(This article was originally published at Value Stock Guide on Jun 16 2011 and is a reprint)
TTM Technologies (TTMI) was brought to my attention by one of the subscribers to the VSG Premium program. As a result of the interest, I decided to review the company to see what merits it might hold for someone who is looking to buy a good, solid business at an attractive price.
The Business of TTMI
TTMI manufactures printed circuit boards for technology, communications, aerospace, defense, and medical markets. Apple (AAPL) is one of its major customers, but its customer base overall is well diversified. Unless TTMI has a durable competitive advantage in some ways, this sector is rife with strong competition (Sanmina (SANM), Flextronics (FLEX), etc) and consequently the companies continue to operate with low margins and constant threat of further margin erosion.
Growth Financed with Acquisition Added Debt
Between 2009 and 2010, TTMI’s revenues doubled from $583M to $1180M. Net income as reported jumped to $72M from $23M (adjusted upwards from $5M to remove the effects of restructuring and other one time charges). This growth was fueled with acquisitions, but it brought a lot of debt in the mix as the table below shows:
|Net Income (adjusted)||72.69||23.11||84.35||34.68|
|Long Term Debt||478.68||139.88||175||45|
As a result, the Long Term Debt is now 40% of the Total Capitalization of the company (Equity + Long Term Debt) compared to 24% average for the Electronics Manufacturing Services sector. As per the latest 10-Q, about $332M in long term debt comes due in 2013 and the current effective annual interest rate is 2.26%.
Returns on Invested Capital is Not Impressive
Consider TTMI’s ROIC (again using numbers adjusted for one time charges).
It is interesting to see that as the company is growing, its ROIC has actually declined. Since ROIC is a measure that is designed to remove any capital structure influences, one could reasonably expect that the significant amount of debt that was brought on in 2010, with a cost of borrowing about a 1/3rd of the ROIC, will help improve the ROIC going forward. If this is happening, we have not seen it yet.
The ROIC does not point to any sort of moat that the company might be enjoying and it correlates well with its industry average. But with so much change in the company in the last few years, perhaps a competitive advantage may be emerging. It should certainly make for an interesting next few years for the company.
Potential Red Flag
Another aspect of the leverage is the company's short term cash needs. The company has started to pay down the long term debt aggressively and in the process has pushed its current ratio down to 163% which is low compared to the industry average (around 270%).
If TTMI were to maintain its high growth rate and stem the current ratio deterioration, it will need to fund it through further debt or equity issuance. With the debt already at 40% of the total capitalization, there is little flexibility to add more debt. If it does add more debt, than it is stepping into high risk territory where any competitive hiccup can drastically affect the company's prospects. Another option is to fund it with additional equity issuance, which is more likely to happen and it raises the prospect of dilution for the current shareholders.
Another point any potential investor should consider is that the bulk of current long term debt matures in 2013, which will either need to be paid down or be replaced with new debt. Perhaps the economy will be kind enough to offer them as low a prime rate as they have their debt tied to now, but I highly doubt it. The more I think about this, the more it seems likely to me that another equity issue is just round the corner.
The company currently trades at close to 13 P/E and over 2.5 times the Tangible Book Value. Even though the P/E ratio is less than its peers in the industry, there is additional risk due to the leverage employed and it justifies shareholders demanding higher returns. At these levels, I see the stock fairly priced and with growth prospects unclear due to their already leveraged balance sheet and the ever present competitive threats, investors may be wise to look elsewhere.