CECO Evnironmental: A Pollution Control Smallcap Long Pick

| About: CECO Environmental (CECE)
CECO Environmental Corp. (NASDAQ:CECE) is a leading vertically integrated provider of systems and parts to the air pollution control industry. The Company focuses on engineering, designing, building, installing and monitoring systems that eliminate airborne contaminants and control emissions from a variety of industrial facilities. The Company operates through seven subsidiaries which together have in excess of 1,500 active customers in industries including automotive, pharmaceuticals, metal working, foundries, paper, food, and chemicals.

Although the company has incurred a net loss over the past seven years, now it seems to be the right time to invest in this company. In the last 6 months, CECO Environmental experienced an extraordinary demand of its products and services. Year over year, it´s revenues increased in Q1 by 62% and in by Q2 59%. The strong demand and improvements in it´s operating margin pushed the company into profitability, as it reported a net income of 0.12 cents a share in Q2.

Management holds more than 50% of the outstanding common stock of 12,8 Million shares and various hedge funds hold over 70% of the free float of 4.8 Million shares.


* Phillip DeZwirek (NYSE:CEO): 2.6 Million
* Jason DeZwirek: 3.9 Million

Hedge funds:

* Sandler Capital Management: 1.55 Million
* Tontine Associates: 0.9 Million
* Dynamis Advisors: 0.47 Million
* Stark Asset Management: 0.44 Million

As the company`s backlog, which was at the end of Q2 $43.7 Million (an increase of 66% over its backlog of $26.3 Million at the end of Q205), and its bookings, which were at the end of Q2 $87 Million (an increase of 64% over its bookings of $53 Million at the end of Q205), are still growing at a remarkable high rate, the earnings should improve hopefully at a higher rate if the latest improvements in the operating margin will sustain. Higher margined international contracts, which made up 3% of sales over the last two years (or roughly $2.5 Million in 2005), have increased significantly in fiscal 2006, comprising over 10% of bookings to date.

However, the biggest risk seems to be the high leverage (189% long-term debt/equity) with its loans secured by substantially all of its assets, which may make it difficult to obtain additional debt financing on acceptable terms. Admittedly, according to William Gregozeski, a analyst at Capstone Investments, the company is working to pay off its debt by the end of the year and has received a new credit line, which includes interest rates 175 basis points below its previous rate and less restrictive covenants.

Due to the nature of its contract-specific business, the latest cash flows from operating activities were negative (Q1: -2.0 Million, Q2: -2.4 Million). Sluggish cash flows from operating activities in the coming quarters will be a warning sign, that the managament is unable to transfer revenues into earnings.

The stock is currently rated by only one analyst from Capstone Investments who has issued a Strong Buy rating with an price target of $17. William Gregozeski estimates that CECO Environmental will earn $0.37 in 2006 and $0.70 in 2007.

From a technical perspective, the stock seems to be quite strong:

* It had a strong run-up from $2 in May 2005 to nearly $13 in April 2006.
* The consolidation was a little bit to hefty as it lost almost 50% from its high in April. However, the stock found a very strong support at the 200 day moving average, which is a positive sign.
* The stock consolidated 3 months in a trading range between $7 and $9.
* The breakout on Friday, which was backed by a strong increase in trading volume, above the key-resistance at the $9-level and its 100 day moving average, could signal that the stock will climb to its recent high at $13.

CECE YTD chart:


However, given the strong constitution from a technical perspective an investor should watch closely the improvements in the cash flows from operating activities and possible sales of the mentioned hedge funds.

Disclosure: The author has a long position in CECE.