Twin Disc, Inc.: Undervalued, Underleveraged, Undiscovered

Jun.13.07 | About: Twin Disc, (TWIN)

One position that has continued to perform well is Twin Disc, Inc. (NASDAQ:TWIN). As value investors, it is clearly unusual for us to claim that a stock that is already up 85% year to date is still undervalued, however TWIN is an exception.

Based in Racine, Wisconsin, TWIN manufactures very large transmissions and power control systems for massive machines in 3 major categories: 1) oil drilling rigs; 2) heavy duty trucks and military vehicles; and 3) large boats used for offshore oil-drilling rigs and yachts. TWIN has the #1 or #2 market share in virtually every market in which it competes. TWIN’s business is exceptionally strong as it continues to benefit from increasing demand from the oil and military markets.

TWIN’s organic revenue increased over 20% last quarter and its backlog is at record high levels. Management has solid visibility into its business and expects next year to be even stronger than this year from both a revenue and profitability perspective.

TWIN continues to improve profitability by increasing productivity, outsourcing certain low margin manufacturing functions and leveraging the fixed aspects of its cost structure. Consequently earnings have increased (and will continue to) even faster than revenues (organic E.P.S. increased 90% last quarter).

TWIN’s business is highly seasonal and the company is now in its seasonally strongest quarter. We expect this quarter to be yet another strong one for TWIN as it continues to benefit from increasing demands from its end markets and from a highly accretive acquisition of an Italian company completed last year. The company’s products augmented TWIN’s offering to the marine market and will enable TWIN to get its products on more vessels and to increase the number of TWIN products placed on each vessel. The acquisition will also allow TWIN to consolidate some of its European operations and to extract SG&A saving from the acquired company which was a privately held, family-controlled Italian company.

We believe TWIN is vastly misunderstood as people underestimate the strength and sustainability of the company’s business. Even if the U.S.A were to withdraw from Iraq tomorrow, TWIN’s military business would remain strong as our military infrastructure is highly depleted since much of our equipment has been operating 24 hours a day, 7 days a week in hot, sandy environments. We believe TWIN’s oil services would remain strong even if oil were to drop below $45 a gallon, something we do not expect to occur in the near future.

TWIN is also misunderstood because it has recently taken some non-cash, non-recurring charges due to the Italian acquisition. These charges have reduced the company’s “reported” earnings and masked the company’s true profitability. The company will not be recording any more charges and shareholders should benefit from the “clean” results the company will be reporting in the future.

We are also bullish on TWIN because it has a very healthy balance sheet and the CEO owns over 20% of the company’s stock, so his incentives are highly aligned with the company’s shareholders’. Management is experienced, conservative and very disciplined. We are also encouraged because, despite the significant increase in TWIN’s stock price, insiders have barely sold any of their personal holding of TWIN stock. Considering how bright the company’s prospects are and that the stock is only trading at 16x LTM EPS (excluding charges), we understand why insiders are not selling stock.

In addition to being undervalued and underleveraged, TWIN is undiscovered and not widely owned by institutional investors. The company has no analyst coverage (yet) and company intends to improve its investor relations in order to increase its awareness in the investment community. We see several catalysts for TWIN including reporting continuing strong results, a dividend increase, a stock split (to improve liquidity) and a increase in its awareness in the investment community.

As with many of our holdings, TWIN is a logical takeover candidate given its undervaluation, healthy balance sheet, strong competitive position, and experienced management team. While we do not believe a takeover is imminent, should the Board decide to sell the company, we believe TWIN shareholders would be highly rewarded.

Disclosure: Author has a long position in TWIN

TWIN 1-yr chart

TWINbetween a Olevia and Sony