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National Presto Industries (NYSE:NPK) operates in two primary segments: Defense Products and housewares/Appliances.The Defense Products segment makes precision mechanical/electro-mechanical assemblies and medium caliber cartridge cases, and performs load, assembly, and pack operations for the U.S. government and prime contractors. Its Housewares segment distributes various small appliances to retailers in the U.S.

Initiating with BUY rating. Dec 8 2008 - National Presto Inds. (NPK) - The Best Offense is a Strong Defense. Initiating Coverage with a Buy Rating.

  • Although under-the-radar, NPK’s growing and highly profitable Defense Segment is expected to generate approximately 75% of operating income.
  • NPK has no debt and $120 million or approximately $17.50 per share of balance sheet cash that could be used for accretive acquisitions or paid out to shareholders as dividends. The estimated forward dividend yield is 8.1%.
  • Management has delivered solid results and we believe the company’s diverse set of uncorrelated businesses provides diversification for investors.
  • Given strength in Defense, its solid financial position, and strong operating results, we are initiating a BUY rating...

RISKS

  • Defense Product sales are dependant on Department of Defense spending. The new presidential administration may attempt to reduce defense spending. We do not expect a material decline in NPK’s Defense business.
  • Sales of the Housewares/Small Appliance segment are dependent upon the strength of U.S. retail markets and consumer spending, particularly during the holiday season. We are modeling weaker Q4:08 sales and margins in this segment.
  • The company may be unable to bring the Absorbent Products business to profitability or to realize value in this segment.

INVESTMENT THESIS

  • Strength in Defense. Historically (from the 1940’s into the 1970’s) National Presto operated in the defense industry but by the early 1990’s the company was no longer in the defense business. NPK acquired Amtec Corporation in 2001, Spectra Technologies in 2004, and assets of Amron LLC in 2006 (see Defense Products below). In 2005, the Defense segment represented less than 20% of total company revenue, but in that same year NPK was awarded a lucrative and high-volume prime contract for the Army’s five-year 40mm systems program. By 2007 the defense segment represented 53% of total company sales and two-thirds of operating profits. We project 53% of sales and 77% of operating profits derived from this segment in 2009. We note that recent militant terrorism in India highlights the continued need for defense spending, even with a new administration in the White House.
  • Diversified Segments. We think the company’s business segments are uncorrelated to each other and somewhat defensive in difficult economic times. For example, the Defense segment is not generally a cyclical or seasonal business. We also believe that the Defense Department likes to maintain a stable domestic supply of munitions such as those supplied by NPK. Most munitions used by U.S. troops are detonated for training purposes within the United States, so even if the new presidential administration were to engineer a withdrawal from Iraq, demand for NPK’s munitions should remain high. Growth could come from new military programs or through tuck-in acquisitions. Having reliably executed the 40mm program for several years, we think NPK and its subsidiaries could be considered for other defense contracts. With approximately $120 million of cash and no debt, the Company is well-positioned to seek targets similar to Amtec, Spectra and Amron.

    The Housewares/Small Appliance segment is not immune from economic woes and declines in consumer spending, especially during the holiday spending season. Our thinking is that Presto’s products should not be as negatively impacted as big ticket durable goods such as auto’s and larger appliances. The company’s goods are smaller consumer items that make good holiday gifts, even during a recession. Presto could benefit from the stay-at-home / eat-at-home trend as most of their products are for the kitchen. The business could also benefit by taking share from weaker competitors who may not be as financially stable in leaner times. Profit margins should benefit from lower raw material costs with declines in resin costs for plastics and commodities such as aluminum and copper. Lower petroleum prices impact material, fuel and processing costs favorably – although this could be offset by somewhat lower volumes and discounting. We note that all of the unit’s goods are produced in the Orient, primarily China, and sales and gross profit margins benefit from a stronger dollar.

    The Absorbent products segment is not viewed as highly cyclical but more like a consumer stable with sales expected to remain consistent even in a weak economy. The company makes generic products which should actually benefit from a “trade-down” mentality in tough times – as consumers will still need diapers but they may not need the most expensive name-brands. Segment performance is extremely sensitive to material commodity costs, including such items as wood pulp and petroleum based products. Freight and energy costs can also have a significant impact on overall results.
Source: National Presto Industries: Initiating with a Buy