We have discussed several times how Ceradyne’s seemingly low valuation is a result of peaking body armor sales to the US military. Uncertainty as to whether such sales levels can continue, let alone grow, have led to a current price/earnings multiple of just 11x expected 2006 sales.
We outlined three potential outcomes for investors in our scenario analysis:
1. Base Case: After 2006, military sales are flat as replacement units make up for the initial order fulfillment. The rest of the company can grow 15 per cent. Due to the 80/20 mix of military/other, this translates into total revenue growth of three per cent.
2. Bull Case: After 2006, military sales rise at the company-average 15 per cent per year due to technological advances the military needs or market expansion (i.e. into vehicle armor.) This would mark a total revenue growth rate of 15 per cent.
3. Bear Case: After 2006, with the initial order filled, there is a 50 per cent drop in military orders, but the remainder of the business continues to grow 15 per cent. Given the 80/20 revenue mix, this would mean an overall sales decline of 37 per cent.
An order like this one, even though it is only for a prototype, suggests that the bullish case is possible. Not probable, mind you, but worthy of consideration. For the record, our bullish scenario indicated potential annual earnings per share of $4.80.
Also in the news today was something Ceradyne doesn’t need, but that certainly doesn’t hurt either. The New York Times reports that DHB Industries received a letter from the American Stock Exchange Tuesday warning the company that it did not comply with certain standards for listed companies. DHB has the current contact for the Army vest that may be re-bid (which was also a consideration for the bullish case.)
CRDN 1-yr chart: