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Tecumseh Products (TECUA) is a Michigan-based manufacturer of compressors for a variety of applications, including air conditioners, freezers and refrigerators. The stock has taken a pounding since the recession, having fallen more than 70% from its 2008 peak.

Tecumseh trades for less than half of the company's tangible book value. A company trading at such a hefty discount to book value is usually in deep trouble, but Tecumseh has zero net debt.

The company's problem, however, is its profitability, as Tecumseh has operating losses in each of its last three fiscal years. But as we've discussed before, earnings and cash flow can be very different at times, and that may be the case here. The company spends tens of millions less in capital expenditures than it books in depreciation. If it is able to continue on its current course, Tecumseh could actually generate several million dollars of free cash flow in the current quarter.

But counting on continued under-investment (relative to depreciation levels) may be a dangerous assumption. The industry in which Tecumseh operates is capital-intensive, and should require relatively large investments in equipment. Of course, it is possible that the company is systematically over-conservative in determining its depreciation rates, but it is also possible that the company will require large future investments to make up for current under-investment.

On this subject, the company does offer some information. It expects capex to average between $20-$25 million in the future, which is nearly double what it is now, but still way below (as in almost half of) historical depreciation rates.

While lower investment rates do increase free cash flow, they could also result in a drop of the company's competitiveness. The companies that are willing to invest could come up with products that are better and more efficient than are Tecumseh's. Tecumseh's two largest competitors (Danfoss and Copeland) are private, so not much info can be gleaned of their levels of investment; but Danfoss does appear to have a technological edge, having made the world's first oil-free compressors (which are thus 33% more energy efficient than standard compressors) for the HVACR industry.

Tecumseh is clearly cheap, but is it generating free cash flow at the risk of its future competitiveness? Only if this company falls within the value investor's circle of competence can he answer this question. Otherwise, he risks buying into a situation that may get worse rather than better.

Disclosure: No position

Source: Tecumseh: Debt Free, But at the Expense of Competitiveness?