Baron Rothschild, an 18th century British nobleman, is credited with saying, "Buy when there's blood in the streets, even if the blood is your own." Later this week I expect a blood in the streets buying opportunity in the stock of C&D Technologies (CHP) and intend to take advantage of it. It's unquestionably a contrarian investment, but one that could pay off handsomely. I want to thank Ben S., a regular reader, for bringing this opportunity to my attention in an e-mail last weekend.
Most investors know that the addition of a company's stock to a major market index creates significant upward price pressure as ETFs move to add the stock to their portfolios. A similar phenomenon occurs when a stock is removed from a major index, which will happen on Friday when C&D is removed from the S&P 600 Smallcap Index (^SML). Recent examples of other companies that have gone through similar index removals include Sterling Financial (STSA) effective November 18, 2009, Independent Bank Corporation (IBCP), Central Pacific Financial (CPF) effective November 10, 2009 and Wabash National Corporation (WNC) effective July 16, 2009. It will almost certainly be an ugly time for C&D's existing stockholders, but it can be a great buying opportunity for contrarian investors who are actively looking for companies in transition that are reinventing themselves in preparation for a brighter future.
The energy storage sector is one that doesn't make sense to a lot of investors because there are huge disparities in the relative market valuations of old-line companies and new entrants. In general the old-line companies trade at rust belt discounts while the newcomers trade at premium prices. Since I'm a great believer in the idea that age and experience have a clear advantage over youth and optimism when it comes to hard core manufacturing, I expect the established companies to adapt to emerging business realities and appreciate significantly as they maintain or improve their market position in coming years. Conversely, I expect the new entrants to trade in fairly narrow bands as they struggle to complete their product development, prove their manufacturing competence and earn a share of developing energy storage markets that are potentially massive.
C&D and its predecessors have been engaged in the battery manufacturing business for over 50 years. It operates plants in the U.S., Mexico and China, and sells its products globally for use in UPS systems, wired and wireless telecommunications, CATV systems, utilities and other applications. Its revenues increased from $253 million in the year ended January 31, 2005 to $365 million in the year ended January 31, 2009. While C&D suffered a 12% revenue decline for the nine month period ended October 31, 2009 because of the recession, the magnitude of its revenue decline compares favorably with the 37% revenue decline suffered by the industry leader Enersys (ENS).
The scariest things about C&D are a balance sheet that includes far too much debt for my taste and a six year string of operating losses. On a more positive note, the debt seems to be well-structured and manageable, and the operating losses are declining at rates that make management's forward looking statements about turning the corner in the first quarter of next year appear reasonable. While I see a number of potential problems that need to be resolved, I also see tremendous opportunity.
Some of the more intriguing aspects of C&D's business that are not readily apparent to a casual observer include:
- New facilities in China that were commissioned in early 2008 and have roughly $75 million per year in unused capacity;
- A commitment to research that has consistently maintained R&D spending in the $6 to $7 million range despite cost cutting efforts in the rest of the business;
- A $19 million Department of Defense contract to develop large format lithium-ion batteries for military applications; and
- A manufacturing partnership for a new class of advanced lead-acid battery based on Firefly Energy's composite foam electrode technology.
C&D is not an old-line battery manufacturer that's stuck in another era. It is a visionary manufacturer with substantial sales that has already paid the costs of moving into the high-growth Asian markets and energy storage solutions for the future. The DoD contract would have had a huge impact on a pure-play lithium-ion company, but because of the source it barely caused a ripple.
It would be a grave understatement to suggest that C&D's stockholders have had a tough time over the past few years, as evidenced by its 5-year stock price chart.
At Monday's closing price of $1.31, C&D had a market capitalization of $34.46 million, a price to book ratio of 0.81 and a price to sales ratio of 0.10. If the removal of C&D from the ^SML causes further price erosion, which certainly appears likely, today's rock bottom market metrics will only become more attractive. On balance, I think that C&D has a very attractive risk reward profile that merits further study by experienced investors who have a relatively high risk tolerance. It's not entirely clear whether the ETF liquidations will happen on Thursday or Friday, but one of the two is certain to have far higher volume than normal and with a week to go before Christmas, the short-term price impact could be substantial.
Over the last year I've had pretty fair luck calling the bottom in energy storage stocks. I bought Enersys (ENS) in the $5.90 range and sold it for $23.50. I bought Active Power (ACPW) at $0.26 and Exide (XIDE) for under $2.00 and am up almost 300% on both companies. I've recently quintupled my position in ZBB Energy (ZBB) and still have great expectations for Axion Power International (OTCQB:AXPW). By the end of this week I'll be adding C&D to my personal portfolio. I'm not a trader and I plan to hold C&D for a minimum of 12 to 18 months, but I expect the ^SML removal to give rise to opportunities for both short-term traders and long-term investors alike.
Disclosure: Author is a former director of Axion Power International (AXPW.OB) and holds a large long position in its stock. He also holds small long positions in Active Power (ACPW), ZBB Energy (ZBB) and Exide Technologies (XIDE).