Hutchinson Technology (HTCH) has had a tough few years, but indications are that this is about to change. There's a new product about to be launched which could bring substantial growth back to the company.
Hutch Tech is a leading manufacturer of high tech suspension assemblies. Their primary product is the arm that suspends above a spinning hard drive and allows accurate reading of the information on the drive. The company has experienced declines in sales and revenues along with negative operating cash flow for several years. Most of these declines were the result of hard drives losing market share to solid state memory devices. The 2011 floods in Thailand were a further disaster, as assembly had recently been shifted to a state-of-the-art manufacturing plant there that was subsequently incapacitated by the flooding. The following graph illustrates HTCH share prices over the past five years:
The stock price rose sharply in December and January for reasons that appeared at the time due to cost cutting, refinancing and small improvements in hard drive suspension assembly market share. In February, an SEC filing revealed that Goldman Sachs had acquired a substantial number of shares (more on that below). But why such a sharp increase in price?
A New Product that is a Potential Blockbuster
News is starting to leak out that explains why HTCH has been rebounding. There is a new product that has blockbuster potential which has emerged from development and is now being prepared for production. This author has confirmed that the new product is an optical image stabilization assembly. Using the same expertise that allows Hutch Tech to build an arm that hovers accurately above a hard drive, Hutch Tech is going to start producing camera lens assemblies for mobile and portable devices that will stabilize images through a combination of hardware mechanisms and software algorithms. Hutch Tech holds patents on this technology and, if they can produce these with the necessary affordability, reliability and performance, they could create a huge market.
Of course we're not certain whether or not this new product will be a blockbuster or just a new product line. The company says it is not ready to start publicly discussing their image stabilization product. However, we don't see how investors can lose with this news. If Hutch Tech continues to improve it's core business and the new product contributes a little, the stock price will still improve substantially. If the new product is a blockbuster, the potential of this stock is huge. Here are the key reasons why we believe the stock value will increase sharply:
- The company is undervalued. At a recent price of $2.80 per share, the market capitalization of Hutch Tech is $70.3 million. This is just 28% of trailing twelve month sales, 27% of 2013 revenues expected by analysts, and 24% of 2014 revenues expected by analysts.
- The balance sheet is straightforward and in good shape. At December 31, 2012, the total assets of $342.7 million consisted of $138.5 million in current assets, $199.3 in property plant and equipment, and $4.9 million in other assets; there are no intangibles or goodwill. Liabilities were $181.2 million, of which $52.4 million were current and $127.3 million was long-term debt. Stockholder Equity was $161.5 million. In January 2013, Hutch Tech completed refinancing which reduced its debt by $6.5 million, extended the maturity of some of its long-term debt, and maintained its cash position.
- Hard drive suspension assemblies are experiencing modest sales increases. Industry projections suggest that hard drive sales have found a new floor and will remain relatively stable for at least the next five years. Hutchinson Technology reports that its market share amongst hard drive manufacturers is growing and sales are increasing.
- Margins are improving. By the end of 2013, assembly in Thailand will be restored and recovery from the 2011 flooding will be completed. Unneeded real estate in Hutchinson is on the market and other expenses have been reduced. All of this will positively impact profits and cash flow. The company expects to return to positive operating cash flow this fiscal year.
- The new image stabilizing product can only help. The company has expertise and intellectual property relevant to inexpensive devices that measure precisely even when vibrating or moving. There is clearly a market for a better approach to image stabilization. The company is gearing up, hiring engineers, machinist/toolmakers, and interns. Indications are that Hutch Tech may have the capability to become a leader in the market for mobile optical devices.
- Informed investors are buying Hutchinson Technology. Since early 2012, insider transactions have been decidedly bullish. As part of debt refinancing done during the past year, Goldman Sachs received stock warrants equivalent to 9.9% of outstanding shares, though they are prohibited by provisions of the agreement from holding at any given time more than 4.9% of outstanding shares.
As HTCH returns to positive operating cash flow, the market should return the company to a reasonable valuation. With its current product mix, a market capitalization reflecting book value would yield a share price near $7; at just one times annual sales, the share price would approach $12. If a new optical image stabilizer proves to be a blockbuster, a much higher value would be expected. We believe Hutchinson Technology is a strong speculative buy and have set a $10 target price. As more information about its new product becomes available, we are prepared to revise the target upwards.