It was unforeseen to the author that Taitron Components, Inc. (NASDAQ: TAIT) would perform as spectacularly as it has over the last 150 days. The stock is currently up more than 200% year-to-date and briefly topped 325% before retreating from its multi-year high of $7.35 per share.
But investors fortunate enough to have enjoyed this assent are now faced with the conundrum of whether to hold or sell. It is in the author's view that TAIT is trading at fair value but could still have some upside potential; albeit how much more is unclear. Therefore, it would prudent to take some profit at this level.
Management's superb execution
TAIT has reported by and large exceptional results, relatively speaking, since the firm's change in strategy in 2016. Management shifted away from its legacy "discrete component superstore" model, which required holding an extensive inventory of a wide variety of products and resulted in significant periodic inventory obsolescence charges against earnings, and towards original designed and manufactured ("ODM") projects. That year, sales grew 22% y/y and have continued growing each year thereafter. (10% and 8% in 2017 and 2018, respectively).
Source: TAIT 10-ks
Margins also strengthened as a result of shift. The company's margins were impacted for the back half of 2018 by the US tariffs on China imports that went into effect in July of that year. The company did, however, successfully pass off a portion of the cost to its customers. But despite the increased costs related to tariffs, management still increased gross margin to 44% in 2018 from 39% in the previous year, while net margin increased to 17% from 9% in the same periods.
Source: TAIT 10-ks
Management also decided to deleverage the balance sheet and strengthen TAIT's financial position since the strategic shift. In 2018, TAIT completely paid off the remainder of its debt. By removing the cost associated with debt service, the company freed up cash to put towards the business and pay a dividend. Currently, the company is paying 12 cents per annum per share in dividends. In the same period, TAIT generated $2.3m in free cash flow, or 41 cents per share. The company spent less than 1/2 of a percent on capital expenditures for each of the last 3 years. and owns all its property unencumbered of any debt.
Three separate methods are used below to ascertain a fair value estimate for TAIT: discounted cash flows, market multiples, and liquidation value. But first it is important to understand that TAIT is a nano-cap stock (market capitalization under $50m) and as such comes with inherent risks. For example, TAIT lacks an economic moat and, in 2018, one customer made up 48% of the firm's sales. It is reasonably possible for a competitor with greater financial, manufacturing, and marketing resources to step in and take market share with very little recourse from TAIT. This is just one of many risks associated with TAIT and, more generally, with the nano-cap stock segment.
Discounted cash flows method
Forecasting TAIT's cash flows is highly subjective because of the lack of management guidance as well as volatility in past results. Therefore, this method is the least dependable and should be evaluated through the lens of a robust sensitivity analysis.
The base case assumes over the forecast period the company will modestly grows sales at a rate of 5% per year, with gross margins weakening to 41% of sales while SG&A costs fall to 26% of sales. The weakening in gross margins over the forecast period is attributable to tariff costs and anticipation that TAIT will not be able to sustain its current margin going forward. SG&A will continue to decline as a percent of sales as cost remain relatively fixed, however, the forecast allows for expected salary increases. It is assumed TAIT will pay the statutory tax rate 21%, although TAIT does have deferred tax assets that can be used to offset its future tax liability. TAIT is expected to continue reducing inventory on hand over the forecast period. The firm will continue to pay a dividend which grows at 6% over the forecast period. Finally, it is assumed TAIT will grow at 2% in perpetuity with a cost of capital close to 15%. Based on the foregoing assumptions, TAIT is worth $4.81 per share. Obviously this valuation is subject to the quality of the assumptions. The table below illustrates how varying assumptions of key drivers impact the per share value of TAIT.
Source: Author's analysis
For example, if TAIT cannot sustain a 5% sales growth rate and instead loses 5% per year, the company's value drops to $3.90 per share. Because of the inherent uncertainty with forecasting such a small company's cash flows, these values should be taken juxtaposed to the other methods discussed regarding valuation.
Market multiples method
In the case of TAIT, a more reliable valuation method than discounted cash flows is using market multiples. The peer group used in this case included: ARW, AVT, KLAC, QBAK, TESS, and VOXX. The average p/e of competitor firms was roughly 19x while the median was closer to 17x. Other multiples also considered included: price-to-sales, price-to-book, and price-to-operating cash flows. After removing the statistical outliers from the peer sample, it is estimated that TAIT's value ranges between $3.31 and $5.67 per share.
Liquidation value method
The preferred method for valuing a company of TAIT's size and risk profile is liquidation value. In other words, if the company had to dissolve the business and liquidate assets, what cash amount would be left after paying off all debts and selling all the assets. Also referred to as the "fire sale".
Cash will yield 100% of its value on the balance sheet. It is assumed accounts receivables will only yield 80% because of the potential nonpayment from creditors. Similarly, PP&E (excluding depreciation) is valued at 65% because of the possible difficulty associated with selling properties. It is important to mention, however, that the discount to PP&E is a very conservative assumption given the properties and equipment are carried at cost, rather than fair market value. For example, the firm's Valencia, CA headquarters was purchased in 1999 for $3.3m. Last year's assessed value for tax purposes came in at $4.6m.
On the other hand, TAIT's Mexico property has been for sale since early 2015. So, although, the properties are carried at cost and could be undervalued, unlocking that value is an entirely different matter. Inventory will yield 25% because of the nature of the products. Finally, liabilities will cost 100% while all other line items are expected to yield zero dollars. Base on these assumptions, the liquidation value of TAIT is $1.62 per share.
In summary, TAIT currently trades closer to the high end of its intrinsic value.
Source: Author's analysis
Deciding when to exit a position is arguably just as difficult as the decision to invest, especially if there is strong momentum carrying a stock seemingly ever higher. The fear of missing out can be a powerful emotion tempting investors to hold on even as less subjective indicators suggest the ride may be coming to an end. In the case of TAIT, the stock has begun to touch a price range that, in the author's view, is speculative. This may be just the right time to exercise prudence and remember that the fear of missing out is always a much easier pill to swallow than regret for not selling at a great price.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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