PC Connection (PCCC) stock was cruising along in late 2011; strong third quarter earnings and the subsequent announcement of a 40-cent per share special dividend propelled the stock up nearly 75% between early October and early February.
PCCC's bull run came to a quick end, however, when the company reported fourth quarter earnings that disappointed investors, particularly on the top line. The stock fell 19% when markets opened the next morning, and continued falling, closing Monday at $8.41, 35% below its January highs.
The volatile stock movement is unusual for PC Connection, a stodgy reseller of IT equipment to businesses, governments, and consumers. Before the stock's rise began in October, it had traded in a relatively tight range between $7 and $9 per share since late 2010. Indeed, while third quarter earnings were strong, that performance alone did not seem to warrant the 75% rise; nor did what appeared to be a revenue miss for the little-followed stock seem an appropriate cause for the 35% drop.
As the dust has settled, however, PCCC looks like an interesting play. At Monday's close, the stock trades at less than eight times trailing earnings; even in the low-margin, low-growth re-selling business, such a valuation should have room to expand. Its tangible book value sits at $8.23 a share, just 2% below its current trading price. And despite the revenue disappointment, PCCC showed strong growth in 2011. Net revenue was up 6.5% for the year, with earnings up 25%, as gross profit margin rose 100 basis points to 12.6%. Three of the company's four segments -- SMB (Small and Medium Business), Large Account, and Public Sector -- all saw year-over-year revenue growth, with only the tiny Consumer segment declining. That decline was the result of a focus on margins in the group, according to PC Connection's 10-K; furthermore, the Consumer group represented just 2.7% of sales for the year.
The concern about the fourth quarter seemed to reflect not only the top-line miss, but higher selling, general, and administrative costs (SG&A), which rose to 10.3% of sales in the fourth quarter from 9.3% in the year-prior period. Year-over-year, that growth was just 60 basis points, however (from 9.7% to 10.3%). Executives on the Q4 conference call (available here) noted that the rise was due to higher labor expense for service personnel and increased marketing expenses, both of which are investments for the company's move toward higher-margin service solutions. Supply constraints from hard drive shortages related to the 2011 flooding in Thailand also hurt the top-line, particularly in the notebook and desktop product lines.
Free cash flow is another concern for the company, which burned $15 million in 2011. But the key factor behind the lack of cash generation was a $42 million increase in its net accounts receivable. As the company noted on its conference call, it has started offering financing to credit-worthy large accounts. That $42 million -- nearly 20% of market capitalization -- will flow into PC Connection in 2012, and improve its balance sheet.
In short, PCCC has performed well since the 2008-09 recession, reversing a small 2009 loss of five cents per share and showing top- and bottom-line improvement in 2010 and 2011. Meanwhile, the stock has started to stabilize in March, hitting short-term support just above $8 per share, providing a potential entry point in the near term.
To be sure, the fourth quarter revenue miss is a concern; but the company still showed yearly growth in its main segments, improved margins, and returned capital to shareholders through the special dividend. Such a performance seems undervalued in a stock trading just above its tangible book value, and at less than eight times its trailing earnings. The competitiveness in the space, weakness in government spending, and the short-term troubles that arose the fourth quarter may all provide downside risk. But PCCC's low valuation and strong performance over the last two years give it a downside cushion, and make its potential reward well worth the risk.