Orbit (ORBT) is a strong company with a robust backlog currently reporting great results. The stock had moved up on this good news, but with the recent market downwave, the shares have sold off. “Mr. Market” has thrown the baby out with the bath water, providing a second chance at buying a great company with a solid operating history at a very attractive price. Here is the story:
About the company
ORBT has two business segments: a power group and an electronics group. The power group offers power supplies, AC power sources, frequency converters, uninterruptible power supplies and associated analytical equipment. The Electronics segment designs, manufactures, and sells customized panels, smart displays, color LCD Displays, embedded single board computers components, and subsystemsplasma based telephonic intercommunication panels, full-mil keyboards, trackballs, and data entry display devices, as well as commercial, non-military ruggedized hardware for prime contractor programs. These products are used in military helicopters, drones, ships as well as railroad signaling, air traffic control towers and for oil and gas exploration.
The key reason to own this stock is for earnings. In the first quarter of 2011, ORBT reported strong results, $0.11 per share, and ended the quarter with a record backlog of $21.2 million - the highest in at least the last 5 years. On that news, the stock jumped 21% on the day and rallied a total of 53% to the highs of $5.34 over the next few months even as the overall market declined - a clear indication that investors were happy with the unique prospects of the company.
The second quarter, reported August 9, 2011, came in at $0.17 per share in earnings, one of the best quarters in company history and the highest since December 2008. Once again, ORBT reported a very strong backlog of $18.3 million at the higher end of the $12 million to $21 million historical range. In fact, at the current price of $3.70 the company’s market cap is only $17 million, less than its current backlog of guaranteed future revenue.
Guidance for the year provided by management was excellent, implying the company will earn roughly $0.54 for the year. With the market sell off however, the stock fell all the way back to the mid 3s and is significantly undervalued, in my opinion, based on guidance and backlog. This provides a great buying opportunity. In 2006 and 2007, ORBT earned $0.55 in each respective year and the stock was trading in the 9s. This year they are on track to earn $0.54 and the stock is a third of what it was back then. Tangible book value is $3.39 and the company has close to $30 million in NOLs (net operating loss carryforwards).
Earnings guidance and the future potential for ORBT look promising. As management noted on the 2Q:11 conference call (login required), near term future prospects are solid. (Below is an excerpt directly from the transcript on Thomson One):
Moving on to our expectations for 2011, we are expecting several follow-on orders in the coming months from existing programs such as for RCUs, STARS keyboard, and orders for the oil and gas services industry. Our Power Group is also expecting significant orders for its COTS division on follow-on programs.
ORBT recently posted an investor presentation (.pdf) on its website, where the company lays out its future orders along with the timing. This allows us to map out future revenue and provides us with a good idea of what’s coming up, providing a good level of comfort that business remains strong and is easy to model out and see it turn into earnings and cash flow.
Longer Term Prospects Are Good
One problem that may be affecting ORBT is the concern about reduced defense spending. The key point here, and it’s a huge point, is that if you look at the company’s order history, roughly 90% of ORBT’s business is for existing military programs in the form of modernization and refurbishment, not new programs. So there is little risk that a new helicopter, tank or ship gets canceled and they lose business.
ORBT fixes, updates and replaces existing Black Hawk computers, existing MK gun control panels etc. As you can see below in another excerpt from the 2Q:11 conference call, management explains that they expect to benefit as we pull out of the wars in Afghanistan and Iraq as the equipment comes home and it is cleaned, fixed, refurbished, and updated.
…we still believe that the (Defense Department) cuts will be in those areas that won't materially affect us. As assets (helicopters, tanks, drones) return from the Middle East, the need for refurbishment and modernization could be a defense spending priority. This potentially can provide great opportunities for our Company.
This excerpt below from ORBT’s 2010 annual report (.pdf) suggests that the company will benefit from a change in military spending:
…we believe that any future cuts in defense spending will be in certain areas of the defense budget that will not affect us. In fact, we believe that defense budget dollars that are allocated to modernization and refurbishment of military equipment will remain the same or increase which will generally benefit us.
With these major wars winding down, certain defense companies will be hurt - those that provide combat necessary products like radios or body armor - but in ORBT’s case, the company will actually benefit given their niche focus of refurbishment and modernizations of small pieces of equipment. It is also important to remember that they have customers outside of defense. Keyboards for the FAA air traffic control towers, satellite communications, oil and gas, railroad signaling. Along with the fact that ORBT is not reliant on any huge one time orders and instead has a steady flow of business, the company also noted in its investor presentation (.pdf) that it has been grandfathered into recurring programs which generate ongoing revenues.
As the current program follows up on orders, secured earnings in 2012 will likely be in the range of $0.55 to $0.60 by my model. While this is not great growth, it is still solid and could be complimented with a small acquisition. Nevertheless, at the current price, no growth is being priced in at all. SG&A has decreased so far in 2011 and should remain stable in 2012. Bookings/orders for the first half of 2011 were up 40.4%, as compared to the same period of 2010 which bodes well for the future, as most of these orders have delivery dates in 2011 and through the first half of 2012. As new follows on orders for existing programs come through, the second half of 2012 should shape up nicely.
At the current price, ORBT looks cheap on an earnings basis, cheap on a book value basis and cheap based on future prospects as military efforts overseas slow down and domestic efforts pick up. The stock is trading at less than 7x this year’s earnings and very close to tangible book value. This cheap valuation is not inherent in the company’s history. Remember it traded in the 9s a few years ago, affording the stock a 15x multiple and as recently as a few weeks ago, it was given a 10x multiple before the market fell.
The company’s NOLs will help them avoid paying taxes for several years and generate good free cash flow. In fact, the NOL assets alone are worth almost double the company’s current $17 million market cap.
I believe the stock has sold off because somebody wanted/needed to get out of the stock. In a scary market, small cap stocks sell off hard but come roaring back when the smoke clears. I believe that this will be the case with ORBT as investors realize that they have thrown the baby out with bath water. The catalyst for a rebound in the stock price is going to be (1) New order announcements and (2) continued robust earnings results.
I suspect the company will announce new orders within weeks. In recent past, the company has averaged 1 or 2 orders per month and based on the commentary from the 2Q:11 conference call noted above, we should see some new orders in the STARS keyboard (FAA) and orders from the oil and gas services industry.
The company will report another strong quarter and provide another strong outlook which will in turn remind investors that the stock is undervalued at less than 7x earnings. As ORBT continues to deliver the results, I think a 10x to 12x multiple of earnings is in order, which puts the stock 50% to 70% higher than it is today.