The only stocks I find attractive as of late is cheap companies with wide enduring moats. This is not to say I they aren't always attractive but, there are a limited number of 'monopolies' through intellectual property, processes, or competitive advantage that are sustainable for Mr. Buffet's favorite holding period. Simulations Plus Incorporated (NASDAQ:SLP) is exactly the type of company that can provide alpha many of us are seeking.
"Simulations Plus, Inc. designs and develops pharmaceutical simulation software for use in the pharmaceutical research and in the education of pharmacy and medical students. It offers ADMET Predictor software, which provides a range of numerical models that predict various properties of chemical compounds from their molecular structures; MedChem Studio tool for use in data mining and for designing new drug-like molecules by medicinal and computational chemists; MedChem Designer software for use in molecule sketching; DDDPlus, which simulates the in vitro laboratory experiments that measure the rate of dissolution of the drug contained in tablets and capsules in a range of experimental conditions; and GastroPlus that simulates the absorption, pharmacokinetics, and pharmacodynamics of drugs administered to humans and animals to the pharmaceutical companies, the FDA, and other government agencies. The company also develops and sells interactive, educational software programs that simulate science experiments conducted in middle school, high school, and junior college science classes, as well as Abbreviate!, a productivity software program. In addition, it offers contract research and consulting services to the pharmaceutical companies…"
SLP is the leading developer for software used in the research and analysis of a catalog of chemical compounds for regulatory government agencies as well as large pharmaceutical companies and research universities. They license their software to the NIH among other government agencies and 8 out of the top 10 largest pharmaceutical giants. They use to provide software to assist the care and daily living of disabled individuals. This was a low profit segment of their software portfolio and the sale of their 100% owned subsidiary, Words+, resulted in a net gain of $724K and net proceeds (before the mark down of assets) of $1.77M. Cash and equivalents currently sit at $13.17M as of 02/09/12 (3rd PP) and management has shown their willingness to change executive direction of cash allocation to increase shareholder return as well as bow to overwhelming shareholder opinion.
Equally as important as good management and product, we need to ask ourselves, can we purchase SLP at a reasonable price? The answer (I am writing this after-all) is assuredly, yes. The current price of $3.50 dictates:
- P/E: 20
- Market Cap/FCF 28
- EV/FCF: 22.5
- Growth rate (estimated): 12%
DCF yields a fair value per share of $4.00 a share with a conservative $2M FCF. FCF should increase at a greater rate than 12%, the expected revenue growth. We can expect approximately $10M in revenue, $8.8M in gross margin, $5.1M in income from operations and $3.8M in net income (historical 25% tax rate). This would yield a $0.24 eps annually or $0.26 FCFps due to high amortization of software compared to actual current costs. One year out projects of valuation metrics are:
- P/E: 14.5
- Market Cap/FCF: 13.8
- EV/FCF: 11
- DCF: $6.38
As you can see, SLP is a long-term stock with impressive potential. Management's decision to divert cash away from stock buy-backs to a commitment of a $0.05 quarterly dividend currently provides a 5.7% yield with huge growth potential. The dividend commitment is approximately $3.25M a year that should be covered by next years' full year's earnings with at least an additional $500K surplus. Considering the $13M excess cash balance (and the 0.75% return on investment from it) I see the dividend as stable with potential for a near-term increase.
For a plethora of reasons covering management, a large sustainable moat, and various near-term catalysts, I believe SLP is a good purchase indiscriminately below $4 a share and a rational purchase below $4.50 a share.
Disclosure: I am long SLP.