Williams Controls (WMCO) is is a leading global designer and manufacturer of Electronic Throttle Control Systems ("ETCs") for the heavy truck, bus and off-road markets. The company is well-positioned to profit from an expected increase in heavy truck sales that will extend into 2012. With operations and increasing sales in both India and China, management of this microcap has done a good job competing on a global basis in its specialized market.
At recent prices in the 10.50 area, WMCO has the potential to increase to 17 within two years, generating an annualized return of 27%.
From the 10-K:
We primarily design, manufacture and sell electronic throttle controls, pneumatic controls, and electronic sensors for heavy trucks, transit buses, off-road equipment and military applications. Electronic throttle controls send a signal proportional to throttle position to adjust the speed of electronically controlled engines. The use of electronically controlled engines is influenced primarily by emissions regulations, because these engines generally produce lower emissions. The original applications of electronic engines and electronic throttle controls were in heavy trucks and transit buses in the United States and Europe in the late 1980’s. As a result of the continuing implementation of more stringent emissions standards worldwide, demand for electronically controlled engines and electronic throttle control systems is expanding both geographically and into lower horsepower engines. China, India and Russia are implementing more stringent emissions standards for heavy trucks and transit buses, which we believe will increase the penetration of electronic throttle controls worldwide. Additionally, countries around the world have adopted emissions regulations that we expect will continue to increase the use of electronic throttle controls in off-road equipment.
Industry Growth Expected
Industry research groups report that demand for class 8 vehicles will increase in the area of 50% for 2011 and that demand will remain strong through 2012. From the transcript of the 4Q 10 (Fiscal Year ends 9/30) earnings conference call:
Projections for calendar year '12 and '13 are over 300,000 class 8 trucks, basically double of what we saw this year. We also believe calendar year '12 and '13 will show increased penetration in the emerging markets of China and India, where we are well positioned.
For a business of this type, R&D consists primarily of expenses incurred in order to achieve program wins: company engineers collaborate with customers to get products designed into new vehicles. As such, R&D expense is a tell for future sales.
GAAP accounting requires that R&D be expensed as incurred. For WMCO, a portion of R&D is actually expenses that should more appropriately be applied to future revenues from the associated program wins. The investor can keep this entrepreneurial interpretation in mind when looking at profitability. An analysis along the following lines might be done:
R&D as %
The dollar increase in R&D, and the heavy percentage devoted to the activity in 2009, bodes well for future sales. Similar to a tech company, it is important that R&D be maintained at appropriate levels throughout the cycle.
There is some underfunding of legacy pension plans, amounting to about .86 per share. The expected returns, at 6.75%, and discount rate, at 5.5% for 2010, are appropriate, unlike some other larger companies. The pensions have been capped and the issue is being properly managed.
Major competitors include AB Eletronik GmbH, Kongsberg Automotive, Siemens VDO Automotive AG, Felsted Products, LLC, Hella KGaA Hueck & Co., Heinrich Kubler AG (“KSR”) and Comesys, Ltd. Several Chinese competitors, most notably Alion and GoFa, are also significant competitors. Other companies, including Dura Automotive Systems, Inc. and CTS Corporation compete in the passenger car and light truck market and may attempt to compete in the heavy truck and transit bus market in the future.
The company is demonstrably customer oriented, as witness the expedited freight expenses incurred to keep their lines rolling. R&D is conducted through the Conceptual Design Center, a facility that can produce a manufactured prototype on an expedited basis, in order to work closely with customers on product development and design wins.
CTS coming up as potential competition raises a point about reliability. CTS made throttle controls for Toyota which were implicated in acceleration issues that became the subject of much adverse publicity. WMCO has a strong quality control program and a long track record. As such, it may be difficult to displace them from existing accounts. Nobody wants a bus or a tractor trailer roaring down the highway with a stuck throttle.
