Giga-tronics Inc. (GIGA)

Giga-tronics Inc. (GIGA) designs, manufactures and markets a range of test and measurement equipment related to wireless communications, flight navigation, and defense systems. Last week, the stock took a 20% dive after the company released its 2Q F11 earnings, which showed a loss of $0.02/share on slightly higher revenues but increased COGS and SG&A (mainly due to R&D). Has a value opportunity presented itself? Let’s find out.

GIGA does not lend itself to being valued based on its earning power, because it has never really made money. In the last 10 years, it has had negative earnings for 7 of them, for a net loss of $14.46 million. So, the only way to value it based on its income statement would be to make certain assumptions about future growth which, at this point, would appear to be unwarranted. Remember, to value the earnings power of a company, we look at the company’s earnings over a full business cycle and calculate average margins throughout, then treat as a no-growth perpetuity. Valuing growth is a much more difficult task fraught with error.

Rather than earnings power, we can value GIGA based on assets. One attractive element of GIGA is that it has NCAV of $2.12/share (vs. a share price of $2.20). However, more than 1/3 of current assets is represented by Inventories, so we have to consider whether this inventory may be in danger of becoming obsolete, or otherwise would not be recoverable for the value it is being held at. As far as NCAV is concerned, there is no value opportunity here (there may have been a compelling opportunity to buy a company at a price just slightly above its NCAV if the company was also profitable, but alas that is not the case here).

We turn to non-current assets in search of some reason for paying a premium to NCAV. We find that the bulk ($11.6 million out of $12.24 million total non-current assets) is represented by Deferred Tax Assets (DTAs), which arise when a company has accrued an expense which has not yet been realized. The problem is, to realize benefits from DTAs, the company must be earn a profit. Given the company’s track record, it is unlikely that the full extent of these DTAs will be realized in the foreseeable future (remember, in the last 10 years, it has positive earnings in just 3 of them for a total of $4.57 million). So, we eliminate these DTAs (and expect that management should consider impairing this asset) and find that there is $599,000 of Net PP&E and $16,000 of Other Assets (capitalized R&D costs, which we will also eliminate). Adding the $599,000 to the NCAV, we still do not reach a valuation that represents a Margin of Safety to justify a purchase at $2.20. We haven’t even begun to include the off balance sheet liabilities ($4 million+ PV of operating leases) nor have we accounted for the 891,000 options outstanding, both of which would further depress the intrinsic value of the assets.

In short, even after a 20% drop in price, GIGA does not appear to be undervalued, and almost certainly not with a margin of safety that would attract a value investor. If you’ve analyzed this company and reached a different conclusion, I would love to hear from you.

Author Disclosure: At the time of publication, the author DOES NOT have a position in securities of this company.

Read more: Giga-tronics Inc. | Frankly Speaking http://www.frankvoisin.com/2010/11/12/giga-tronics-inc/#ixzz172GJOBJc
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