National Presto ( NPK) operates in 3 distinct segments: Housewares/small appliances, Defence Products and Absorbent Products. From a business perspective, pressure cookers, ammunitions and diapers cannot be more dissimilar. Still, the company has managed to successfully integrate distinct businesses and gain economies of scale in each segment.
National Presto is currently valued at $600 million in market capitalization. It has no long term or short term debt, $146 million in cash and marketable securities and $310 million in Book Value. The question is, whether the shares are currently priced attractively enough to justify taking a position.
Valuing the Assets
This will be a quick exercise. It is evident that the company is selling at a premium to the book value (almost 2x). This is not a classic Grahamesque investment. Still, there are a few key takeaways that we need to consider.
a. The company has a large amount of cash on hand. Given that the company's 2008 sales were $448 million, you would conservatively expect that the company does not need more than 2% of its sales in cash to support its ongoing business. Given that, about $10 million in cash is enough for the company to continue to operate and support its current level of sales. Therefore, the company can realistically distribute about $135 million in cash to the shareholders without much impact on its normal business. In reality, the company has been distributing the cash to the shareholders as dividends, which are often quite large ($4.25 per share for 2008, the current stock price is around $87 per share).
One reason the company is likely maintaining a large cash position is for acquisitions. This is how the company has grown in the past.
b. The company has a pristine balance sheet. The current ratio is 5.8 which is phenomenal. There is no debt or off-balance sheet liabilities and that points to a conservative management.
c. Current Assets have shown a gradual decline over the years, largely due to high dividend payouts (this is also the reason why the annual cash flow is negative. ) Adding back the dividends to the cash flow puts it firmly in the positive territory. Apparently, the management believes that returning cash to the shareholders is important and it has sufficient liquidity to support its current business and next years growth. I agree.
Earnings Power and durable competitive advantage
The story of National Presto lies in its earnings power. A quick glance at the income statements show that in 2008, the company enjoyed a net profit margin of around 10%, a gross margin of almost 18%. The companies SG&A expense was only about 3.8%. The company appears to be running a very tight ship.
Does the company have a durable competitive advantage that allows it such great economics? It would appear so given the numbers. Also keep in mind that the housewares/small appliances segment is very competitive (Walmart (WMT) being one of the key retail channels) but the company still managed to eke out a 22% gross margin in this segment. This is only possible with much more efficient cost structures than its competitors. This is not a surprise given that the company has been competing in this segment for over 100 years now.
The business in the Defense Products and the Absorbents segment have competitive advantages built in via medium to long term supply contracts with the government and private label customers.
Let us quickly put some numbers to the Earnings Power calculations. We will be using 2008 data from the company's 2008 Annual Report and 5 year historical financial ratios.
Net Earnings: $44.18 million
Assumed Cost of Capital: 12% (suggesting that the company is a riskier investment than the average stock market. This is debatable as the company’s revenue sources are diversified and a large part of the revenue is easily estimated using the existing contracts. A more realistic number would be close to 10% but we will stick with 12% for now to be a little more conservative).
We will adjust Net Earnings to bring it closer to reality. The LIFO method of valuing inventory resulted in an increased cost of sales by about $2 million in 2008. This can be added back to the Net Earnings (also the current value of inventory should be 4.4 million higher after adjustment). One can also assume that the maintenance capex is lower than the depreciation expense on the P&L . Perhaps 25% of depreciation can be added back to Net Earnings (.25x 8.8 = $2.2 million). The company also has unrealized gains on marketable securities which are government bonds and therefore not risky in the amount of 0.36 million.
Adding these to the reported Net Earnings gives us an adjusted net earnings of 44.18+ 2+ 2.22+ 0.36 = $48.76 million
In a zero growth situation, the company's Earnings Power Value or EPV is 48.76/0.12 =$ 406.33 million
To get the intrinsic value of the company we will add to this number the excess distributable cash of $135 million and reduce this number by the interest bearing debt (which is zero).
This gives us a no growth intrinsic value of 406.33+ 135 = $541.33 million.
But the company is not a zero growth company. Over the last 5 years, the company's Net Earnings have grown by 23.34%. Its 5 year Return on Capital is 10.3% (2008 ROC is almost 18%). If you conservatively assume that the company will continue to grow at 10% per year (keeping in mind that there are durable competitive advantages here that protect this growth and margins), than we can recalculate the EPV as initial cash flow/(cost of capital – growth rate).
New EPV in 10% growth scenario is (48.76 – 31)/(0.12 – 0.1) = 17.76/0.02 = $888 million.
Please note that we reduced the numerator by 10% of Total Capital (Equity) assuming to generate 10% in growth, proportional amount of capital would need to be reinvested, reducing initial distributable cash earnings.
Intrinsic value in 10% growth scenario = 888 + 135 = $1,023 million, which is equivalent to $149/share.
The company currently sells for about $600 million, representing a 41% discount to the intrinsic value and should be bought.
Additional thoughts: If the company continues to make smart choices in how to deploy its cash (acquisitions), stays conservative and keeps the business lean, it will likely exceed our conservative estimates. This company may also become an attractive acquisition candidate if the shares stay undervalued for long periods as this is a cash rich and very profitable company.
I bought my initial shares at 85.5 and will add more over time. I do not anticipate losing any sleep over this investment and plan to hold on to it for a long long time.