Description

This is an update to an idea I posted in Sept. 2004. While it was only rated a 4.6, the stock is up over 40% and I believe it’s even more attractive now than it was when I originally posted it. (Note to avoid the controversy that has plagued similar “updates,” in the very, very unlikely event that I win the $5k price, I’ll decline it).

Hawk ($200mm Enterprise Value) is a leading provider of friction products and powder metal precision component parts to diverse industrial markets. 80% of revenues are derived from sole-source applications. The Company has 20+ year relationships with many of its customers and it does not have any significant customer or sku concentration. Insiders own 30+% of the stock. For more information on the biz, see my earlier post, the company’s 10k or call the company to get a copy of their recent presentation.

The company is experiencing significant growth due to the growth of its end markets and more significantly, from taking share from its competitors including one of its major European competitors which is experiencing financial difficulty. Below are the company’s 2004 actual results and (the high end of) management’s 2005 guidance. Note that Adjusted EBITDA excludes non-recurring restructuring charges and management’s estimates tend to be very conservative (in 2004 they vastly exceeded guidance).

2004 2005E
(high end)
Revenue $241.2 $270.1
Revenue Growth 19.1% 12%
Adjusted EBITDA $29.2 $35.7
Margin 12.1% 13.2%

EV/ADJ.EBITDA Multiple 6.8X 5.6X


Even more important is that in 2006 the company will realize annualized cost savings of $2.5mm as a result of a recent plant move. Therefore, assuming no “real” EBITDA growth in 2006 (which is ridiculous as the company expects at least high single digit revenue growth in 2006) the company will generate 2006E EBITDA of at least $38.2mm (35.7+2.5), implying a 5.2x valuation.

An example of Management’s conservative estimates is reflected by comparing their original guidance for 2004 (provided on April 8, 2004) to the actual results.


FOR 2004
Original Guidance Actual Results
Rev growth from continuing ops 10% 19%
Income growth from cont. ops 10-15% 50%




My belief that management’s 2005 guidance is too low is supported by the April 5, 2005 announcement where the company increased its Q1 guidance (originally provided feb, 23, 2005), but as it did last year when it also increased Q1 revenue guidance, it did not increase full yr guidance.


FOR Q1 2005 ESTIMATE
Original Guidance Revised Guidance
Rev from continuing operations 13%-15% 20%
Income from continuing operations 5%-7% 9%-12%%


Please note that income from continuing ops is different from Adjusted EBITDA , but I have provided the income from continuing ops to demonstrate how conservative management’s estimates are. However, backing into what adj ebitda would have been based on their guidance and comparing it to actual results would show a similar pattern of management underpromising and overdelivering.


Other Factors Since my previous post

1) I had originally expected the company to refinance its $65mm of expensive high yield with another high yield deal and save at least 250bps. In fact, the company did a larger high yield deal (but at a 325bps saving) and refinanced the $65mm and its bank debt. While this refinancing was not accretive (as I expected it to be) because they refinanced the cheaper bank debt, the financing gave the company financial flexibility to pursue its growth plans.
2) The plant move from Ohio to Oklahoma did not occur as rapidly as I had anticipated, because the company’s business was very strong and because they got a new piece of business from Eaton, so management did not want to risk jeopordizing its operations in any way . The result is that the savings I had anticipated did not yet occur and in fact in 2005 the company is experiencing some operating inefficiencies from operating both plants (these costs are hard to quantify). The good news is that shareholders will benefit from the $2.5mm saving that HWK will begin to have in 2006.




The company was in NYC last week meeting with several research houses, one or more of whom may begin to publish on the stock in the very near future.

Catalyst

- continued strong results
- heightened investor awareness as stock hits new highs and market cap passes $100mm
- possible research coverage initiation