P&F Industries – A Profitable Asset Play

Purchase Price: $9.00 (6/3/2016) Market Capitalization: $31.87 Million
Enterprise Value: $31.12 Million TTM EV/EBITDA: 3.98
Price Target: $15.00 (~66% upside) Time Frame: 24 months

P&F Industries (PFIN) manufactures and sells Pneumatic equipment to Industrial, retail, and automotive companies. With the recent acquisition of Universal Air Tool Company, the company has now entered the U.K. market. PFIN operates under one segment (Tools) two sub-segments:

  • Florida Pneumatic – Imports and sells pneumatic hand tools, most of which are of its own design, primarily to the retail, industrial and automotive markets. This includes sanders, grinders, drills, saws and impact wrenches. The tools look like their electric counterparts but are powered by compressed air. Florida Pneumatic imports approximately seventy-five types of pneumatic hand tools, most of which are sold at prices ranging from $50 to $1,000, under the names – Florida Pneumatic, Universal Tool, AIRCAT or NITROCAT, as well as under the names of private label customers. These products are sold to retailers, distributors, and private label customers through in-house sales personnel and manufacturers’ representatives. You can find some of its products here on Amazon.
  • Hy-Tech – Manufactures and distributes its line of industrial pneumatic tools and parts under the “ATP” brand. Under the ATP brand, Hy-Tech produces and sells over sixty types of pneumatic tools, which include impact wrenches, grinders, drills, and motors that are sold at prices ranging from $450 to $28,000. Some of its customers include refineries, chemical plants, power generation facilities, heavy construction enterprises, and oil and mining companies.
PFIN notes
PFIN 5-Year Price Chart

Risks

Energy Prices

Both Hy-Tech and Florida Pneumatic provide derive a portion of their revenues from the energy sector. Last recession, virtually everything crashed together. This time, Oil has gone first and now seems to be in a recovery phase. Hy-Tech is most affected by this and markets have priced in the depressed crude oil prices. If crude oil rises, then we’ll likely see some margin expansion within Hy-Tech. This seems more like a catalyst than a risk since Crude Oil is now counter-cyclical to the company’s financials.

Currency Fluctuations

Florida Pneumatics segment purchases the inventories about 50% of its inventories from China and 49% from Taiwan. These inventories are purchased in the local currency. Any moves to the upside for the Taiwan Dollar or Renminbi will decrease the segment’s gross profits. I believe that the Dollar will only get stronger at least in the short-term since there are no other alternatives; the Fed is also raising the Fed Funds rate which is bullish for the Dollar.

Customer Concentration

Two of the company’s customers accounted for 8.6% and 21.1%. The company does not necessarily point them out, but I believe that they are Sears and Home Depot in no particular order. Though Sears’ survival remains a looming question mark, the products can easily be sold elsewhere as mentioned in the earnings call.

Catalysts

Sale of Nationwide

Last quarter, the company one of its major segments, Nationwide. Nationwide’s products primarily catered to the housing sector. The positive part of this transaction IMO was that the company just sold a cyclical segment at the top of the business cycle and used that cash to pay off virtually all of its debt. What we have now is a company that’s:

  1. Debt Free
  2. Profitable
  3. (Current Assets + Real Estate – Total Liabilities) Covers the market value of its equity. The Real Estate probably shouldn’t be counted since the company derives operational benefits from it, but the balance sheet number is conservative as the company has owned some of these properties for a while, so they’re likely worth more than the balance sheet’s book value.

Dividend Initiation

The company also initiated a quarterly dividend last quarter, to start returning cash to shareholders. This will likely drive more volume from institutional investors seeking dividends. We have hedge fund manager, Andrew Shapiro of Lawndale Capital Management to thank for the new Shareholder friendly initiatives.

Valuation

Since nationwide accounted for 39% of the company’s revenues, we should expect a drop going forward. The company separated Nationwide’s financials in the Q1 report. Nationwide netted $408,000 in Q1 2015. The company, before currency losses netted $781,000, but also recorded interest expense of $192,000. The company carries $130K debt load compared to the $6.5 million they had this time last year. The interest expense should be minuscule going forward. Assuming a tax rate of 35%, the savings on interest going forward will be (1-0.35)*192,000= $124,000. So, what we have left is 781+124-408 = $497,000 net income projection for next year’s Q1.

Q1 is usually the least profitable quarter. If we apply this ratio to all the other quarters, net income going forward should come in around $2 million or so.

