It's always great to see the analysis behind the other side of one of our investments. We got to see just that today when Northland Capital Markets initiated on CVD Equipment (CVV) with a $16 price target and an Outperform rating. A copy of their report from their website is here. Once we read today's initiation report, we were easily able to conclude that it actually corroborates our views on CVD and our price target of $5.
Copied And Pasted From His Report Two Years Ago At Now Defunct Broker ThinkEquity
First, today's report is nearly a cut and paste from the analyst's initiation piece on CVD Equipment back from 2011 when he was an analyst at ThinkEquity. It appears that much of the material was copied verbatim from the 2011 report, meaning little has changed with CVD over the past 2 years.
Prior Estimates Were Much Too High
Moreover, it appears that the new initiation report uses the same exact model as was used at ThinkEquity, which was far too optimistic. Look below to see how similar the models look. It appears that the only change was the name of the broker at the top ... and of course the numbers were drastically reduced to better reflect CVV's poor operating performance.
When comparing the models, it's striking just how overestimated revenues and profits were. The 2011 initiation report forecasted revenues of $41.6 million in 2012 and earnings of $0.48 per share. CVD earned just $22.2 million and earned $0.07 in EPS. This means that revenue was overestimated by 87% and EPS was overestimated by 580%!
Another way show the poor performance of the company is to look at today's initiation report which forecasts CVD will have $31.8 million in revenues in 2015, which is nearly 25% below the 2012 revenue estimate from the original initiation report. Bullish investors claim that the poor results were caused by the disruption from moving into a new plant; however, a miss of this magnitude suggests far deeper issues. We explained these issues in our Seeking Alpha articles (here and here) where we exposed the truth behind the graphene hype, highlighted the extremely competitive nature of CVD's business, and showed that CVD has no meaningful intellectual property.
Where's the Graphene?
Another thing that struck us was the lack of emphasis on graphene in both the past and new initiation reports. Graphene is hardly mentioned in either of the reports. While the bulls on CVD focus on graphene, the exclusion of graphene from these reports makes it appear that graphene is irrelevant in the near-term. For what it's worth, this corroborates our view that graphene is irrelevant.
Using the Valuation Metrics from the First Initiation Shows CVD Has A Lot Of Downside
What's most curious to us is that the valuation metrics for CVD have completely changed since the first initiation reports from two years ago. In the original initiation piece from 2011, CVD was valued at 2x 1-year forward revenues (meaning his 2012 estimate). In the Northland initiation piece today, CVD is valued at 3x 2-year forward revenues (meaning his 2015 estimate). Boosting the multiple by 50% on even more distant revenues provides instant upside, but we don't believe the increase is justified given CVD's declining backlog, orders, and revenues. If the same 2x revenue metric was used today, then CVD would be worth just $7.86 per share, which equals 36% downside from yesterday's close of $12.24. Even if we the new 2015 revenue estimate of $31.8 million, we still get 16% downside.
Furthermore, in the original ThinkEquity report on August 15, 2012, CVD's price target was set by valuing the company at 18x forward EPS. If we use that same valuation metric today, then CVD would be worth just $1.98 per share on his $0.11 EPS estimate for 2014!
If we take the current 2015 estimate of $0.35 in EPS, then CVD would still only be worth $6.30 per share!
We don't believe today's initiation report by Northland Capital Markets adds anything new. If anything, it serves to shed light on the ridiculous valuation of CVD today given its declining backlog and order book, and shows that the estimates are most likely overly optimistic and cannot be relied upon.
We believe CVD is a compelling short, and have set a price target of $5 based on its historic earnings, which is a generous valuation for a company that has since turned unprofitable and is now shrinking.