LGL Group - Turnaround Likely To Be Solidified After Solid Q3 Results

| About: The LGL (LGL)

Summary

LGL reported a solid quarterly result in line with what the management mentioned in the past.

The foreign sales have stopped declining, the US revenue was stable, and the backlog increased.

As the company's cost base remained the same, it is highly likely that its profitability will be sustained.

The valuation and share price also remain attractive, and therefore, I would continue buying shares.

I initially covered LGL Group (NYSEMKT:LGL) here.

My investment thesis was based on the following points:

  • This niche manufacturer of frequency and spectrum products has recently shifted its focus from low-margin, volume-orientated products to high-margin, quality-orientated offerings.
  • This enabled the business to become profitable after 4 years of continuous losses. The turnaround is likely to continue, as backlog increased by 10% in the past two quarters.
  • This is likely going to lead to sustained free cash flow generation, supported by company's reserve of around $10 million of federal NOLs.
  • These developments could also attract M&A activity, as LGL was already approached by several interested parties in 2013.

I believe that all these points continue to hold and that the profitability is likely to be sustained, as LGL reported positive Q3 results with increased backlog.

Share Price Reaction

As you can see, since my initial article in October, the share price is only little changed. Prior to Q3, the share price unreasonably slipped without any fundamental news, and the price action reversed after 10th of November, when the company showed positive results.

I believe that as the share price moved only little and the company showcased that the turnaround is likely to last, the upside is intact. The main positive points for the quarter were increased backlog and foreign sales stabilization, which likely means US revenue (aerospace/defense focus) is going to increase in the next quarter. The valuation is also unchanged, and the company continues to trade at only a slight premium to NCAV.

Operational Results

As mentioned, the quarterly results have confirmed all my thesis points. As you can see below, LGL Group has been able to stem the decline of the foreign revenue, which is linked to the low-margin segment of telecommunications. The company also managed to turn a slight net income profit, with only a slim negative operating margin, which was expected as per the comments of the CEO last quarter.

The US revenue continued its steady pace, but this is likely to change, as the most positive operational development was the increase in backlog of $1.3 million, or 13.4%, from the last quarter in June. As the foreign revenue is now stable, the backlog is likely to materially impact the results - as opposed to backlog improvements in the past, where any increase in backlog was offset by the decline in foreign revenue linked to telecoms.

This means the profitability is likely to be sustainable, and the company could see increased profits if the backlog continues to increase.

Finally, while the cash flow from operations has not been significant in the past nine months ($0.268 million), I believe that in the coming quarters this could change, as revenue is likely going to increase due to the backlog developments.

What is next?

I believe apart from the sustained profitability and possibly increased revenue, management should present a strategic plan going forward. While the current trends are likely to create some shareholder value, the company itself might be more valuable as a part of a bigger semiconductor, where scale could transform LGL's margins. I mentioned that LGL has been already approached in 2013, and thus, it might not be a far-fetched scenario for the company to be approached again, especially when the fundamentals are now better.

I believe a sale of the business would be more beneficial than if the company should try to grow the business on its own. Not only could it burn some of the NCAV value, which is as of now the main source of shareholder value, but it could also create operational uncertainty and volatile results.

Conclusion

That being said, as my thesis was confirmed in this quarter, I would proceed with further purchases of the stock. As mentioned in my initial article, I would buy additional 35% of the desired position, as the price did not move significantly, the valuation remains the same, but the fundamentals improved. It is likely that the company is going to see sustained profit going forward.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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