Methode Electronics - A Good Time To Buy In

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 |  About: Methode Electronics, Inc. (MEI)
by: View From The North

Summary

MEI's 43% growth in F2014 and continued growth going forward will drive higher earnings. Next year, EPS will be above $2.00.

Strong auto sales, and new relationships started with BMW and Tesla, support upside.

The company has a fortress-like balance sheet with fewer liabilities than equity, and pays a dividend.

Looking at the market, it appears that the "hot money" is looking to find a new home. A company that I believe deserves some of this attention is Methode Electronics (NYSE:MEI).

MEI designs, manufactures, and markets components that use electrical, wireless, radio control, sensing, and optical technologies. They sell to the end market -- i.e., OEMs, in the automotive, networking, data center, consumer electronic, aerospace, and industrial equipment industries. Among other places, they have facilities and do business in the U.S., China, India, Germany, the UK, and Mexico.

Earnings

MEI's next report is likely to come out in June, per their history. They are on track to deliver April FYE results with a consensus estimate of $1.78 EPS, and will then provide F2015 guidance. The three analysts covering this stock have an average estimate of $2.04, or 14.6% growth. (Estimates are taken from the Thompson Reuters StockReports dated April 9, 2014. Similar numbers are aggregated on Yahoo.)

Here's why the EPS forecast is so bright: Solid revenue growth, as seen on the company's slide. It's not often that a company's management is willing to put out a revenue forecast that goes three years into the future. Of course, the standard "forward-looking statements" disclaimer applies, but I believe this speaks to their confidence.

To the numbers -- here is a summary:

FYE April 2012 2013 E2014 F2015 F2016 F2017
$M Rev 465.1 519.8 745.0 800.0 845.0 929.0
11.8% 43.3% 7.4% 5.6% 9.9%
$ EPS 0.52 E 1.78 E 2.04
240.4% 15.3%
Click to enlarge

For 2014, I show the analysts' estimated revenue, with the company's forecasts after that. As one can see, the growth this past year has been impressive to say the least. Their January Q3 results -- $547.9M, $1.26 EPS -- have already smashed through the results from the full fiscal year 2013. Looking at EPS, F2014's growth shows obvious signs of increased volumes, along with improved margins. For the first nine months, this year's gross margin was 20.8% vs. 17.2% a year earlier.

The F2015 EPS estimate represents 15% growth in EPS. MEI itself has not guided for F2015 yet, but will likely do so in their June presser. The 15% seems reasonable, at double the growth of revenues, since MEI has shown that these higher volumes also represent economies of scale. Taking that forward to F2016, we could see an 11% jump in EPS to $2.26, followed by a 20% jump in F2017 to over $2.70.

As noted on the management slide, these forecasts actually exclude certain areas, and many future opportunities exist. Considering past years' growth trajectory, there is momentum that implies the company can continue to get new orders.

Continued Growth Forecast

During F2014, they raised guidance a couple of times as new agreements were signed and revenue streams became active. They did not update guidance in the most recent quarter, but did disclose some of their newer relationships. I feel there is a good chance the guidance for F2015, which they'll provide in June, could be higher than expected.

Why? Because MEI derives a lot of business from their Automotive segment, and recently there has been a pickup in vehicle sales.
The last SAAR rate is estimate is for 16.33 million light vehicles in the U.S. Commercial vehicles are also projected to see increased sales, per an industry research firm. Additionally, MEI has just started relationships supplying parts to both BMW and Tesla (NASDAQ:TSLA). BMW is ramping up its volume and sales, and saw their best Q1 in 2014.
While these contracts have only small revenue impacts right now, they get Methode in the door, and I feel like these are two companies with high standards implying that MEI is doing something right.

I would like to note here that MEI did not trumpet their new relationships with Tesla or BMW. They only talked about them in their conference call, and are quietly optimistic. In addition to automotive components, Methode has Power Products and an Interconnect segment. These are also areas that grew substantially in 2014, and will likely continue to grow as the world of electricity transmission and storage is going through a modernization.

Balance Sheet

With these growth areas, and looking at the revenues projected by the company, the EPS trajectory is upwards. A typical area that could derail a growing company is debt. Per the Q3 financials, Methode has fewer liabilities -- i.e., all debts -- than it has shareholders equity.

  • All Liabilities: $165M
  • Shareholders Equity: $342M
  • Long-term Debt: $50M
  • Cash: $97M

Dividend

There is no visible hole in the financial situation, and management agrees. In Q3, they raised their quarterly dividend to $0.09, up from $0.07. It should be noted that the last increase was in fall 2008 -- prior to the great recession -- and they paid it each and every quarter since then.

Valuation

The three-analyst consensus rates this a buy with a target range of $38-$42. At the $40 average, they are giving it a 19.6x FPE over their $2.04 F2015 EPS.

Methode has a current market cap of approx. $1.2B. The comparable Russell 2000 index recently traded at a forward P/E estimate of 19.05x, according to Birinyi Associates. Of course, this means some companies are below, and some are above, with growing companies usually valued above the average.

Thus, the minor disparity in MEI's FPE vs. the index is acceptable to me. I truly believe the analysts' F2015 forecast is a bit conservative and will be revised higher when they get the next update by management. This growing company can also justify higher placement on the P/E curve.

Is the company worth $40 today? Probably not. There is always risk to any forecast, and multiple factors affecting the valuation. I do believe it should be trading closer to $40 than $30, and would say it's an easy decision to buy in prior to June, and below $35.

Valuation Risks

Of course, the main caveats to any price target come from the general market and liquidity; i.e., if there is a correction to the stock market, I would not expect MEI to be immune. More specifically to Methode, the major risk is that future revenues do not grow. This would happen if their clients reduce the volumes for existing contracts, perhaps building fewer end-user products -- for example, cars -- or if they do not award new contracts. Both within and outside of automobiles, the electronic components of today's world are changing fast to meet our new technological age, and there is always a risk that MEI's customers look elsewhere. Mitigating the above is the current slate of known contracts. These may have flexible volumes and delivery dates, but the work is at least committed to Methode.

Conclusion

Methode had a very strong growth year in F2014, and all signs point to continued growth. They have notable relationships with major OEMs such as GM (NYSE:GM), and are starting relationships with companies like Tesla and BMW. I believe this current period between quarterly reports, and while the market is in a period of confusion, provides a good entry point and a safer place to park money than the "hot stocks."

Methode is not sexy. It doesn't get valued by subscribers or potential sales. It is a real company with earnings that are growing fast.
Valuation is a tough business, as it depends on the money flow of the marketplace. Still, I think this is an easy buy below $35, with more of an opportunity cost analysis required above that level.

Disclosure: I am long MEI. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.