Nam Tai Investment Brief

Oct. 8.08 | About: Nam Tai (NTP)

Nam Tai Electronics (NTE) is a holding company with subsidiaries engaged in the manufacture of electronics. The company operates in three segments: consumer electronics and communication products [CECP], telecommunications components assembly [TCA] and LCD products [LCDP]. For FY 2007, the revenue and operating profits for the various segments broke down as follows: CECP (36% of revenues, 73% of operating income), TCA (53% rev, 34% OI), LCDP (11% rev, 3% OI). As of Q2 2008, the TCA & LCDP segments have deteriorated significantly as outlined below.

  • Intrinsic Value: $10 - $15 per share
  • Accumulate: $8.50 or better

FUNDAMENTAL METRICS

Share Price (09/25/2008): $8.81
Market Cap: $395M
Dividend Yield: 10%
TTM P/FCF (P/5-yr avg FCF): 7.9 (8.4)
Greenblatt ROIC (3-yr avg): 30.2% (30.5%)
Debt-to-Equity: 0
MRQ Total Liabilities to Equity (ex-goodwill): 0.30 (0.31)
TTM P/E (Forward P/E): 6.32 (12.77)
P/S: 0.58
P/B (tangible - ex goodwill, intang, land rights): 1.1 (1.2)
PEG Ratio 5 yr expected: 0.97

VALUATION

Leaning toward Warren Buffett's owners earnings approach to DCF analysis (growth rate of 6%, 5% discount rate over 5 years), here are some valuations based on varying levels of free cash flow:

5-yr avg FCF $44M ' $13.50 per share
2004 FCF $36M ' $11.00 per share
TTM FCF $50M ' $15.00 per share
Arbitrary FCF $20M ' $6.00 per share

Over the last 5 years, NTE has been remarkably consistent in its FCF generation despite the cyclical, competitive industry they operate in. 2004's FCF result of $36M was the weakest result in that 5 year time span. My arbitrary $20M is an attempt to account for a cyclical downturn hitting NTE and the industry.

I am also cognizant of the very real possibility that NTE could slip into negative earnings and cash flow if the downturn is severe. However, the strength of NTE's balance sheet provides an additional margin of safety. With $272M in cash ($6 per share) and no meaningful debt, NTE has insulation against both adverse economic fundamentals and the credit crunch. While it's tempting to take out the cash and value company's business at less than $3 per share, much of the cash will be eaten up by ~$160M or so of capex by 2009. Even so, the company is on more than solid footing and should have over $100M cash on hand, assuming flat results over the next year and a half.

Additionally, the company pays a very high (if fluctuating) dividend, currently near 10%. This ensures shareholders get some return for a foreign stock with low liquidity and bolsters investor confidence.

ASSESSMENT

Nam Tai Electronics marks somewhat of a departure from my usual methods. I usually prefer to have a better grasp on a company and the industry in which it operates but the tech space simply moves too fast for someone with my background. In this case, I'm relying on more of a Walter Schloss approach and basing my investment thesis primarily on the strength of its copious cash flow and solid balance sheet. I realize this opens me up to unknown industry trend risks as Nam Tai is a small player with no moat and is a price taker, not a price maker but I am banking on the company's strong financial position to buffet those risks.

I am also encouraged the company has managed to improve margins despite a big drop-off in revenues. Much of this margin bump was due to a drop-off in the low margin TCA segment, which is expected to rebound in the 2nd half of 2008 and thus bring margins back down somewhat. For 2008, management projects gross margin to come in near 12%, higher than both 2007 and 2006.

PERFORMANCE MEASUREMENTS

2008 gross margin: 12%
Revenues: Down 20% YoY for 2008 2nd half 2008 +15% vs. 1st half 2008

TCA: 30-40% growth
LCPP: 15% growth
CECP: flattish

Capex: $80M annually for 2008-2009
FCF ex-factory capex ~$20M to $40M annually during this downturn

(This post was specifically edited for Seeking Alpha. For more detail on the risks and upside on NTE, click here.)

Disclosure: Long