Ceradyne: Why the Low Valuation?

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

Comments

[InvestingPe...:]

While we at InvestingPennies.com concur with your assertion that Ceradyne (CRDN) is undervalued at its present value, we believe it's a far stretch to fully associate it as an alternative energy play. With the majority of current revenues coming from armor sales, Ceradyne may have its hands dabbled in other industries but it will continue to be focused as a defense manufacturer. If the Bull is picked up as anticipated, even more so will CRDN reflect its armor-centric strategy.

2008 Jun 19 06:14 AM

[Steve Alexa...:]

Agree with the assessment, and would add that Ceradyne is using it's windfall defense profits of the last 3 years to increase their non-defense revenues (now close to 40%), particularly in solar crucibles and aluminum smelting. Future is bright, not bleak.

Steve
magicdiligence.com

2008 Jun 19 12:07 PM

[seekingvalue:]

I'm long CRDN from around $34 for the reasons you guys outlined above, plus the strong balance sheet. I think the odds are good that the armor orders will continue a while longer, and they do have good opportunities with the Bull armored vehicle, solar cell crucibles and aluminum smelting. But let's be honest, this isn't a clear value play. While ~40% of revenues are non-defense, only around 10% of profits are non-defense. If the (Bull, solar, aluminum) opportunities don't work out, and if armor sales drop toward pre-Iraq levels, CRDN could hit $15 or less. If armor holds up AND the opportunities work out, I wouldn't be surprised to see $100+. So on the whole, I do think CRDN is a good buy at $38-$39. But it's not a forehead slapping, back up the truck, buy it and rest easy in the assurance of future wealth kind of buy.

2008 Jun 19 02:19 PM

[Urbane Gori...:]

If I remember, the crucilbles for aluminum are disposable .... Kinda the Gillette blade of manufacturing supplies....In other words, you have to keep buying new ones.. And didn't they just sign up ACH as a buyer recently? .... Looks good..

Thx jegan

2008 Jun 19 06:09 PM

[mkreisel:]

Ceradyne is nothing but a Iraq war play. If you want to know what happens to defense contractors after major wars, study the charts for BA, GD, LMT between 1968 and 1975.

Perhaps you will learn enough not to toss out the "undervalued" label that quick.

2008 Jun 20 03:29 AM

[tresspass:]

Unlike WW2 and WW3, the current day struggle is being fought over resources ( which will dictate ideology---the 2 other wars ) and not ideology which appears to be on the surface but a mere sub-text to the bigger game. The best equipped will win all. The USA, no matter how decrepit we may look in the world and our own eyes does not and will not lose in the mid nor long term---analogies to Rome, England, et.al are foolish using today's criteria. I don't pretend to know how it will be fought out but most of it will be on the ground----and the US will not be the only buyer in the NATo and good guy alliance needing to be supplied.

After getting a feel for the events unfolding these past few weeks, I gather the inevitible will happen. Not an investor yet, but clearly Ceradyne is a fair bet on the fallacies of human nature......looking at an option play here, if there are any leaps.

2008 Jul 03 01:18 PM