Now, these calculations are not perfect, but once the company reports Q2 earnings, we should be able to get a sense of what to expect regarding earnings. There are also other nuances in the Q1 2016 report i.e., the $98k charge for ‘Amortization of debt issuance costs’ that likely won’t recur next year. One thing to note, though, is that Hy-Tech’s gross margins are abnormally low as a result of the weakness in Oil & Gas. This will likely revert to the mean over the long-run.

Lower Valuation than its Peers

PFIN market equity is covered by liquid current assets + real estate – total liabilities and is still profitable.

SNA- Snap-On trades at 19x earnings and a 500% premium to its book value and offers a 1.5% dividend yield.

SWK- Stanley Black & Decker carries negative tangible book value, trades at 18.5x earnings and offers a 1.9% dividend yield

Conclusion

Placing a limit order for $9.00, this will make up 8% of the portfolio. I want to reiterate that this is a cyclical stock and things tend to go south quickly when they do. However, our downside at these prices are limited. I think anyone that’s willing to hold this for 5 or so years will likely see some decent returns.

 

Update

I moved to the U.S./Arizona in 2005 and have lived here ever since. Saturday was my first day at the Grand Canyon! I spent the day at the Grand Canyon and didn’t have much time for research. I’d post pictures, but my phone camera didn’t do it justice.

I’m still working on due diligence on $PFIN and $RCII, also adding another one – Amcon Distribution $DIT. This one will fall under the Consumer Defensive section of my portfolio that is currently non-existent. Because the majority of investors associate volatility with risk, Cheap stocks in defensive industries with stable revenues, stable cash flows, AND low valuation multiples are usually a dime in a dozen. Amcon fits that bill. The company is paying off debt and from what I’ve seen so far, recently started repurchasing shares. It’s also another profitable asset play. Current Assets + Land/Buildings >= Market Value of Equity. So, this one is now last on my DD list. I also like what I’m seeing so far on P&F Industries – if this continues to hold true, I should have a post up hopefully by Wednesday.

Skullcandy Update

The company needs a new management team. The new CEO has had 3 years and all I see is excuses. Earnings calls are always overly optimistic “we’re seeing great customer adaptation in xyz” etc, but the concomitant financials consistently say otherwise. Competition is eating their lunch and gross margins continue to fall. The industry is transitioning to wireless headphones, and the company’s wireless products deliver lower margins than its wired counterpart. Skull Candy and Bose are the only brands I use. I own skull candy wired earphones and they are the longest lasting earphones I’ve ever had. I’ve only have to replace them when I lose them.

Part of the problem is management’s execution – The company went promotional on its inventory in Q4 of 2015 but then ran out of the wireless earphones in Q1. If the company was under-stocked in Q1, then why didn’t they increase the average price of those wireless headphones to support the gross margins? Gross margins fell 330 bps in Q1. The company also plans to spend more on marketing to promote the brand, which means lower operating margins for the foreseeable future.  Headphones are not seasonal in the same sense that apparel retail is. Consumers buy heavier apparel (Jackets etc) in the Winter and lighter apparel in the Summer. So, while an apparel retailer might need 4 quarters to clear excess inventories, a headphone company should only need one.

I read through the last few years of earnings call transcripts and it’s been one excuse after another, then they blamed China for the most recent one. Declining gross margins have been because of competition. Since the wireless counterpart exhibits lower margins, it makes it just that much more difficult to value the company since I don’t know how much lower it will be going forward. I also don’t have access to IBIS world or a Bloomberg terminal or any other professional platform, so industry research is just that much more difficult. The current valuation proves that investors have lost confidence in management’s word.

Given that the company is now well prepared for China’s slowdown, Q4 of this year and Q1 of next year will likely not be as rough as the previous year’s counterparts. But given that the wireless portion of the business is quickly growing and the wired counterpart is declining, and the wireless exhibits lower margins than the wired counterpart, what seems obvious is that margins are just going to keep falling. The company also expects higher SG&A expenses, I just can’t see the light at the end of the tunnel for this one.

The company could be a prime target for a LBO transaction. It fits the bill – obscenely low valuation, founder is dumping the stock and there isn’t another shareholder with a large enough ownership to make a dent in a proxy fight. But buying solely on the hopes of a PE buy-out also fits the bill of the greater fool theory – I’m taking a pass on this one.