03

3.83

3.28
















book value

      5.21

  5.00

   4.55

  4.14

  3.64

  3.49

  2.99

   2.79

  2.67

  2.40

  2.06

   1.82

   1.54

  1.30
















inv %

38%

37%

33%

39%

37%

36%

43%

43%

52%

51%

37%

44%

48%

52%

cash %

45%

49%

53%

51%

40%

43%

33%

41%

29%

34%

48%

42%

32%

28%
















p/b

      0.76

  1.20

   1.43

  1.49

  1.63

  2.16

  1.19

   0.85

  1.12

  2.14

  0.90

   1.12

   2.49

  2.52

 

 

Site Visit.  It didn't look like a recession had hit.  It appeared they were working at nearly full capacity.  The parking lot was full.  They operate in a run down industrial park in an inexpensive part of San Diego.  The CEO's office was outdated and shabby.  Informal interviews with employees and other industry personnel (offsite) revealed common thread about tremendous uncertainty in the future.  CEO is not issuing guidance.  He is optimistic about their use of the cash in the near term for a possible acquisition.  He likes small, low risk acquisitions.  He doesn't like financial leverage.  Another executive said the last half of the year will be better than the first half (as is usually the case with this company).  I get the feeling that earnings may continue to deteriorate but that they are staying ahead of the curve. 

Every January, they send out a survey to their biggest customers for the year's outlook for product orders.  They didn't tell me the results of the survey but they laid off 9 people at the beginning of the year and all the remaining employees took 5% pay cuts.  I was impressed at their discipline to cut because this was right on the heels of 2008, a record year, and they have record amounts of cash.  They also said 2006 started out slow, like this year, and then turned into a great year.  The CEO said they stopped paying a dividend because he thinks he can make better use of the cash in this market.  I get the feeling he is shopping.

Since it's a tech company for balance-sheet centered investment idea, I was most concerned about the inventory.  They basically outsource to Taiwan the manufacture of rf connectors.  Their key competitive advantage is their product availability.  They aim to keep 5 months worth of product on the shelves.  Lead time on manufacturing new product can be 2 months.  They use a computer inventory tracking & planning program that is supposed to level out spikes and dips to decide on how much inventory 5 months actually is.  They are getting discounts on manufacturing costs by prepaying.  They are also picking up new product lines as other manufacturers discontinue support.

 

Compared to other players in their space, revenue seems to be holding up.  Sequential sales aren't down nearly as much.

 

 

comparable

sequential

 

 

quarter

 

quarter

molex telecom

-37%

 

-24%

commscope

-26%

 

-14%

richardson

-14%

 

-14%

tessco

 

-23%

 

-20%

amphenol

 

-14%

 

-13%

average

 

-23%

 

-17%

 

 

 

 

 

RFIL connectors

-12%

 

-6.5%

RFIL total

 

-28%

 

-2.90%

 

 

 

 

 

*richardson mrq ended 2/28/2009

 

** rfil mrq ended 4/30/2009

 

 

*** tessco mrq ended 3/29/2009

 

 

Aside from connectors, RFIL has 2 other segments that are small contributors (under 20% total) to revenue.  These 2 segments (1) medical and (2) wireless communication devices, have higher margins and lumpy revenues.   The products are more unique and these segments are potentially higher growth areas.  They are immaterial to this investment thesis but represent additional upside.   These 2 segments contributed most to the drop in comparable quarter revenue, so I backed them out to show only RFIL's core connector business.

 

Risks & Why the stock is cheap:

Uncertainty in financial markets has lead to a temporary pause in wireless infrastructure projects

Tiny trading volume.  Share price is prone to collapse.

Mixed messages from management.  Shareholders don't like to hear stuff like this:

(1)   They are cutting dividend off.

(2)   They are talking about growth via acquisition

(3)   They are not issuing guidance

 

 

Catalyst

 

Buyout - Somebody wants to buy a lot of connectors for wholesale.

 

Effective Use of Cash to improve efficiency, make acquisitions

 

Increase in wireless capex

 

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