The global economic meltdown that occurred in the final third of the last decade took a wide range of commercial casualties, but very few industries suffered on the scale of those associated with infrastructure, the epicenter in housing as it was. Private industry construction projects ground to a halt as lines of credit closed, and governments squeezed spending on both new and existing public works. At the same time companies across nearly every other industry froze expenditure and halted growth. Fast forward five years and the bad times are now presenting investors with opportunities, with some of them completely off the radar. WPCS International (NASDAQ:WPCS) is one of them. Here's why:
Before considering the opportunity that WPCS presents, a few basics on the company's operations and day to day business.
Headquartered in Pennsylvania and with operations across the United States, China, and Australia, WPCS provides design-build engineering services for communications infrastructure worldwide. It currently employs a team of 250 staff, the vast majority of which are electrical engineers but which also includes a sales/administrative team and, of course, a small executive team. The company focuses on three main areas of operation; wireless communication, specialty construction, and electrical power. It is completely technologically independent, and provides a 360 degree service that includes design, project management, installation and maintenance.
Within the company's three main operational areas its focus is on markets with high demand for advanced communications and infrastructural technology. The main markets in which it operates are healthcare, public services, energy and corporate enterprise.
During fiscal year 2013 (page 7) the electrical power side of the company's operations drew the most revenue, accounting for approximately 46% of total. During the same period wireless communication operations accounted for a little over 40%, and specialty construction operations accounted for around 12% of total revenue.
This is all well and good, but what does design-build engineering for communications mean? The best way to describe what the company does is by way of example. Taking the wireless communication/public services arena, WPCS designed, installed and serviced the wireless network system used by the emergency services in Cape Coral, FL. Another notable one: WPCS is in the process of installing an integrated communications network that will act as the first response system in the new World Trade Center Towers. High profile for a stock fallen drastically out of favor recently.
The opportunity that WPCS presents investors is rooted in turnaround. The company was hit hard by the recession and as a result its financials suffered. Its market cap has hit rock bottom last year at an anemic $4.5M from pre-recession high of about $122M, and shareholders had to endure a 1:7 reverse split in May to keep it out of nominal penny territory. In light of this, a consideration of the past few years financial reporting will likely give an inaccurate view of the company's potential. With infrastructure spending picking up it is becoming increasingly apt to consider pre-recession operations as an indication as to what the future might hold. For this reason, this article will consider financials from the past five years.
In 2007 WPCS reported revenues of a little over $70M which, with an operational expense of approximately $62M translated to a net income of $4.5M. Throughout 2008 the company acquired a host of smaller electrical engineering firms which drove a revenue increase to a little over $101M for the period. The revenue increase resulted in a corresponding rise in operational expense, around $95M, resulting in a net income of just under $4.1M. At the time of the 2008 reporting the company's stock was trading at around $5.5 with a market capitalization just shy of $60M based on around 7.3M shares outstanding.
In 2009 the company reported further revenue growth. Revenue increased by around 6% to just short of $108M, with a net income of $1.7M. At the time, it employed over 300 engineers, a decent sales force and a solid executive team the company looked set to become a global leader in its industry. Then the global infrastructure industry ground to a halt. In 2010 revenue fell to $105M which, with operational expenses of a little over $104M, equated to a net income of approximately $500K. The company's market capitalization fell to $20M. During the next year things got worse. For the fiscal year 2011 WPCS reported a decline in revenues to $96M and a net loss of just over $37M. The company's market capitalization dropped again to a little over $18M.
At this point things started to turn around. The company streamlined its operations and downsized - its employee levels dropped from 550 to 250 in 2 years - and now seems to be in a position from which it can grow as the industry picks up speed. While revenue fell again in 2012 to $65M, this time it was surgical, with close to 40% reduction in operational expense resulting in a reduced net loss of $20M from over $37M. WPCS reported its latest financials in July this year. During fiscal year 2013 the company generated just over $42M in revenues as it continued to streamline operations, and suffered only a minor net loss of $6.8M. At that time it had a backlog of orders totaling $26M. In order to maintain compliance with NASDAQ listing requirements WPCS effected a reverse stock split at a ratio of1:7. Its current enterprise value is just shy of $5.8M.
So, with what looks to be bottomed out financials, how is the company going to drive growth towards its pre-crash levels?
The electrical power sector of its operations remains the dominant revenue-generating sector, but this is set to change in the near future. In 2012 electrical power accounted for 55% of the company's revenue, but this dropped during the last year to the aforementioned 45%. The fastest growing area of WPCS's operations is wireless communication, which grew from 36% of total revenue generated during fiscal year 2012 to 41% during fiscal year 2013. This is no real surprise, as infrastructure across all walks of industry and public works is increasingly demanding wireless connectivity. Specialty construction is also increasing, rising from just short of 9% in 2012 to 13% during 2013.
Certain industry trends suggest that there may be opportunity for the company to further expand its operations.
