The Long Case for KSW, Inc.

When we look for value stocks, we like these criteria: solid business with good YoY growth of top and bottom line, positive free cash flow, shareholder-friendly and efficient management, little or no dilution, little debt, below average P/E and a PEG ratio below 1.0.

Finding a stock with so many positives at a low price is not easy, but I think KSW Inc. (KSW) fits the bill.

KSW, Inc., through its subsidiary, KSW Mechanical Services, Inc., furnishes and installs heating, ventilating, and air conditioning systems. It also processes piping systems for institutional, industrial, commercial, residential, and public works projects primarily in New York. The company offers its products under direct contracts with owners of buildings, subcontracts with general contractors or construction managers. In addition, KSW serves as a mechanical trade manager, performing project management services relating to the mechanical trades, such as dividing the mechanical portion of the contract into bid packages for subcontractors and equipment, negotiating subcontracts, and coordinating the work. It also acts as a constructability consultant. The company is based in Long Island City, New York.

With a market cap of only $ 41.62M (O/S = 6.13M) the company is quite small and this may be a reason why no analyst officially follows this company.

But the company’s excellent fundamentals certainly merit more attention.

Revenues increased nearly threefold (from $26.28M to $77.13M) between FY2004 and FY 2006 while the book value nearly doubled in the same period.

This impressive growth has slowed down recently (ttm revenue $77.93M) but considering the hard drop that many other construction related stocks have experienced in 2007, KSW’s slower growth is still a positive. The ttm EPS is $0.54, resulting in a P/E of 12.48 which is 30 - 40% lower than its bigger competitors (Trane Inc. (TT) has 18.30, Johnson Controls Inc. (JCI) has 17.62).

The company has a significant backlog of orders. Some of the latest projects awarded include $9M in additional contract work with the Chetrit Group/Stellar Management and the HVAC trade management on the new Center for Science and Medicine at the Mt.Sinai Hospital in Manhattan.

At the end of December, 2007, the company’s backlog was approximately $111M, not including the construction costs relating to the Mount Sinai project, currently estimated at $58M.

The company does not make any prediction about the time frame for the execution of these works, but we can compare backlogs and revenues in previous periods in order to estimate 2008 revenues.

click to enlarge

As we can see from this table, revenues in % of the previous year’s backlog varied significantly during the past years. But backlogs in the third and fourth quarter of 2007 were nearly the same as 2006 and revenues for the first 9 months in 2007 were a little higher than those in 2006. We may thus estimate FY 2007 revenues about $78-80M. This appears to be confirmed by the ttm revenues of $ 77.93M.

Likewise the EOY 2007 backlog is only little higher than that of 2006, so I would estimate 2008 revenues and earnings at about the same level as in 2007.

Applying an average P/E of 18 to KSW’s ttm EPS, the stock should trade now at $9.72 .

On November 12, the stock moved from AMEX to NASDAQ, but it seems that very few have taken notice. Actually the stock trades below $7 at low volume (3m avg. daily volume is 24,168 or about 0.4% of the O/S) and often shows a high bid/ask spread of up to 10%. This makes it difficult to trade bigger lots, but with a bit of patience there are good chances to accumulate the stock quite cheaply.

The all-time high of KSW’s share price was $8.65 in late July 2007. Since then the pps has dropped about 22%.

There is no obvious reason for the actual depression of the share price. The company's business is not directly affected by the housing crisis.

On November 5, 2007 Chairman of the Board, Floyd Warkol, commented in a PR:

Demand for our value engineering and trade management services remains strong, and we see no slowdown in the New York City commercial construction market. The Company has been able to choose those projects which offer the best return for our shareholders.

One might think that part of the selling pressure could have been caused by Warkol's frequent sales of small lots of stock, but there is no positive correlation between the trend of the share price and the number of shares sold on average by the CEO.

A short analysis of the Yahoo insider trading page and a comparison with some Form-4 filings shows that the Yahoo data are probably not complete, but for the ease of use the following is based anyway on these data.

According to Yahoo, Warkol exercised stock options for approximately 672,000 shares and sold about 358,000 shares from March 2006 to October 2007 (19 months), with an average of 19,142 shares disposed per month. During the period before end of July 2007, when the share price was in an up trend, Warkol sold 19,453 shares per month. During the down trend, the average dropped to 17,483 shares per month.

At the end of 2007 Warkol held 669,950 shares directly and indirectly, about 10% less than a year ago.

A comparison of KSW’s pps with that of its two bigger competitors reveals that there was a similar peak around mid/end July and subsequent drop for all three companies.

TT has recently regained about 30% due to its planned acquisition by Ingersoll-Rand Co. Ltd.

JCI had an intermediate peak at the end of October after posting a 29% YoY increase of net income for the quarter ended September 30, 2007, but the pps since dropped again about 17%.

KSW is 41% owned by insiders and 19% by institutional investors. The biggest insider-owner is CEO Floyd Warkol with about 10.6% of the O/S.

Considering KSW’s growth over the past years and the significant size of the backlog, I think that the target price for 2008 should be above $10 and I consider the stock to be undervalued for the time being.

Disclosure: Author has a long position in KSW

Comments

[kswischeap:]

I'm surprised there was no mention of the balance sheet. The $18.3 in cash is almost $3/share and they carry no debt. Trades at an ev/ebitda of under 4.5. Also I would add EME and FIX to the list of comps.

2008 Jan 04 11:43 AM

[Bharper:]

$2.80/shr in cash as of end of 1Q08 and the stock is now trading at $4.75/shr in early June 2008. Stripping out the cash and cash interest, about 4x TTM.

2008 Jun 05 04:18 PM