VSE Corporation: Open Your Eyes To This Buried Smallcap Treasure

From VSE Corporation’s (VSEC) web site:

VSE Corporation was established in 1959 with a mission to provide engineering and technical support services to reduce the cost and improve the reliability of DoD systems and equipment. Our expanded mission now includes providing innovative services and technologies to help our customers succeed in the engineering, energy, environment, information technology, and defense services markets. The company has three business units. The Energy and Environmental Group provides high-level consulting services in the field of energy and environmental management. The Federal Group provides engineering, technical, management, integrated logistics support, and information technology services to all U.S. military services and other government agencies. The International Group provides engineering, industrial, logistics, and foreign military sales services to the U.S. military and numerous foreign governments. It consists of three operating divisions. One of these division, the BAV Division, provides assistance to the U.S. Navy in executing its Foreign Military Sales [FMS] Program for surface ships sold, leased or granted to foreign countries by providing program management, engineering, technical support, and logistics services for ship reactivations and transfers, as well as follow-on support. BAV’s expertise includes: ship reactivation/transfer, overhaul and maintenance, follow-on technical support, FMS integrated logistics support, engineering and industrial services, training, and spare and repair parts support.

VSE’s principal clients are agencies of the Federal Government, particularly the Department of Defense. The Navy represents VSE’s largest client, the Army is its longest standing client, and the Air Force is its fastest growing client. There is a lot more information on their website with regard to services, platforms, clients, etc.

The company has a market cap of 100.2M and there are 2.4M shares outstanding. The float is very small and consists of 1.4M shares. The percent of shares held by all insider and 5% owners is 55%. The percent of shares held by institutional & mutual fund owners is 14%, and the percent of float held by institutional & mutual fund owners is 30%. Donald M. Ervine, Chairman, CEO, President, and COO owns 42,350 shares. James M. Knowlton, Executive VP; Director, International Group owns 15,759 shares. Calvin Koonce, a Director, owns 497,071 shares. Clifford Kendall, a Director owns 29,333 shares. Bonnie Wachtel, a Director, owns 27,468 shares. The total number of shares owned by these insiders is 611,981 shares which represents 25% of the shares outstanding. No institutional holder or mutual fund owns more than 3% of the shares. The average number of shares traded per day is 7,472.

The company pays an annual dividend of .28 per share for a yield of .7%. No analysts cover the company and there are no conference calls.

As of December 31, 2006, the balance sheet shows cash of 8.8M and accounts receivable (principally U.S. Government) of 66.7M. The company carries 8.4M in PP&E on the balance sheet, and accounts payable is listed as 44.3M. There is no long-term debt. Total stockholder’s equity is 38.2M.

The last 5 years have seen nice growth in revenue, net income, and earnings per share.

Over the last 3 years, net income has been growing at an annualized rate of 57%.

Here are some considerations which might aid in determining a suitable buy-in point.

Market cap: 100.2M

Current share price: 41.66

Price/Sales ratio: .28

Price/Book: 2.6

PE ratio: 13

Recent growth rate of earnings: 26%

PEG: .5

Enterprise value: 91.4M

Owner earnings: 4.1M (computed as net income + D&A – total capex)

EV/OE: 22

(EV/OE)/G: .8

Return on equity: 20%

Let’s reverse engineer a DCF calculation to see what growth rate is built into the current price. Here are the assumptions used in the DCF calculation:

1. Owner earnings: 4.1M

2. Growth rate in years 1-5: 17%

3. Growth rate after year 5: 3%

4. Discount rate: 11%

Under these assumptions, we obtain a DCF value of 42.33, just slightly more than the current price. Thus the current price appears to reflect a fairly modest (in comparison with previous performance) growth assumption over the next 5 years.

By the measures used here, namely, PEG, (EV/OE)/G, and DCF valuation, the stock appears to be priced very attractively.

Disclosure: Author has a long position in VSEC.

VSEC 1-yr chart