Ceradyne: Why the Low Valuation?

| About: 3M Company (MMM)

Ceradyne (CRDN) develops, manufactures and markets advanced technical ceramic products and components for defense, industrial, automotive/diesel and commercial applications. It is a large supplier of ceramic body armor plates used to protect soldiers. It also makes high purity ceramic crucibles used in the manufacture of polycrystalline silicon for photovoltaic solar cells. This is definitely a growth area, but the market hasn’t tagged CRDN as an alternate energy stock as yet.

Next earnings report due: July

Market cap: $1 billion; EV: $940 million

The company is projected to earn $4.75 per share in the FY ending Dec ’08, and $5.05 next year. At the recent price of $38.50, the stock is trading at just 8x EPS. The company is generating a good amount of cash, in line with its net income, so effectively it is trading at 8x FCF too. Capex is running slightly above D&A, and working capital has been a minor source of cash. It is buying back its stock, which is nicely accretive at this valuation.

Why the low valuation? It looks like people are concerned that the military may reduce its orders as the war in Iraq winds down. This seems misplaced, as the company has not benefited to the extent that other military suppliers have from “one-time” war-related orders. The defensive nature of its products means that sales should remain steady in the future. The company’s booming solar crucible business is also not being reflected in its valuation.

Fair value $70 (15x calendar ’08 EPS estimate of $4.75).

Also check out my other piece today recommending PWR as a short.

Disclosure: Author has a long position in CRDN