Cash Generation and Deployment
The test of management's performance, and the company's financial strength, can be found in the amount of cash generated and the uses to which it is put. In this instance, over the past several years, capital has been deployed in a timely manner into R&D, as well as the establishment of operating facilities in Suzhou, China, and Pune, India. The balance sheet is pristine, with minimal long-term debt. During the past quarter, the company paid a $1.00 special dividend.
Confronted with diminishing revenues and the need to cut costs in 2009, R&D was protected and maintained at levels that permitted program wins that will be reflected in future profitability. It went from 6% of revenue to 10% during the 2009 year. During fiscal 2010, supplier capacity constraints necessitated substantial expenditures on expedited freight in order meet customer demand. The company met these needs and turned a profit in 2010.
As a participant in a cyclical industry, WMCO should be valued on a variable P/E, based on where it is in the cycle. Working with projections out to the end of their 2012 fiscal year (9/30/2012), I project EPS of 1.37. Applying a TTM P/E of 12.5 (for a cyclical stock at a peak) works out to a target of 17, within two years. Shares traded in the area of 17.50 for much of 2007, when earnings were less than I project for 2012.
There isn't enough analyst coverage to get a professional consensus. There was one analyst on the last conference call.
With 7.3 million shares outstanding, and a market cap of 79 million, the stock is thinly traded and not optionable. Under the circumstances, it may not be possible to buy or sell in large quantity, even by the standards of a retail investor. The natural tactic here is patient accumulation: buy a few shares and then try to enlarge the position on dips or when the market as a whole is down.
I bought some last week, and my brokerage required me to place the order by telephone on a recorded line, although I got the on-line commission rate. I asked why, and was informed that it was an SEC requirement, something about manipulation. I put in a question at the SEC website, and have yet to receive a reply. There is nothing wrong with this stock.
As it happened, looking at a level 2 screen there were 100 shares available at 10.45 and 2,200 at 10.61. A limit order for 1,000 shares at 10.61 was promptly filled at 10.45. There is supply out there.
The target price requires global heavy truck sales to grow as projected, and WMCO to participate on a favorable basis. Projecting that sales will double during that time frame, and that margins will go back to levels last experienced in 2006, quarterly monitoring consists of comparing progress to projections and adjusting the position and expectations accordingly.
The special dividend demonstrates that the board does not see the need to retain the funds and deploy them for acquisitions or further expansions. Competitors or customers flush with cash might see the company as an acquisition target. This could be a situation where patient accumulation will be rewarded with a sudden gap upward.
A Philosophical Digression
Back when I took Accounting 102 (not that long ago), my instructor spent an evening hammering at the importance of one question: "What drives it?" The point is, when trying to project financial data into the future, the whole exercise is futile unless the analyst has an answer to that question.
I first took up a position in WMCO back in February and March 2009, when the stock traded in the 5 to 7 area. I traded in and out with small profits, being hesitant to hold an illiquid stock in the volatile market that prevailed at the time. I again traded in and out in February to April this year, booking small, quick profits and reluctant to hold into the minicrash and euro crisis. From there I more or less forgot the situation and went on to other things.
Then the other day I was mulling an article on the concept of monitoring a stock by keeping tabs on what drives it - perhaps a no-brainer, but something that can get lost in the shuffle. With so much macro news and economic uncertainty, so much focus on the next unemployment number or FOMC meeting, it's possible to lose sight of a simple chain of cause and effect.
The trucks never stopped rolling, and now they are rolling pretty much like they did before. As the years and the miles go by, equipment wears out, and needs be replaced, with newer and state of the art vehicles. Industry projections are easily available, and to the extent WMCO is able to successfully compete, the company should prosper accordingly.
In any event, as I was casting about for examples of how to apply the concept, this name came to mind. Checking projected truck sales, the first search brought up the information linked earlier in this article. From there a quick look at the latest transcript confirmed that management sees the same outlook and expects to participate. Heavy truck sales drive WMCO's revenue and profitability, and heavy truck sales are expected to increase.
Disclosure: I am long WMCO.