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P & F Industries (NASDAQ:PFIN) operates 2 businesses. Its subsidiary Florida Pneumatic designs, imports and sells pneumatic hand tools like sanders, grinders, drills, saws and impact wrenches. It sells these products to the retail, industrial, automotive and aerospace markets. These products are mostly manufactured in Taiwan, but also in the PRC and a small part is manufactured in the US. Final assembly is in the US in Jupiter, Florida.
The other subsidiary, Hy-Tech, manufactures “heavy-duty pneumatic impact tools, grinders, air motors, hydro-pneumatic riveters, hydrostatic test plugs, impact sockets and custom gears” in the US. It sells these products under the brands ATP, Numatx, Thaxton, OZAT and Quality Gear. These products are similar to Florida Pneumatic products but are more for the mining and oil industry and for large construction projects such as large infrastructure construction.
Recently the company acquired 2 custom gear manufacturing businesses. This transaction complements the Hy-Tech subsidiary, which is much smaller than Florida Pneumatic. Note both newly acquired businesses are in Bridgeview, Illinois and there is some similarity in the websites of these 2 businesses. Therefore I think these businesses might be viewed as affiliates of each other. They might be closely cooperating or have the same owner or owners of the same family.
The reason I discuss this stock is because it is a good pick when comparing it to other stocks using various measures. I use a ranking algorithm to rank international and US-listed stocks with market cap below $25 million. I think this is the maximum market cap for which there is a substantial size effect, independent from the liquidity effect. I rank them on various value metrics and on other metrics such as measures for trading liquidity, financial strength and payouts. According to this ranking P & F Industries is one of the best nanocaps compared to other US-listed nanocaps.
I believe most great investors are very consistent in their investment process. A consistent investment process is investing based on multiple favorable metrics. My ranking algo's do just that. They provide me with a wide choice of ideas for investing based on statistics.
While I prefer to invest based on statistics rather than conviction I also try to improve my investment results with fundamental research. I do that by following a consistent research process. Part of this process is that I always check the same things: earnings quality and asset allocation, governance, payouts, related party transactions, executive pay, ownership, and signs of financial distress. See my analysis below. I will conclude with a discussion of new developments at P & F Industries.
As a quant I use the method described in the book Quantitative Value to judge earnings quality and asset allocation. This method compares companies on 8-year metrics involving the gross margin, free cash flow and return on equity and on assets. This method cannot really distinguish between these 2 concepts but for the returns I do not think that matters.
When I compare these metrics with those of other companies my conclusion is P & F Industries is not a high quality business. Two 8-year metrics are quite good: those involving gross margin stability and free cash flow. The 8-year metrics involving return on capital and return on assets are worse than average.
What can an investor do to check governance? I always start with a simple search on the company name and keyword "fraud". With such searches you can usually find it if there is anything. With P & F Industries this search does not reveal any relevant information.
Next I look into the filings. With P & F Industries there are 2 red flags. The main shareholder and CEO is also the chairman. And the COO is also CFO and Treasurer. So with this stock risk of inadequate control is elevated.
The company started paying a dividend in 2016. It continued paying dividends in 2017, 2018 and so far each quarter in 2019. In 2016 the company paid $1.6 million of special dividend on top of the new regular dividend.
In 2012 it did a small dilution raising about 1% of tangible assets. In 2014, 2017 and 2018 the company was a net spender on repurchases. In particular the company spent much on repurchases during the first quarter of 2019: $3.2 million. In the second half of 2018 and the first half of 2019 the company spent $4.5 million on repurchases in total. There is scientific research implying repurchases paid with extra debt are much less positive for the stock price than repurchases paid from existing cash. So it is encouraging the company also reduced debt with about $1.2 million during the last 4 quarters.
This is a pretty clean company in terms of related party transactions. In June 2018 the company bought back a small number of shares from Joanne Horowitz, the sister of the CEO/Chairman. The purchase price was $8.27 per share or 5% below the average closing price of the prior 3 trading days. In February 2019 the company bought for $2.971 million of shares from former large shareholder Fidelity for 97% of 20-day average of the closing price prior to the transaction ($7.62 per share).
Normally I do not like it when a company buys shares from a family member of an insider. But with the 5% discount and the smaller discount for the transaction with Fidelity I suppose this is OK.
The CEO/Chairman and controlling shareholder received pay of $1.7 million in 2018. The COO/CFO/Treasurer got $693k. Variable pay is very high, especially for the CEO/Chairman, but he does not get any equity based compensation. I do not like high variable pay because it increases chances of excessive risk taking.
Already in 2017 Jan Svenda opined that the CEO/Chairman receives an excessive salary. I think that was based on information from the annual report over 2015. Considering the size of the company and the difference in pay with the COO/CFO I think the controlling shareholder is paying himself at least $600k per year too much. What does that mean in practice? For the September quarter paying the CEO/Chairman $150k less would more than double the operating profit.
