Hutchinson Technology (HTCH) closed Friday at 2.05, a stunning 90% discount from its book value, approximately $20 per share. Hutchinson's primary operation is the design and manufacture of disk head suspension assemblies. Principal customers include Seagate (STX) and Western Digital (WDC). They closed their 2008 fiscal year on a sour note, with a large, non-cash write-down of Deferred Tax Assets. The company has strong R&D, proprietary and patented technology, and precision manufacturing expertise. In addition to the write-downs, 4th quarter results were hurt by “ramp-up” expenses on their TSA+ technology, which is now in production.
I have followed HTCH for several months, originally buying it at 14.xx for both my personal and Marketocracy portfolios. I sold the personal holding at a small loss, not because I saw problems with the stock, but because I wanted the funds for other purposes. I added to the Marketocracy position as prices declined this month. The shares are now blowing up and down Wall Street, like $20 bills in the wind, waiting to be picked up by passersby.
The situation reminds me of a case where I made some pretty good money in June 2007 – Komag (KOMG), a manufacturer of disks for disk drives, with the same set of customers that HTCH has, ran into a slowdown and the shares tanked to well below book value. The company appeared to be well-run and had a strong balance sheet. I was able to buy it in the low teens, as I recall, and it was acquired by Western Digital for 32.25 per share. The disk drive industry is in the process of consolidation. It was an agreeable experience, marred only by the relatively modest size of my position, and one I would like to repeat.
HTCH originally came up when screening the sector for strong cash flows, and is now trading at .46 of cash flow, according to Morningstar. Anything under 8 X cash flow is attractive: but, .46? When analyzing stocks, I like to compute a ratio of earnings to cash flow – some companies are aggressive with depreciation or for other reasons show very low earnings compared to cash flow. Hutchinson averaged something over 4 per share cash flow from 2003-2007, with earnings frequently less than half that amount. The 10K section on accounting principles says they test cash flows associated with assets and impair when they see problems. Because most of the assets are building and equipment, I would have expected usable lives and straight line depreciation, but what I saw was testing for impairments.
Technology moves fast in the computer business, so maybe their approach is realistic.
Cash and investments stands at around 11 per share, long-term debt is 90% of equity, higher than I prefer. The quick ratio stands at 4.5, the current ratio is 5.7. They have long term debt to renew in 2010, but cash and investments on hand cover the amount, and cash flow, as noted, has been strong. Earnings have been pressured by the slowdown, and I see little reason to anticipate that 2009 will be easier than 2008. However, management expects that they will maintain market share in 2009, and they continue to do their R&D and keep up with the industry. Expenses have been pared as necessary., promptly and decisively. If and when TSA+ achieves greater acceptance, gross margins and profits should increase as production ramps.
There is 72 million remaining on their buyback authorization, after they spent 57 million during the last quarter buying shares at an average price of over 16. 23 million shares remain. Here's the interesting thing: 72 million divided by 2.05 per share is 35 million shares, but there are only 23 million left to buy. I expect that the company will repurchase as many shares as prudent cash management permits. Wayne Fortun, President and CEO, recently bought 20,600 shares at 4.68. At 2.05 per share, today's investor can do substantially better than this insider, always appealing.
I have had good luck over the years with situations of this type, a technology stock with a strong balance sheet and a genuine business, trading at a discount to physical assets, usually on concerns for industry slowdowns. At times Teradyne (TER) and Pericom Semiconductor (PSEM) have met this profile.
In any event, I am going to scoop up shares of Hutchinson; otherwise they will just blow away and be swept up as litter and recycled or burned. What I need is one of those sticks with a nail sticking out of the end, to spear them off the ground.
Disclosure: Author holds a long positions in HTCH, no positions in PSEM, TER, WDC or STX