Seeking Alpha

Taitron Components: Buy On A Dip

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About: Taitron Components Incorporated (TAIT)
by: Anthony H. Steinmetz
Anthony H. Steinmetz
Value, special situations, arbitrage
Summary

Management is doing excellent work returning cash to shareholders.

With the cash balance growing quarter-over-quarter it is anticipated management will look for new ways to reward investors.

The company's customer base remains too concentrated with 57 percent of sales coming from 2 customers.

The stock is overvalued at its current market price but remains a good investment on a pullback.

Taitron Components (NASDAQ: TAIT) continues to impress. Contributing to the stock's success are expanding margins and management's focus on returning cash to shareholders. Additionally, the company remains debt-free.

But not everything is on the up-and-up at Taitron. The company reported a third straight quarter of double-digit revenue declines and working capital levels are a growing concern considering the current trend in sales.

Overall, Taitron is speculative at its current market price. Currently, the stock is trading at a premium compared to competitors, which is partly justified given Taitron's superior business margins. However, it is unclear whether this premium will be maintainable over the next several quarters. With that being said, the Author really likes Taitron and considers it a worthwhile investment, but will only consider a position at a better entry price than what is currently being quoted in the market.

The Good

As a shareholder, there are several things to like about Taitron. The most noteworthy items include the company's margin profile, growing cash balance, and robust dividend policy.

First, Taitron's margins are the best in the industry. Over the last 12 months, the company reported gross, operating, and net margins of 48.4 percent, 17.6 percent, and 21.4 percent, respectively. This compares to an industry-wide average of 26.0 percent, 6.6 percent, and 5.7 percent respectively (more details about industry participants will be discussed later in this article). Although it is uncertain whether Taitron will maintain its outlying margins, in the interim the company should continue to demand a higher premium as a result of them.

Next, shareholders should be delighted for Taitron's growing cash balance. At the end of the third quarter, Taitron had an unrestricted cash balance of $5.0 million, equating to approximately 31 percent of the company's current market capitalization. In the third quarter alone Taitron grew its cash balance by $871 thousand (noteworthy, however, is that figure included the sale of the company's Mexican PP&E for $200 thousand). See Taitron 2019 Q3 10-q for more information. As the company's cash pile continues to grow, it is anticipated that management will explore additional ways to enrich shareholders, including increasing dividends and potentially share buybacks.

This brings the conversation to Taitron's dividend policy. As operations have improved, management has taken the opportunity to reward shareholders by raising its quarterly dividend. Currently, the common stock offers a 14¢ per share annual dividend; up from 12¢ in 2018 and 10¢ in 2017. And the stability of future dividends appears relatively safe given the company's free cash flow per share--31¢ over the last twelve months--and a debt-free balance sheet. Additionally, as Taitron's cash position increases management may spin off some of the cash via a special dividend.

At present, shareholders should feel pretty satisfied about Taitron's financial position. However, there are some looming concerns that are holding the company's stock price back and until management gets a handle on them, the stock will remain turbulent.

The Bad

The main concern with Taitron is its concentrated customer base, as well as the firm's working capital levels.

First, Taitron has a highly concentrated customer base. The company is a supplier and a distributor of electronic components to original equipment manufacturers ("OEMs"), contract electronic manufacturers ("CEMs"), and other electronic component distributors. Taitron does not manufacturer products; rather it designs and engineers electronic products for OEM customers and then sources CEM customers to manufacture the custom designed and engineered products. Taitron also distributes both brand name and original designed and manufactured (ODM) products to OEMs, CEMs, as well as other distributors. See Taitron 2018 10-k for more information.

Of the $8.2 million in sales Taitron did last year approximately 57 percent came from only 2 customers. This has similarly been the case in the last three years with 2 customers making up 51, 55 and 47 percent in 2017, 2016 and 2015, respectively. Aside from Taitron's self-proclaimed "exceptional customer service and customer relations" there is nothing really placing Taitron's services and products over that of its peers. And if just one of the company's larger customers' goes with one of Taitron's numerous competitors, that would spell doom for an entire year's (perhaps years') profitability. It would behoove the company to try and grow its market share by broadening out to new clientele.

Another concern is the ongoing need for inventory write-downs. Historically, Taitron marketed itself as an inventory superstore where customers could easily find the electronic products needed in a fast and convenient manner. But the superstore strategy required excessive write-downs of inventory year-after-year.

*Data Sourced from Taitron's Consolidated Statement of Cash Flows

Then in 2016 Taitron shifted its focus away from the superstore strategy and took a corresponding $3.6 million write-down to solidify a new path. Since then, inventory write-downs have left profitability relatively unscathed. But a close look at current Days Inventory Held (DIH) reveals that another substantial write-down may be on the horizon. As of September 30th, DIH stands at 436 days compared to 335 days at the end of 2016, and DIH has been creeping up each quarter in 2019.

*Author's own calculation using Taitron's 10-k and 10-q reports

In both 2017 and 2018, Taitron took an $180 thousand inventory write-down in the fourth quarter of each year. Based on sales trends for the first three quarters of 2019 as well as the rising DIH, it is anticipated that Taitron will take another, potentially much larger, write down again in 2019.

Fortunately, management is currently seeking to fill a number of roles within the organization that will help the company reach a larger customer base and increase sales--which will have a positive effect on the company's working capital metrics. The roles include marketing analyst and marketing director and also an inside sales role. See Taitron's Career Page for more information.

Market Comparison

*Author's own analysis. Data gathered from SEC.gov and Seeking Alpha

Market comps are signaling caution to investors considering Taitron at its current market price. The company's P/E and EV/EBIT are trading essentially in line with competitors, but sales metrics tell a different story. Taitron is trading at more than double industry sales comps. For example, competitors currently trade at .8x EV/Sales while Taitron is trading at 1.6x. Similarly, competitors are trading at .9x P/S while Taitron trades at an astounding 2.3x.

The most likely explanation, in the Author's view, for the sales premium is Taitron's superb margins. But, as previously discussed, it is unclear whether its margin profile is actually maintainable or margins will revert down closer to its peer group. If the latter turns out to be the case, the stock price will likely trade closer in-step with industry sales comps just as it is with earnings; which would imply a value between $1.10 and $1.90. This is something to keep in mind if you are considering an investment in the company.

Conclusion

Taitron remains a rewarding company, but looks frothy at its current market valuation. I will revisit the company if the stock trades around or below $2.30 a share, or if something fundamentally changes within the company.

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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