Capitalizing On Growth Opportunities In WSI Industries

| About: WSI Industries (WSCI)
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WSI Industries (NASDAQ:WSCI) continues to demonstrate strong growth in sales and earnings as reported in its 2012 fiscal third quarter, highlighted by the company as its best quarter in over 10 years. WSCI is a contract manufacturing company based in Monticello, Minn., and provides precision contract machining for various markets including recreational vehicles, energy, aerospace and defense, and biosciences. The company reported fiscal 2011 revenues of $25.0 million and is on pace to well exceed that figure for fiscal 2012, having generated $22.5 million of year-to-date sales through its fiscal 2012 third quarter.

WSCI presents itself as an interesting investment opportunity based on its revenue and earnings growth, strong balance sheet, dividend yield, solid customer base, ability to generate cash, growth prospects, and attractive valuation. These factors are discussed in greater detail below.

Revenue and Earnings Growth: As previously mentioned, WSCI had an excellent fiscal 2012 third quarter ending May 27, 2012. Sales grew by 45%, and earnings were up by 51% compared with its fiscal 2011 third quarter. Revenues were $9.5 million and earnings were $598,000, or $0.21 per share on a basic and diluted earnings-per-share basis. Sales were up for both of its key two markets, recreational vehicles (up 38% compared to Q3 2011) and energy (up 91%), as these two segments made up 95% of the company's revenue in Q3 2012.

Strong Balance Sheet: WSCI has steadily improved its financial position with a healthy balance sheet. It has a current ratio of 2.33 (current assets divided by current liabilities) as of the end of Q3 2012, and working capital is now $5.8 million (current assets minus current liabilities). Book value is $11.1 million, or $3.83 per diluted share, and tangible book value is $8.8 million, or $3.01 per diluted share.

Dividend Yield: WSCI reinstated its ongoing dividend program after reporting Q4 2010 results, following the temporary suspension of the dividend for nearly two years due to lower sales resulting from the U.S. economic downturn. The dividend is paid quarterly at a rate of $0.04/share, which computes to a 2.7% yield based on the July 6 closing price of $5.85 per share.

Solid Customer Base: The company has the luxury of having a solid customer base, which was a factor of the company maintaining profitability during the recent U.S. economic downturn in all quarters except for Q2 2009. For fiscal 2011, 67% of the company's sales were made to Polaris Industries (NYSE:PII) relating to the recreational vehicle market (all-terrain vehicles and motorcycles), and 18% of WSCI's fiscal 2011 revenue was generated from National Oilwell Varco (NYSE:NOV) for sales relating to oil field drilling equipment. Both of these companies are healthy, multibillion-dollar enterprises, and thus WSCI is in a good position to have such quality customers comprise 75% of its revenue.

Furthermore, the company has significantly increased its business to a large customer that provides services to shale fracturing companies. Sales to this customer increased nearly 300% during Q3 2012 (compared with Q3 2011) as WSCI capitalized on part of a $5 million order first announced in September 2011.

Ability to Generate Cash: While Q3 2012 earnings were strong at $0.21/share, the company actually generated substantially more cash than these bottom-line results would indicate. Adding back non-cash expenses like depreciation and amortization, stock-based compensation, and deferred taxes, while subtracting for capital expenditures during the period gives a quasi "cash equivalent" earnings figure of $986,000, or $0.34/share before taking into account long-term debt repayments or dividends. The company spent $2.5 million of capital on machinery and property, plant, and equipment thus far in fiscal 2012 to support its new programs and customers, and cash generated during Q3 2012 clearly showed that its investment already yielded generous returns.

Growth Prospects: WSCI has a strong reputation in its industry and has continuously shown an ability to generate additional sales through deals with new customers, while adding new programs with existing customers. In addition, it brought on a new chief operating officer late in 2009, and he eventually took over as the company's chief executive officer at the end of 2011. Benjamin Rashleger was president and chief financial officer of privately held Milltronics and helped grow the company until it was sold in 2007. It's likely that the 36-year-old CEO has tapped into some of his industry contacts during his tenure at WSCI to help grow the company's sales into new sectors and with new customers.

As per the June 19 press release, Rashleger stated the following:

We remain very positive about our business as we wrap up fiscal 2012 and are optimistic that fiscal 2013 will show continued improvements. Our customers are clear leaders in their industries, and we have made significant investments in equipment and personnel over the past couple of years to support their growth as we increase our business with them. We look forward to building on our success with continued expansion of our business and by staying focused on the execution of our strategy of partnering with key leaders across industries, and providing them with a superior value and the highest quality service.

Attractive Valuation: Relative to the July 6 closing price of $5.85/share, WSCI trades at a P/E ratio of 14 based on its trailing 12 months of earnings ($0.42/share). Note that this includes EPS of only $0.10/share during the first half of fiscal 2012, primarily attributed to start-up costs for new programs such as the shale fracturing segment. Look for earnings in the first half of fiscal 2013 to be well above $0.10/share (particularly given that the company posted $0.21/share for a single quarter in Q3 2012), thus lowering its price/earnings multiple substantially. If the company were to just average $0.17/share of quarterly earnings for the next three quarters, this would imply 12-month earnings of $0.72/share and lower the price/earnings ratio to only 8 based on the current stock price. In addition, the company only trades at 1.5 times its book value, and as previously mentioned offers a 2.7% dividend yield at present price levels. WSCI only has 2.9 million shares outstanding, making it a quick-moving "low floater" when daily trading volumes can consistently increase beyond recent daily average trading levels.

Taking all of these factors into account, I believe that WSCI has excellent prospects going forward. The current stock price makes for an attractive investment for the patient, value-oriented investor who is looking for growth opportunities, while generating some modest income through the company's ongoing dividend program.

Disclosure: I am long WSCI.