Today I’m looking at a technology stock. I try to avoid them as much as possible. I do not always understand the technologies employed nor the competition active or sleeping. Investing in a technology stock is usually riskier than investing in other industries.
This tech-stock is quite different from RIM or APPL. It has no high-end product what so ever. They are distributors of other company products to cable companies. That is a specific market not close to dying. You’ll always have to watch TV and every cable company needs parts to repair their systems. There is the niche of AEY. They specialize in urgent repair parts supply! Wow, that is a very specific market.
This market seems profitable to AEY. In the last 5 years they kept profitable even with revenue decrease of over 30% since 2008!
AEY is a major supplier of cisco products to the cable companies. 30% of the company sales are related to CISCO products. They recently negotiated their contract with cisco successfully becoming “premium partner”. This new status obliges them to buy from cisco distributor(read higher cost) but they may carry a higher number of parts available with lower inventory (replenishment delays are shorter when using distributors). They may also sell cisco IT products to their existing customers. This could present a good opportunity of revenue growth.
Net current asset value of ADDvantage currently is over 26m. It is largely composed of cash (12m) and inventory (27m). There also is some debt (10m) and other liabilities(3). The current cash covers the debt ( there are penalties on debt closing so the debt is kept ) so we are left with the inventory. The inventory turnover ratio over 5y average is around 2 so we could convert this inventory to cash very easily over the course of 6months or so.
The current market cap is only 22.5m! You get the inventory at a 10% discount on current price and you get all fixed assets for free!
What are the revenues then? AEY never lost a penny! This company is profitable with good return on equity over the past years. The 5y average net income is 4.8m$ and the TTM is 3m$! You get a P/E of 8.1 on current profitability and 6.8 on a 5 year average basis! This business is declining but still highly profitable. Current management stated that they are not chasing revenues but profitability!
Is the company burning cash so our MOS would be eroded? No! It is actually pumping cash! Operations gives a free cash-flow of 1m per quarter after debt payment and they reduced their inventory and payables last year and this year generating 17m of free cash-flow in the last 6 quarters alone! This cannot continue much longer but this company free cash flow is exceptional for a so depressed P/E! The 5 years average cash-flow is 5M. You get a P/FCF of 5 on a 5 year average or 2.2 on last year FCF!
In the last 5year ADDvantage did not invest in capital expenditure. They may have to enhance their distribution centers in the future but it tells that the management is not burning it’s money on capital extensive projects and that the company does not need capital to generate revenues.
I identify 2 risks over this investment.
Cisco is a risk with high supplier dependency on revenues. It is mitigated by the new “premium supplier” agreement.
Declining revenues is the second risk. Revenues are in decline for the last 3 years. It does not affect profitability that much but it will probably affect it at one point. Last quarter was break-even. It is mitigated by the new IT product distribution agreement with CISCO and low fix charges. Tis will need to be monitored but the stock has a huge MOS with its inventory and cash on hands.
Disclosure : Author has a position in AEY.