While running some new value screens recently, I came across KSW, Inc. (KSW), a company that furnishes and installs heating, ventilation, and air conditioning (HVAC) systems and process piping systems for institutional, industrial, commercial, residential, and public works projects. The company is based in Long Island, NY, and its revenue is concentrated in New York City. Given the economic downturn, revenue and earnings have fallen precipitously, and the outlook for residential and commercial projects looks bleak. That is the bad news.
The good news is that KSW’s balance sheet, flexible cost structure, and strong backlog suggest the company is resilient enough to withstand the near-term challenges and could potentially surprise to the upside this year. As of 12/31/09, net cash totaled $14.75 million, which equals approximately 65% of market cap. In addition, the company is profitable, earning $0.20 in a cyclically depressed year (revenue declined 31% in FY 09). Further, it managed to almost double backlog (from $62.5 million to $121.5 million), suggesting the company is continuing to provide value-add to its customers.
Currently, the business (excluding the cash on its books) is being valued at 6.6 times our estimate of operating earnings in FY 10 ($0.19). We believe the company should not be valued on cyclically-depressed earnings. Rather, we believe an appropriate multiple would be 7-9 times normalized EPS of $0.46 (five year average operating earnings), or $3.23 - $4.15 per share, plus $2.35 in cash value for a mean price target of $6.00 (representing 66% potential upside).
KSW faces near-term headwinds from depressed residential and commercial project demand, but I believe these challenges are more than discounted in the stock price.
Disclosure: The author is long KSW