Hidden Value in T.A.T. Technologies (Part 1)

 |  About: TAT Technologies Ltd. (TATT)
by: Yoseph West

T.A.T. Technologies Ltd. (NASDAQ:TATT) provides a variety of services and products to the military and commercial aerospace and defense industries. More specifically, it operates three businesses: original equipment manufacturing (OEM), maintenance, repair and overhaul (MRO) services and parts services.

It's a company with a strong balance sheet, solid margins and great growth potential. Here are the key ratios:

Mkt Cap P/E P-to-B P-to-S Current Ratio ROIC (5 yr)
TATT 83.37M 19.59 0.84 0.87 5.97 18.85%
Click to enlarge

Looking at these numbers, I just want to highlight the Current Ratio and ROIC (Return on Invested Capital).

Personally, I look for a current ratio above 1 because this means that the company will be able to pay off any immediate debts (current liabilities) easily without having to sell any long term assets. In the case of TATT, it has a current ratio of almost 6 which means that it has more than enough liquid assets to cover its current liabilities and in fact, it can also cover long term liabilities as well. I'll talk about TATT's balance sheet in Part 2.

I'd like to highlight the ROIC because it's a great indicator of the capital efficiency of a company (how much of a return the company achieves from any money spent). In terms of TATT, over the past 5 years, for every $100 invested, they've gotten back $118.85. That's pretty good. I look for companies with at least a ROIC of 10%.

Adjusted Operating Earnings

Again, I've adjusted its operating earnings using the approach recommended in Greenwald's Value Investing to determine the intrinsic value.

*Since TATT has not reported their fourth quarter results yet, I extrapolated their numbers for the nine months up until Sept 30, 2009 to provide a guesstimate of what they would be for the full year. Also, this means that I provided a conservative number for "Special Items Avg Adjustment" and "Adding back 25% of Depreciation & Amortization."

As we can see, TATT has managed to stay profitable for the past 5 years and have maintained a solid margin of around 8-9%. The jump in margin that occurred in 2007 was a result of a sale of realizing part of an investment in a subsidiary so it can be ignored as one-off.

To me, this means that TATT's management have continued to run the operation profitably over the years. Now, let's take a look at the valuation of TATT.

To provide a frame of reference for these valuations, TATT's current market cap sits at around $83m (Total EPV is the key number to use to compare).

Keeping this in mind, we can see that according to 2009's Total EPV, TATT is trading above its intrinsic value, but not significantly. To better assess this, we should consider a couple factors.

Firstly, TATT expects to increase its revenue for 2009 by $37m (currently, at around $86m) by its purchase of part of First Aviation, which would significantly increase the Total EPV.

Secondly, 2009 was a restructuring year for TATT. It took one of its subsidiaries private and has also purchased part of First Aviation Services Inc. This could be a source of increased costs and should pay off in the long term, as it has simplified its corporate structure.

Thirdly, TATT is reliant on the commercial airline industry for revenue and this is very much known as a cyclical industry.

In addition, while I'm hesitant to mention this as it errs on the side of speculation, but if we look at the "Market to Book Ratio", it identifies that in the good economic times (2005-2007) the company was priced at least at 1.2x its book value and that it's a likelihood that if we invest today and hold until we return to more prosperous economic times, we could see a nice return. But, I would not make an investment decision on this basis.

In conclusion for Part 1, I would invest (and have at current prices) in TATT because of the above factors.

For a detailed analysis of qualitative factors that will benefit TATT, such as high barriers to entry for its competitors, highly customized offerings, long-term contracts with customers and a special "insider" relationship with the Israeli air-force which contributes to its reputation and is hard to duplicate, please see John Swift's article.

In Part 2, I will adjust the balance sheet of TATT to determine the business's reproduction costs. From doing this, we should see an increase in the book value of TATT because of its profitable stand-alone subsidiaries.

Disclosure: Author holds a long position in TATT