SIFCO (SIF) is a company that has significant management ownership and arguably one of the longest track records of profitability and stable client relationships in the sector. In my opinion it is not a surprise why this company is transitioning profitably to the commercial segment. It is also doing so with speed. In this article I argue that the adjustments that have to be made before realizing its true earnings power are large and most likely investors have missed performing these adjustments. The company is traded at low multiples for a company of its quality and has the potential to be trading around 200 million or a yield of 5-6% on its current adjusted earnings. It also has a healthy balance sheet; this is a company I would like to own myself in the defense sector.
In the picture below the group divisions are stated with respective net sales. As you can see the majority of net sales is attributable to the Forged Components Group. Aerospace is the primary market sales segment with energy coming in as second; the group produces several critical components that allow commercial airliners, military jets and helicopters to fly. SIFCO's ratio between commercial to military sales is now 55% and 45% respectively. Two years ago the military stood for more than 70%.
As you can see in the image below, the company has large exposure to the most common U.S. defense products and covers many of the platform parts.
Considering that the organization provides products and services to arguably the most demanding military in the world, it should indicate to any potential investor the capability of its business operations. As previously stated, the transition to more commercial industry sales is a decent hedge against the decline of military sales.
As you can see in the image above many parts of the popular 747 and the newer Airbus models are constructed by the company. The parts that the company provides are wide and provide ease for the end suppliers that request a reliable supplier for a large part of the aircraft parts. Combine the wide parts accessory database with a long and strong track record of relationships with a broad array of demanding customers and this company is a preferred supplier of parts in relation to newcomers. The brand reputation of timely deliveries of parts and quality alike makes this company a preferred supplier.
All in all the FCG segment should experience growth at least with inflation in the coming few years and could possibly enjoy adding to its backlog through increased production of Boeing planes in the coming years.
Earnings And Cash Flow Analysis
The revenue increases are related to the non-organic growth of the FCG segment. At the end of 2010 the company acquired T&W Forge Inc. It was financed more or less with its current cash flow and the cash available at that point. The products that T&W provide are complimentary to FCG's business, and T&W has recently expanded its facilities to take on larger component orders. The acquisition led to some diversification into the energy market and now represents 17% of the business. The second acquisition was QAF for $25 million, which was financed by debt at a favorable interest rate of 2.9%. Per YE12 the amount of interest bearing debt was close to $20 million where $8 million is hedged through an interest swap agreement and the rest subject to LIBOR and lender conditions. The interest expenses are covered by the rental income from the leasing of the Ireland facility itself so it is not effectively paying anything on a YOY basis. Secondly, in coming years it will likely pay it down to set itself off for another acquisition. All in all, the margins have decreased somewhat and the OP income without the LIFO expenses would be $14.5 million, effectively decreasing the tax expenses. As these are not cash expenses I will adjust for these items in the CF statement.
As you can see the company has recently invested a significant amount in its FCG segment for 2010 and 2009. I counted half of these CAPEX expenses during Y10-Y9 to maintain its competitive position in the market. Its OE has expanded at a decent rate since 2008, showing that the company handled not only the recession well but also its acquisitions without any significant interest expenses or failures.
I think that with an OE yield of 11% and a CAGR being almost 9% it's a good deal, with an escalating transition to the commercial business. This shows that management is indeed picky on its acquisitions and does not risk itself being over leveraged for its own agendas. The company would definitely not have grown to its current size without the acquisitions. This also means that any further growth is dependent on acquisition of other companies and more importantly, that these acquisitions are rightfully conducted. The company has not underperformed historically in this aspect and has provided significant shareholder returns. Consider the latest divestment of its Turbine component and repair business as a sign of further focus on acquisitions within the FCG segment. Furthermore, the divestment also focuses the company resources to further transition from the military segment to the commercial segment.
As per YE12 the debt is not worrisome considering the company had a significant amount of cash of around $7.1 million in C&C. This is however not an asset play even if you could argue that the buildings are not appropriately reflecting market prices, yet alone the Cork facility would be worth $5-$10 million (33 - 66 % of total booked value).
Considering the strong yield looking at both the 5-Y average and the CAGR of its OE this is quite a compelling investment. Combining this with competent management that is heavily invested in the company makes the company a clear buy candidate. The possibility for the company to double its current price is certainly viable as the company still has further contract awards coming up due to its track record alone. And there's the acquisitions potential, which should drive the company to a yield of 5-6% in the long term, which would account for an appreciation of the current price today of more than 100%. If you only consider the income statement you most likely would think this stock is an opportunity as the yield would be relatively low. However, when adjusting for LIFO expenses and depreciation, the profitability is more accurately measured. The company's greatest risk is likely the issue of a contracting military segment; however, it appears that the organization is adequately mitigating this risk through the transitioning into the commercial sector, and given its strong track record as a producer of high-quality products it is likely that future growth will be experienced.