Forward Industries Competitive Moat Check (FORD)

| About: Forward Industries, (FORD)

This is one in a series of articles examining Joel Greenblatt's Magic Formula for picking value stocks. Today's stock: Forward Industries (NASDAQ:FORD).

Forward Industries designs and sells cases, bags, clips, hand straps, faceplates and other accessories for consumer electronics and medical equipment.

Let’s take a look at the big five numbers -- the five key metrics that determine whether a stock has a growing and sustainable competitive position. These factors are: (1) return on invested capital — ROIC, (2) book value growth, (3) earnings per share growth, (4) sales growth, and (5) free cash flow growth, over the past five years.

I checked Forward Industries’ financials on ADVFN. ROIC last year was 41.3 percent and it was 27.5 percent on average over the past five years. Book value per share has grown by an amazing 56% per year from $0.49 in 2001 to $2.92 per share in 2005. Earning per share however has been a different story. Earning per share had gone from $-0.33 in 2001 to $1.37 in 2005. This last quarter however earnings growth has become negative. Revenue growth has been an average of 28.7 percent over the past five years, but has declined in the recent quarter. Finally, free cash flow has gone from -$0.7 million in 2001 to $7.0 million in 2005. All five number seem to indicate a wide moat, but in the last quarter these numbers have weakened.

One thing to note is that OEM customers account for 97 percent of Forward Industries’ sales. I don’t think that OEM customers are likely to be brand loyal. Forward Industries has approximately 200 active customers. Five of their customers accounted for approximately 88% of their total net sales in Fiscal 2005. These major customers include Motorola (MOT) and Nokia (NYSE:NOK) for cell phone products, and Abbott Laboratories (NYSE:ABT), Bayer Healthcare (BAY), and Lifescan for carrying cases for diabetic monitoring kits.

So what is Forward Industries competitive advantage? I believe that it is associated with the fact that they do not manufacture any of the products that they sell and distribute. Forward Industries’ subsidiary Koszegi Asia’s ability to source quality cases in China on short lead times is probably what has made them so profitable in the past.

The carry case industry, however, is very competitive. Forward Industries estimates that they compete with approximately 1,500 producers and distributors throughout the world. Forward Industries believes that they can sustain their competitive position through maintenance of an extensive product design capability, rapid response time to customer requests for proposals and product shipment, competitive pricing, reliable product delivery, and product quality. They believe that their ability to compete based on product quality assurance considerations is enhanced by the local presence of their Hong Kong and outsourced Chinese quality control and shipment facilities.

My question is: Are any of their competitors currently also using Chinese production with a local presence? I would also like to know how costly it would be to create a similar local presence quality control system in China for the carry case industry.

If the answer to these two questions indicates that Forward Industries doesn’t face a direct threat to their current competitive edge, I would label this company a wide moat company. A recent comment by Forward Chief Executive Officer Jerome E. Ball indicated sales and profit were adversely affected by unit pricing pressure in the past quarter. That doesn’t sound positive, but it is also only one quarter.

Given that Forward Industries only has a market cap of $66 million, I would probably cut them some slack in determining whether the have a wide moat. I would be very interested in hearing your comments on this company. I’m sitting on the fence on this one.

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