Description

Disclaimer:  This is intended for information purposes only (not investment advice) and should not be relied upon as a basis for investment.  The author holds a position in the issuer and undertakes no obligation to update any future changes in the position or in the investment opinions expressed herein.

Why write up a company that starfox02 has already done a phenomenal job writing up in August 2022 and has since doubled in price?  Well, I think it might double again and so a refresher could be timely.

Instead of repeating everything starfox02 said, I highly recommend reading his thesis again.  The company makes fuses / connectors / power components / etc. for applications that value reliability and quality over price (Commercial planes, data center routers, non mass-market EV, rail applications, defense equipment and so on).  

The main points of starfox02 thesis were:

1. The company is trading at 9.5x earnings.  This is too cheap not only as an absolutely number and relative to peers, but also because,

2. The company should benefit from long term secular growth (the “electrification of everything”).

3. The company has self-help opportunities to expand gross margins through the elimination of low (or even negative!) gross margin products, price increases, alignment of sales incentives and so on.

With the benefit of the 18 months that passed since starfox02’s writeup, the last two items played out nicely.  Revenue increased HSD between 2021 and 2023 and the gross margins expanded from 25% to 34%.  

The earnings multiple remained stubbornly flat, but the other two points were enough to push the stock to a double.

Looking ahead, the main points of this write up are:

1. The company is trading at 10x earnings.  This is too low because,

2. The company should benefit from long term secular growth (the “electrification of everything”).  This should contribute to MSD revenue growth and to an expansion of the EBIT margins (thanks to benefits of scale) towards competitors’ range.  Following the progress that has been made in shoring profitability, management’s focus is shifting to top line growth.

3. Capital allocation.  Since starfox02’s thesis, the company generated enough cash to move the balance sheet from a position of $50M in net debt to $70M in net cash.  A share repurchase program was announced last week.

Multiple

Bel Fuse is trading at a lower multiple than any of its peers:

In the past, when Bel Fuse had a mixed history of profitability it made sense, but this has changed in recent years as the company started focusing on profitability rather than on sales.  The return on capital has been indistinguishable from competitors lately:

(as an aside, I would ignore the fact that Bel Fuse had a higher ROC than competitors in recent quarters, because it is just now experiencing the pains of the post-COVID inventory glut, which the others felt earlier;  I am content with settling on a comparable ROC that, if consistent over time, should imply a comparable PE).

Note that this was achieved with a better balance sheet than peers.  Only one peer has a net cash balance sheet.  We’ll talk about this point further as we discuss valuation.

Revenue Growth / EBIT margin opportunities

The company’s verticals grow faster than GDP.  This is not a unique feature of Bel Fuse, but rather a common trait shared by the industry.  Growth in GDP provides a baseline LSD growth, which is then augmented by the increasing prevalence of electric parts as society electrifies more and more domains.  A good example would be EVs, that were virtually nonexistent 5 years ago and are now growing 10s of % annually (in this segment think less about Tesla / Rivian and more about electric school buses, heavy duty equipment, marine equipment and so on).

The benefit of the top line growth should lead to an even stronger EBIT growth because some costs are fixed.  While Bel Fuse’s EBIT margins have been trending higher, they are still well below the rest of the industry:

As a side note, while it will play a lower role going forward, there are still self-help actions being taken.  On the 2/22/2024 call, the company disclosed an effort to streamline the operations in a Pennsylvania factory that should yield $1M in incremental annual cost savings in 2024.  I assume that the low hanging fruit has been picked, but this reported project alone should increase EBIT margins by 20bps.  I would be surprised if they cannot find additional similar opportunities (albeit, at a slower pace / lower impact than before).

Capital Allocation

With the company now in a strong financial position - carrying a $70M net cash pile – management announced a $25M share repurchase program.  CFO, Farouq Tuweiq mentioned on the 2/22/2024 call that “we do expect that to be, I'd say, relatively in a handful of quarters to be through that”.

The company also seems to be patient with acquisitions, saying that “Despite the many wins of 2023, we're not able to be as acquisitive as we hoped given the limited availability of viable targets”.

The capital buildup + demonstrated patience increases the odds that either a decent opportunity will fall in their lap or that the company will continue to “programmatically” return capital to shareholders.  Both options should be good for shareholders (a combination probably best).

Note that the company carries a 2.5% fixed rate debt, so total liquidity is roughly double the net cash figure.

Valuation

The next 12 months will be ugly.  COVID made customers weary of supply chain shenanigans, which led to overstocking.  Historically, the aftermath of de-stocking of excess inventory took between 3-4 quarters (per the company 2/22/2024 call).  Competitors have been reporting this issue since Q4 of 2022, so we are now 5-6 quarters into a supply glut.

This is not a new phenomenon to the industry and literally every competitor experienced the same issue.  The industry has been handling the issue by slowing production (e.g., suppliers AND customers planned longer Chinese New Year factory shutdowns this year to help absorb some of the excess inventory).

As a long term investor, I ignore this and look 2-3 years, but 2024 could be ugly for the company (and the industry).  In the context of the new buyback plan and the capacity to acquire competitors I am not sure if it is a positive or a negative but wanted to flag this.

If we model a 4% revenue growth over the next 3 years (MSD should be the long term growth), 100bps lower gross margins than 2H 2023 (feels conservative, and could surprise for the upside), and a 10% increase in R&D / SG&A (slightly slower growth than revenue), Bel Fuse could end 2026 with an EPS of $8 and $25 / share in net cash. 

EPS and net cash assume the completion of the repurchase program but not any follow up repurchases.  It also ignores M&A opportunities.

What should Bel Fuse be worth in that scenario?  As a start, more than the $50 / share it is trading for right now…

A valuation of 10x earnings + cash would get the stock to $105.  15x earnings would get the stock to $120 / share and would still be the lowest PE in the segment (and this valuation ignores the $25 / share in cash Bel Fuse might have vs net debt the peers have).

The downside seems to be limited with (probably) $10 / share in cash by yearend 2024 and 5$ (hopefully trough) EPS.

The main risk in my opinion is that the price increases drove away revenue, which would imply that the cyclical decline is really a secular market share loss.  This does not seem to be the case given that the entire industry moved in tandem towards declining revenue in the face of excessive inventories.

Disclaimer:  This is intended for information purposes only (not investment advice) and should not be relied upon as a basis for investment.  The author holds a position in the issuer and undertakes no obligation to update any future changes in the position or in the investment opinions expressed herein.

Catalyst

End of inventory glut (probably 2H 2024)