A major driver in both public services and healthcare at the moment is cost cutting, and sound communications infrastructure can help a company achieve that. If WPCS's sales team can approach these markets effectively there could be plenty of bids to be won. Another major driver across almost every market is the quest for increasingly efficient energy systems. This, coupled with the global necessity to produce and integrate alternative energy solutions could drive revenue growth over the next couple of years and beyond.
One thing that points towards a successful future for WPCS is the company's global operations. The company owns and operates a number of subsidiaries across China and Australia. Both of these countries have announced their intentions to invest large amounts in advanced infrastructure over the next 2 years.
China is expected to spend over $600B in 2013 on improving its infrastructure. At the beginning of August Beijing announced the opening of $55B worth of urban infrastructure regeneration projects to foreign bids. To show WPCS's strength in the economy, in May this year WPCS reported it had secured just over $4M in contracts that include Chinese government, commercial and public works. Further to this announcement the company reported another $7M in new contracts at the end of June that included the gas and pipe works across China.
Australia has just seen a change in its government. The new entrants into its parliament have expressed a specific focus on the nation's infrastructure, with a reported $760B expected to be spent over the next ten years. Again illustrating WPCS's standing in the Australian economy, in July the company reported it had been awarded $5.4M in new contracts, a large amount of which involve from Australian government offices. Also included in the new contracts are railway stations across Australia, water works and educat8ional establishments.
The company was founded in 2002 by Andrew Hidalgo. Having built the company from scratch Hidalgo recently expressed his wish to move from his CEO and Chairman position into private equity, but also stated that in recent years the company had suffered financially and he did not want to leave it in such a position. In July of this year the company announced he would be stepping down, and that he will be replaced by Sebastian Giordano as interim CEO. The announcement, when considered in line with Hidalgo's statement that he wouldn't leave the company in a vulnerable position, suggests it might be poised for growth. Hidalgo will still be involved with the company on a strategic advisory basis.
Sebastian Giordano served as a director of the company before his appointment as interim CEO. He has over twenty five years worth of experience as an executive and a board member in a range of industries including mechanical engineering, oil and gas and food manufacture.
WPCS's Chief Financial Officer is Joseph Heater. Heater holds more than twenty five years worth of experience of financial reporting and management. His resume includes the director of financial planning and analysis and assistant corporate controller at multi-billion dollar company Airgas Incorporated. At Airgas he was involved with the due diligence and accounting integration of several acquisitions.
Serving to strengthen this operational management team is the company's Executive Vice President, Myron Polulak. In 1995 Polulak founded New England Communications Systems Inc. He built the company up into a leading provider of wireless engineering technology across northeastern USA. Prior to his building of New England Communications Systems Polulak worked in various sales and management roles at Motorola.
In short, the current management team seems strong, and well placed to drive the expansion of WPCS over the coming years. As yet no announcement has been made regarding the length of Giordano's interim position, or as to who might replace Hidalgo in the long term.
So, having said all this, where does the opportunity lie for investors?
The economic hardship and the resulting drop in revenues over the past two to three years that WPCS experienced has caused a rapid devaluation in the company's stock. From a market capitalization that peaked at $60M the market now values the company at just $3.7M. Current quarterly revenues totaling just shy of $10M suggest that the company is undervalued at its current price and might have a large potential upside. As the growth rate of global economies increase the established reputation of WPCS should set it to win bids, which will drive its expansion.
As with any investment there are a number of risks associated with WPCS that must be considered. One of the major risks associated with many companies that operate in similar industries is cash flow. Much of the work that WSPC does is done on credit, and its customers are billed on completion. The company reported that as of April 30 this year it had net accounts receivable of approximately $8.4M, and costs and estimated earnings in excess of billings of a little over $1M. The company requires strict credit maintenance in order to complete its contracts. At present the company is managing, but as it expands WPCS will require higher levels of funding to maintain its operations.
Another risk is the competition WPCS faces in the three economies within which it operates. The barriers to entry in the electrical contractor business are relatively low, and as a result the company faces competition from a wide range of service providers. The scope ranges from multinationals that operate at a large scale to individual and local small businesses. WPCS's ability to expand into both local and international markets is dependent upon the ability of its sales teams to market its services effectively. The high level of competition will also serve to negatively affect the company's margins in the future.
In conclusion, the last 5 years have served to slow the growth of WPCS, but not halt it. Economic downturns can be costly, but they can also unveil opportunity for both companies and investors. Companies can derive benefit from the fact that those companies that are operating unsustainably are forced out of business, and those with sustainable operations are left to pick up the available contracts and assets at a cut price. The investor derives benefit from the rapid devaluation that occurs as a result of subdued operational activity and, in turn, the cheap stocks that present themselves. All things considered, WPCS's improving financials, streamlined operations and strong international positioning suggest that at its current price it could be dramatically undervalued.