Broadwind Energy: Anatomy of a Torpedo Stock

 |  About: Broadwind Energy, Inc. (BWEN)
by: Manjunath Sharma, CFA

Broadwind Energy, Inc (NASDAQ:BWEN) provides products and services to the wind energy industry primarily in the US. Broadwind Energy showed up as a torpedo stock (quantitative screen uses more than 20 parameters) as early as September 23, 2009. At that time the stock was trading at $8.5 having increased from a low of $2.6.

click to enlarge images

Quant ScreenClick to enlarge

Quantitative screen uses parameters such as P/E, P/B, CF and other parameters based on academic back testing (20+ parameters). Some of the parameters are book value, earnings momentum, analyst coverage, breadth etc. Other parameters such as intrinsic to price is based on residual income model, calculated using accounting numbers that is publicly reported. Parameters such as insider trades, earnings revisions etc. are weighted based on back/alpha testing using both FactSet and regression methods.

A quick analysis of the Broadwind Energy’s cash cycle, gross margin and fixed cost absorption revealed some disturbing trends based on Q2, SEC filing of 10-Q (September 2009).

  1. Q2 2009 filing reveals a significant slowdown in alternative energy space that adversely impacted demand for Broadwind Energy products.
  2. Company amended the loan agreement and was continuing to focus its efforts on maintaining adequate liquidity and cash balances for future operating needs.
  3. The table below shows that inventory on a DSI (Days sales inventory) basis, is up by 8 days to 65 days at the end of June ’09 quarter compared to 57 days in the year-ago period. In the previous quarter (3/09) DSI was 82 days compared to 53 days a year-ago period, an increase of 29 days. Given the softness in demand, these trends potentially indicate more pressure on inventory.
  4. A significant portion of inventory was locked up in finished goods. At the end of 6/09 quarter, finished goods inventory was a substantial 25% of total inventory as compared to just 1% of total inventory at the end of 12/08. This build-up may potentially force future write-off or markdown that may adversely impact profitability.
  5. Production/COGS ratio of 84% for the recent quarter also shows poor fixed cost absorption.

BWEN RatioClick to enlarge

Q3 2009 earnings (October 30, 2009):

Days Inventory came down substantially to 26 days compared to 55 days a year ago. But the decrease in inventory levels, amid slowing demand, was coming at decreasing margins (YOY comparison) and poor fixed cost absorption. It was another warning sign to long investors.

Full year 2009 and Q4 2009 earnings release (March 12, 2010):

On March 12, 2010 Company released full year and fourth quarter earnings that showed substantial deterioration in gross margins and low inventory levels due to lack of demand. The stock lost 20% or more in the two days following earnings release.

The above example that played out recently reveals how an intelligent quantitative screen can be used to identify shorts or a torpedo stock that can wreck havoc in a long portfolio ahead of time. Any company that shows up in the bottom (or 10th decile) ranks needs to be carefully analyzed for deteriorating operating performance. In the case of Broadwind Energy, analysis reveals that indeed the Quantitative screen picked up this torpedo stock ahead of time and adding some more context (inventory, fixed cost, gross margin analysis) helped solidify the investment thesis with high conviction.

Disclosure: I do not own (long or short) any position in BWEN