Seeking Alpha
Long only, deep value, contrarian, growth at reasonable price
Profile| Send Message| ()  

For those you who were unlucky to have missed out on the 43% decline in Polypore International Inc. (PPO) on January 31, 2012 fear not. You can now possibly make a similar percentage return by going long PPO. The stock is an incredible value by my estimation, and should deliver a return of well over 40% from current levels.

The stock fell from $54 to $38 after Axiom Capital Management issued a sell rating and set a price target of $26. Axiom pointed out that LG Chem, a PPO customer, had announced plans to start operating a separator plant. Axiom also did not agree with the proposed capacity additions planned by PPO, especially in light of the LG Tech Plans. PPO issued a statement defending the capacity increase citing the accelerating demand for electric drive vehicles (EDV). The stock has since recovered somewhat and currently trades at $47 a share.

On February 3, 2012, the company hosted an investor call and listed its various growth areas. It reminded investors that the company's capital investment plans are not based on industry growth projections, but on actual client projects. Talking about the LG Tech, the company cited customer confidentiality concerns and was hesitant to discuss the LG Tech expansion plans. It did, however, point to comments from noted industry analysts who have indicated that LG Tech planned to meet 50% of its internal needs for consumer electronics using the new separator plant. The dry products for EDVs would continue to be supplied by PPO.

The company acknowledged that competition in business is immense, with new entrants trying to gain a footing in the industry on a very consistent basis, but it is extremely difficult to gain clients. An industry insider was quoted as saying that changing a screw provider in a battery pack takes 4 years (this might be an exaggeration, but look at the bigger picture). The industry, since inception, is dominated by 3 players, as the products are very specialized in nature with qualification times with potential customers extending over multiple years. Additionally, a different specialized membrane is required for every battery application. It is not a one-size-fits-all industry. Therefore, PPO has a minor moat in my opinion.

PPO develops, manufactures and markets specialized membranes used in separation and filtration processes. PPO's products are used two primary segments: energy storage and separation. In the energy storage segment, which contributed 72% for PPO's 2010 revenues, PPO's membranes are used in lithium batteries and lead-acid batteries.

Lithium batteries are used in variety of products ranging from notebook computers to mobile phones. Lithium batteries are also used in EDVs and, as mentioned earlier, PPO expects to gain significant revenues from this segment. According to Institute of Information Technology, the lithium battery business is expected to grow at least 10% through 2015. Lead-acid batteries are used in transportation and industrial products. The company expects to grow at a rapid pace in this sector.

In the conference call, the company noted that its products are currently used in 25 vehicles, and this number is expected to increase to 50 by the end of 2012, and to 100 by 2015. This does not include specialty vehicles like buses which are by themselves a strong opportunity for PPO.

In the separations media segment, PPO's membranes are used for hemodialysis, blood oxygenation, plamapheresis, microfiltration, ultrafiltration and gasification/degasification. The company estimates annual dialyzer market will grow in excess of 6% annually. According to independent industry research, the US microfiltration and ultrafiltration membrane is approximately $1.7 billion and is growing in excess of 8% annually. In summary, PPO is expected to grow at a 20% clip over the next 5 years compared to the 13% growth rate of the broader industry equipment and controls industry.

Analysts expect PPO to have earned $2.33 last year (2011 financial results are due February 23, 2012). For financial year 2012, the EPS is expected to increase to $2.92. Even if the company does lose some business (which is unlikely in my opinion), I expect the company to report an EPS not lower than $2.8. Applying a P/E of 24 to my conservative 2012 EPS estimate, my 12-month price target $67 is obtained, thus making PPO an attractive investment. My only response to Axiom Capital Management for issuing a sell rating for PPO is, "thank you."

Disclaimer: Kindly use this article for information purposes only. Please consult your investment advisor before making any investment decision.

Source: Polypore: Profiting From Axiom's Sell Rating