This is not a sexy story. Rather, this investment is one of those – hmmmm, why is this trading here, stories.  The answer to the question is plain and simple that Hurco shouldn’t be trading where it is currently priced.  It’s simply below the radar and has a very slight “information” gap in my opinion related to YOY comps due to the Company utilizing their NOL’s last year making this years net income “growth” look low.  By all metrics Hurco is trading below fair value and has better growth prospects than their peers and the growth is there for all to see in its reported backlog.

 

Hurco Companies, Inc. designs and produces interactive computer control systems, and software, and computerized machine tools for the metal working industry.  Ultimate end user markets are broad and include aerospace, defense, medical equipment, energy, transportation and computer equipment.  Primarily these solutions are for vertical machining centers for the metal cutting industry; turning center product line for job shops and contract manufacturers.  Additional applications are computer control systems and related software for press brake applications.  As part of their customer solution the company provides software options, control upgrades, hardware accessories, and replacement parts related to its machine tool product lines, and provides operator training and support services to its customers.  Hurco reaches their customers through independent agents and distributors in North America, Europe, and Asia.  The Company is headquartered in Indianapolis, Indiana.

 

For those interested in more detail – the 10K is well put together with enough detail but a manageable 60 pages in total.

Below is a summary of historical and projected (2006 and 2007) income statement information.

Relevant balance sheet information

 

Yes, Hurco is a good business with attractive returns on invested capital well above 50%.

 

Here’s what I believe are the relevant snippets from what has been happening at Hurco. 

 

For the third quarter the Company reported net income of $3,802,000 compared $2,879,000 for the corresponding quarter of 2005.  For the first nine months of fiscal 2006, Hurco recorded net income of $10,764,000 compared to $9,208,000for the corresponding 2005 period.

 

OK – big deal its growing.  Well, except for this . . .

 

The provision for income taxes for the third quarter and first nine months of fiscal 2006 increased by approximately $1,300,000 and $4,000,000, respectively, over the amounts recorded for corresponding periods of 2005, due primarily to its prior utilization of substantially all of its domestic net operating loss carry-forwards.  Now we’re talking!

 

Thus for more comparative purposes - income before taxes for the latest quarter was $5,448,000, an increase of 70% over the $3,196,000 reported for the same period one year ago.

 

Before we get too excited . . . currency is going a bit back and forth over the time period which has an impact, but not enough to blunt my enthusiasm for how the business is growing. 

 

Well, this begs the question – can this continue.  On that front, new orders booked in the third quarter were around $38 million an increase of $9 million (greater than 30%, over the third quarter of 2005).  While currency is at play here as well - $1 million or so of the growth – the actual growth is around $8 and above 25% comparatively.

 

So you may be wondering if this is just a function of a good to great economy here and around the world.  And I would say yes, to some extent it is.  But this is a Company that is not standing still.  The recent and current growth is essentially from existing products.  What bodes well for the future is the Company continues to innovate and come up with new products.  As evidence of this the Company recently reported that a new control product (WinMax) is being received favorably by customers.  Specifically, at the recent International Manufacturing Technology Show in Chicago the Company reported a 35% increase in sales leads compared to IMTS 2004. 

 

Hurco is growing organically with its existing products and has the ability to grow through new product innovations as well.  The best part – we’re not paying for this growth in my opinion.

 

Market Cap:  $162 mil. (Fully diluted shares outstanding of 6.4 million at $26)

Debt:  $4 mil.

Cash:  $24 mil.

Long Term Investment: $6 mil. (potentially understated by a small amount)

 

EV = $136 mil.

 

 

The value of Hurco is not a “relative to the market” story.  Really, this is pretty much just a fundamental valuation approach.  I looked at three data points:

1)      Control transactions in the market over the past five years or so

2)      Machine Tool industry comps

3)      Technical Instruments industry comps.

 

Control transactions are illustrative on their face.  Regarding comps – Hurco probably fits between the two categories above.  It’s not a strict machine tool manufacturer as it has higher value add/technological expertise than some of the traditional machine tool companies.  Yet it’s not the high end of the technical instrument group.  I tried to sanitize the higher end by pulling out obvious “non-comps” that related to medical, etc. 

 

Here are the results:

 

                                                            EV/Revenue     EV/EBITDA                P/E

 

 

 

 

 

Here’s how I’d apply the multiples. 

 

Lets ignore the recent growth as abnormal and this years increased backlog.  So we’re simply going to use current info of $140 million in revenue, $22.5 million in EBITDA and approximately $2.20 in fully taxed earnings per share. 

 

Applying the realistic multiples to very realistic performance results in the following values:

 

EV / Revenue = $210 million plus $30 in cash and investments / 6.4 shares = $37/share

EV / EBITDA = $200 million plus $30 in cash and investments  / 6.4 shares = $36/share

P/E = $2.20 fully taxes times 15 = $33/share

 

Based on this, my estimate is that Hurco is trading at 70% to 75% of fair value – if the business was simply going to plod along. 

 

Where the opportunity lies is that the next twelve months of growth is highly probable given what we know about their backlog.  Applying next years likely results ($160 revenue, $26 ebitda, $2.50 eps – which may be conservative) yields a value range above $40/share.

 

Assuming a correction to reasonable industry multiples Hurco offers 30% upside from todays price that could take place at any time. 

 

Waiting for the growth that appears to be in the pipeline and highly probable gives 50% upside likely realized 12 – 15 months from now.

 

I don’t believe Hurco is a deep cyclical – thus how much lower can the multiples go?  Well, lower yes, but over the longer term I don’t see permanent impairment to capital at these prices.

From a business standpoint I believe their installed base and distributor network is a competitive edge . . . that likely is a moat, well, at least there’s a ditch and a bridge but I don’t see deep black water teeming with alligators.