The 69 years old CEO and Chairman Richard A. Horowitz owns 42.3%, his mother Grace Horowitz 6.9%, COO, CFO and Treasurer Joseph A. Molino Jr. about 2% (4.2% including employee options), and outsider Lawndale Capital Management owns 15.9%.
The CEO has signed a voting agreement that he will not vote more shares than 42.5% including the votes from his mother’s shares. Also the amendment to the debt agreement financing the recent acquisition prohibits him from acquiring a majority stake. At least that is my interpretation. See here, item 10.2.4 on page 7.
So the CEO and chairman controls the company in practice but other shareholders can still force him to step down if they do not like his decisions and performance. I like ownership structures like this one.
See here for the recent quarterly results press release for the third quarter of this year. In a subsequent event the company assumed $3.5 million of extra debt for acquiring the gear manufacturing businesses. The extra debt comes from an amendment on an existing revolver agreement (link above). The company does not have any other debt. According to the annual report (page 43) this debt agreement expires in February 2024. But according to the annual report and the recent results filing the company classifies this as current debt.
The company has hardly any cash and about $5.4 million of debt. I suppose the company is fine as long as it satisfies the debt covenants. In particular EBITDA minus capex and tax divided by "fixed charges" should be more than 1.00. Fixed charges is basically interest plus repayments. In the amendment the quotient is called the "fixed charge coverage ratio".
The company said it is borrowing against "LIBOR + 1.5%" plus a base rate of 0.5%. So currently that is about 4% and annual interest expense should be about $220k. Actual interest expense of $144k over the first 9 months of 2019 suggests average debt is somewhat higher than debt at quarter end. Repayments might be a million per year, we do not know. I estimate EBITDA at $2.5 million per year. So it seems the company is pretty safe when it comes to satisfying the requirement for the fixed charge coverage ratio. Also since there are few other liabilities and the current ratio is high I do not think the company is financially distressed.
In the second quarter the company sold part of its real estate. Based on Jan Svenda's article I think the company's remaining real estate is worth about $3.6 million. The company could sell the remaining real estate to pay off debt if it needed to.
As I wrote at the beginning of this article the company has just acquired 2 small manufacturers of custom gears. I like such acquisitions that are clearly complementary with the company's existing Hy-Tech subsidiary. In the recent results announcement the company writes it will realize synergies, that it can use the know how for the Hy-Tech subsidiary and that it will triple the gear production capacity at Hy-Tech. Let's hope that is currently a bottle neck for Hy-Tech. It mentions being able to attract a broader range of customers as well. So it seems to be a good fit.
Unfortunately we do not know much about the assets and liabilities that have been bought. From the website of one of the acquired businesses it seems the company has acquired lots of equipment. Because there might be contingency payments for inventory sales I suppose there is some excess inventory as well.
Recent earnings were disappointing. During the last 9 months the company earned only $208k of operating income including $141k last quarter. The company also issued a couple of warnings along in the earnings announcement. First, costs of products and parts sourced from abroad might increase because of new or additional tariffs on imports into the US. So far there has not been any substantial impact.
Second, the company feels strong competition from battery powered pneumatic hand tools. Apparently the company only offers pneumatic hand tools with an electric cord so far. I do not know how difficult the switch to battery powered hand tools is but I suppose this could be a big issue.
Third, the company said sales suffered from lower production at Boeing (BA). Boeing decreased production after the 737 MAX was grounded. Even after the 737 MAX is allowed to fly again I think production will stay much lower than before. Fortunately for P & F Industries the impact of the issues at Boeing seems to be small so far. In 2018 revenue from the Aerospace segment was $10.6 million. But last quarter's revenue was almost $3 million. So it seems lower production at Boeing rather limits growth than that it directly causes a sales decline at P & F Industries.
I like this stock, mostly based on statistics. But with the recent acquisition I also think there are good chances on sales and profit growth. Furthermore I think once the gear businesses are integrated in the Hy-Tech subsidiary the company is even more valuable for an acquirer. An acquirer can also lower costs for example by replacing the CEO/Chairman. An acquirer or the company itself could also create value by selling of the main subsidiary, Florida Pneumatics.
So I recommend a position in the stock. Do not make the position large because statistical investing is like rolling a special dice with a somewhat higher chance on the 6 than on the 1. In the end the law of large numbers will work for you when you have many positions but there will still be rolls with disappointing outcomes.
Become a statistical investor. Investing is mostly a game of luck. Therefore it is dangerous to invest based on conviction with large positions. But investing with many small positions in undervalued stocks with statistically great returns works just as well. So that is what I do, with 7 proven global stock strategies.
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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.
Additional disclosure: I do not have a position myself because there are still better stocks listed on foreign markets, such as Hong Kong, Tokyo, Russia and Poland.