Compelling Risk-Reward at Smallcap Hardinge Inc.

Hardinge Inc.  (Nasdaq: HDNG) engages in the design, manufacture, distribution, and marketing of computer controlled metal-cutting lathes, machining centers, grinding machines, collets, chucks, indexing fixtures, and other industrial products. Hardinge provides its services to Hardingerospace, automotive, construction equipment, defense, energy, farm equipment, medical equipment, recreational equipment, telecommunications, and transportation industries, as well as to small and medium-sized independent job shops.

Hardinge currently sells its products in the United States, Canada, China, Germany, and the United Kingdom, through distributors, independent agents, manufacturer’s representatives and through its direct sales force (only in U.S.)

Recent Decline

As of market close on November 28th, 2007, Hardinge shares are currently trading at $14.44, well off their 52-week high of $40.13 by more than 64%. This drop occurred in early November when Hardinge released its 3rd quarter financials.

In the third quarter, Hardinge had a 21% sales decrease over Q3 of 2006 in North America and a 10% drop in sales overall. At first glance this might seem bad, but is it enough to warrant a 64% drop in its stock? Hardly. See, what most people didn’t realize is that the drop was primarily caused not by a poor 2007 performance, but rather by a superior 2006 performance. Every other year in September, the North American Technology Show boosts sales for Hardinge by a large amount. This year there was no Technology Show; but there was in 2006. In 2008, the show will be back and Hardinge will make a killing in sales, just like in 2006.

Not only this, but if investors had looked more closely at the numbers, they would find that even though sales dropped 10% this quarter, they are still up 1% from the first 9 months of 2006. That’s right, they’re increasing overall sales year-over-year. In Europe, now their largest market, sales are up nearly 20% compared to 2006.

The large sell-off was way overdone. 64% drop when sales have increased 1%, net income has increase 95%, and earnings have increased 66%? What is Wall-Street thinking?

I could understand the drop if, and only if, Hardinge was seriously overvalued to begin with, but they weren’t. Right now, thanks to a 64% drop, they are seriously undervalued, as is discussed in the next section.

Financial Strength

From a value perspective, Hardinge is fantastically undervalued. Hardinge has a forward P/E of only 5.89, well below the industry average of 20 (!), and a book value of 0.71, compared to 7.38 for the industry. In addition, Hardinge has a debt-to-equity ratio of only 0.12, meaning they rely very little on debt.

From a growth perspective, Hardinge is the #1 fastest growing in its sector. It’s expected to grow at 30% per year for the next 5 years, making the PEG ratio a tiny 0.23.

Great value numbers coupled with great growth numbers makes this stock absolutely fantastic.

Dividend Record and Rate

As if that wasn't enough, Hardinge also provides a dividend to its shareholders. This dividend has been paid out every quarter since 1995. In 2005, the dividend was increased 300% and in 2006 it was increased again by nearly 70%. Sitting at $0.20 per share right now, the yield is a respectable 1.40%. It is likely that the dividend to be raised again in 2007 or 2008.

52-week target

If we take the forward P/E ratio of 5.89 and raise it to the industry average of 20, Hardinge stock could be worth nearly $43 per share, right about where it was at its 52-week high. This, combined with the dividend would yield nearly a 198% return in a 1 year period. The risk/reward ratio is simply too good to pass up.

Disclosure: At time of writing, author has no position in HDNG

Comments

[Monosabio]

I am confused. J.P. Morgan comes out and says that earnings will be down by 30% in 2008. There were no such dire predictions on their conference call in November. What do you say? Is this still a great undervalue play?

[Ryan]

Yes, it is still a great value play. Even if JP Morgan is right, a 66% drop in stock price is not justified. I am skeptical that JP Morgan is right, however, as my research found nothing of the sort. Maybe they're trying to get the price low so they can buy up shares? Who knows. I trust my research over any large research firm simply because we do not know what their motives are.