We're all aware of the turbulence the markets have seen over the past few weeks with commentators spewing "Sell in May and go away" and then the masses were all too happy to oblige. However, in the rapid, powerful move down which the markets have made, without doubt, some bargains are emerging as a result. At Insider-Alerts.com I'm looking for those special situations, where because of market inefficiencies, bargain (or overvalued) scenarios develop, and the insiders give us the first tips that it's happening. One such situation which has developed is with a small IT/consulting firm, Dynamics Research Corporation (DRCO).
Since May 15, insiders have purchased a total of 45,417 shares of common stock in the range of $6.00 to $6.50 per share. The purchases were predominantly by James Regan, the CEO and to a much lesser extent, 3500 shares purchased on May 18 by Richard Tennant and 2500 shares purchased on May 29 by Francis Aguilar, both directors. Prior to the May purchases, the last significant transaction was in August when a senior manager purchased 3000 shares in the $9.75 to $9.99 range.
Monitoring the insider transactions/filings is only the first step in any analysis to determine if a stock is a good prospective buy (or sell). I focus on a couple of key criteria in coming up with an overall view. The points I focus on are:
- How many shares were bought/sold in relation to the amount owned before the transactions?
- Is the stock price near its recent or long-term high or low?
- What do the fundamentals and earnings picture of the company look like?
- Are there any other items of interest that may raise red or green flags?
1. How many shares were bought/sold in relation to the amount owned before the transaction.
CEO Regan owned 396,330 shares at the conclusion of his purchases of 39,417 shares. He increased his position by about 10% with the roughly $250,000 in share purchases.
Director Tennant owned 8300 shares after his 3500 share purchase - an increase of about 70%. Director Aguilar increased his position to 42,765 shares with the 2500 additional purchased.
In itself, the share purchases are not huge when compared to the amount previously held. However, in my view, more important is the point that prior to these purchases, the last one was roughly nine months ago, at a price over 50% higher than where the stock sits today. Further, there has been no insider selling since the stock was in the $14-$15 range early in 2011.
2. Is the stock price near its recent or long-term high or low?
At the $6.22 closing price on June 1, DRCO shares are sitting just above the 52-week low (registered a just few days ago), and multi-year lows. The last time the share price was in this neighborhood was during a brief dip in late 2008, and prior to that, late 1999.
3. What do the fundamentals and earnings picture of the company look like?
A quick look at the earnings shows current EPS of $1.02/share, giving a trailing P/E of 6.1. Price/sales is 0.19, and price/book value is 0.55.
On the surface, people would be racing to get their hands on a stock/company with EPS, P/E, and book value as we have here. However, we all know the economy is in a recession, cutbacks are on tap for defense spending and government contracts in general, and this is the bread and butter for this company. Further, though the EPS looks good, the latest quarter showed a 33% dip in year over year EPS. The company has been working in to its backlog seeing it drop from $801 million to $717 million.
Though top line sales were up nicely seeing 23% year over year growth, net margin on the bottom line went from 3.9% to 2.1% - a decrease of almost 50%. This translated to EPS going from 27 cents in the quarter a year ago down to 17 cents this year. Scanning the 10Q shows that this decrease is primarily attributable to increased interest expenses ($2.8 million in March 2012 quarter versus $300,000 in March 2011 quarter). Immediately following the earnings announcement, two downgrades came out.
In the 10Q, management is very forthright regarding the current state of affairs, noting:
We have seen and anticipate continued impacts from government budget management initiatives, the specific timing and effects of which may not be predictable, such as:
- Program delays, cuts, and terminations,
- fewer new program starts,
- intensified price competition for new business and re-competes of current business, and
- pressure to reduce dependency on service contractors and set more work aside for small and socially disadvantaged businesses.
These events may result in i) new business contract wins being lower than expected or needed to sustain growth, ii) ending of or reductions to current programs and contracts, and iii) lower profit margins as a result of pricing pressure and the need to invest in winning new and retaining existing business - all of which may adversely affect our results of operations and financial condition
4. Are there any other items of interest that may raise red or green flags?
There's roughly 10 million shares outstanding and about 9 million in the float with 10% short at this time. Less than 60,000 shares trade on average any given day. The implication is that any news announcement or catalyst can cause the stock to move significantly with an increase in volume. Likewise, because of the low float and trading volume, the bid/ask spread may be large at times making it difficult to buy or sell shares quickly without paying a premium.
This past week, it was announced that the company was one of 54 getting a piece of a 10 year $20 billion National Institutes of Health award. This caused a temporary spike in the stock price Thursday morning, as some folks probably didn't read the story closely enough, and may have thought that the company won the $20 billion all to itself. There was no indication in the announcement or by the company what would be a realistic amount that could be received by DRC under the contract.
The company is carrying $115 million in debt which is up significantly from prior year. This is likely due to an acquisition of some kind seeing the increase in goodwill by roughly the same amount. This amount of debt, though apparently manageable, is quite hefty for a company of this size.
Overall View: Neutral
On the surface, the stock is cheap, and the insider purchases cannot be seen as anything other than a positive. However, the major concern here is that this is a small company, extremely dependent on government business, and we all know that this business is going to be scaled down. Of course, the business is not simply going to disappear, but there is obviously going to be less of it to go around.
What I would say is that if the stock/company is of any interest to you, or you had considered purchasing in the past, now would appear to be an excellent opportunity for initiating a position. An investor fact sheet is available here. In general, I'd suggest never jumping all-in at one time, but instead slowly accumulating shares. Though your analysis may be correct, and the stock may be significantly undervalued, you cannot discount that the market is not rational - in the short-term, no matter how low the stock price, it can go lower.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.