Why I'm Long Vishay Intertechnology

Electronics components manufacturer Vishay Intertechnology (VSH) recently announced third quarter earnings, a loss of 1.68, caused primarily by non-cash write-downs of goodwill. This follows large write-downs for the 2^nd quarter, which resulted in a loss of 3.89 per share. In spite of the negative news, VSH is attractive at yesterday's closing price of 4.33, based on a tangible book value of 8.36 per share and a cash flow which has averaged 1.52 per share for the past 5 years. Management's philosophy and strategy is well thought out to take advantage of these strengths.

Guidance for the 4^th quarter calls for revenues of 640 to 670 million and flat gross margins. Working that out, and subtracting the previous quarter's SG&A and an estimated 10 million of restructuring, I get .08 earnings before items, a small profit in today's deteriorating environment. As a practical matter, VSH has for many years reported earnings that are a fraction of cash flow: I think the long-term cash flow is a better indicator of value in this case. Priced at 3 X 5 year average cash flow, VSH is cheap.

The company has done many acquisitions over the years, and as such has accumulated a large amount of goodwill on the balance sheet. Due to deteriorating stock market conditions they they have been conducting tests and seeing impairments motivated by the extremely low market multiples for businesses in their sector. Looking past goodwill impairments, which are non-cash, the tangible book value remains: as noted, 8.36 per share, providing margin of security. Cash on hand is approximately equal to debt, very comforting as the global economy falters.

Over the past five years, Vishay has traded at an average Price/Sales multiple of 1.1. It currently trades at .28 X Sales. Looking past the difficulties we all expect in the next few quarters, they should be able to return to a similar valuation, which would give a target price of 15, perhaps within the next two or three years.

The company recently abandoned its effort to acquire International Rectifier (IRF). Because conditions in the industry are deteriorating, the proposed acquisition ran the risk of being ill-timed, and it may be possible to do other acquisitions at more favorable prices over the next few years.

I read the transcript of the 3^rd quarter conference call, available at Seeking Alpha. There were a good number of participants, but the questioning focused mostly on accounting issues and projections, which are very difficult to make right now as realistic management will confess to poor visibility. September and October developed poorly with deterioration in orders, backlog and book to bill.

However, the last questioner, Jonathan Kaplan, asked about share buybacks, dividends and reduced capex. Vishay, as noted, has a very strong cash flow and cash on hand. Mr. Kaplan appears to be an activist investor who would like to see his share price increased by devoting cash flow to the listed actions. Lately we have seen a number of companies reducing dividends to conserve cash. There have been a good many financial companies that have had to raise capital at very low share prices to replenish capital wasted on expensive buybacks. Capex for VSH frequently means acquisitions, but the question could be extended to R&D, which management believes is critical to future performance.

Felix Zandman, Founder and Executive Chairman, fielded the question, and I have selected the following from his response:

We will continue with acquisitions because we believe strongly that acquisitions after restructuring do bring us to a growth...is true that for the future we have to be careful, and we always have been careful. With ten acquisitions we’ve made, we never made a slip-up on that. They have been all positive. Sometime people make acquisitions, they lose money on some. We have been always accretive as of the first quarter... I agree with you that we must tighten the belt and reduce cost as much as possible. ... we have determined many times that paying a dividend is much less for the shareholder, much less beneficial than acquiring a company...every time we look at that, paying dividends doesn’t make sense. .. Concerning buying back shares, yes, it is not a best strategy when you have free cash to do that. To borrow money today to acquiring shares, even at those prices, and in view of the interest you have to pay today, if you get any money, is negative. To spend our – we have 400 – we have presently some $350 million in cash, but we have $350 million in debt. At this point, we don’t want to touch it. Cash is so important. We don't know for how long we’ll be going into the recession. And it’s very important for the company to be stable and good. The product lines are okay. And our job is to produce earnings per share, free cash for future growth. And that’s what we are trying to do. If you have any suggestions and so on, please call us and you can state something...

I think this response pretty clearly shows what Vishay's strengths and strategy are. Acquisitions as a growth strategy are good if done at reasonable terms and integrated successfully. Management, when questioned on the rejection of the International Rectifier offer, saw it as a positive - as the situation developed they avoided the risk of a poorly timed acquisition. The global recession will create future opportunities for acquisitions, and Vishay will have the cash and cash flow to participate profitably.

Also, in the face of a recession, it is tempting to reduce expenses by trimming R&D. Management specifically affirms (earlier in the call) that they will continue R&D at a pace designed to foster future growth. All in all, I think VSH is a good stock to own at today's prices going into a difficult period for the economy.

Disclosure: Author holds a long position in VSH

Comments

[Larry House:]

VSH MAY be a great bargain. It is closely tied to the consumer, and the consumer is a big question mark. Personally, I favor value stocks over growth right now, but the line between the two is all cockeyed. I have owned VSH in the distant past, but it holds no arraction for me now. I hope you come out really well on VSH. I just can't pull the trigger on it at this time.

2008 Oct 29 03:40 PM

[Larry House:]

That's "attraction." My fingers won't work right!

2008 Oct 29 03:41 PM