Description

Kreisler Manufacturing(KRSL) manufactures tubular assembles(used to transport fluids) that are used in aircraft and gas turbine engines. They have a very strong balance sheet, have grown sales almost 27% annually over the past 5 years, yet sell at an EV/EBITDA multiple of only 2.1x.

More about the operations later. In 1999 KRSL received a bid from John Wood Group PLC for $25.5mm or $12.25/share. At the time it equated to an EV/EBITDA of 7.6x. While conducting due diligence, they discovered traces of tetrachloroethylene in the ground below their plant. Understandably, John Wood did not want to purchase a company with any environmental baggage so the merger deal was terminated. Since then, however these environmental concerns have subsided greatly. The environmental consultants have finished examining the site and KRSL currently expects cleanup payments to total about $2.1mm. KRSL has incurance coverage up to $2.5mm to deal with these costs so it shoudn't have much impact. In a conversation with the CEO he told me that he sees no indication that cleanup costs would run over the $2.1mm figure.

In the early 90's KRSL had some rough years, with 5 straight unprofitable years. This was mostly due to production problems; on-time deliveries were only 65% and it's obviously very hard to keep business when customers can't count on delivery. But since then they have greatly improved the efficiency of their production process to the point where on-time deliveries has increased to 97%. As a result their revenues have increased 100% over the past 5 years and their net income has increased 130%. ROE for the past 5 years has averaged 19.1%; when you back out cash and interest income ROE averaged 29.4%. These figures include FY2000 when profits were almost wiped out by legal fees associated with the merger and the environmental issues.

Their balance sheet is very strong with $6.3mm in cash and very little in the way of liabilities. The equity capitalization is $16.3mm. The firm value(market cap - cash) is $10.3mm. With LTM EBITDA of $5mm, KRSL is very cheap. On a P/E basis KRSL trades at a little over 5x earnings. LTM FCF(defined as cffo - cap ex) is $2.1mm or 20% of the firm value. Note that the FCF figure is slightly skewed to the upside because they had a $0.7mm gain from working capital in the most recent quarter.

The commercial aircraft segment of their business currently accounts for 58% of their business. They have been deliberately and consistently reducing this exposure in recent years. Industrial gas turbines is a new business segment that has grown very quickly and now accounts for 22% of their business. Military aircraft accounts for the remaining 20% of their revenues.

The CEO is 71 years old and holds a lot of illiquid stock. The proposed deal with John Wood PLC showed that he is willing to consider a buyout or merger as an exit strategy. In our conversation the CEO wouldn't be very specific but when I asked him if they were considering another deal he did say that "we've been looking into this". JMHO but from his tone it seemed to me like a deal is the most likely outcome.

The proposed deal was for EV/EBITDA of 7.6x. With the likely slowdown in the commercial aircraft segment of their business it is likely that a future deal could be below this valuation. But at a current EV/EBITDA of 2.1x shareholders are very likely to make out well even if an acquiring company picks up KRSL on the cheap.

All in all, this isn't an exciting company and it doesn't have many barriers to entry. But it has been growing, is really cheap, and IMO is likely to be acquired at a price materially higher than where it currently trades at. Also the backlog is $21mm, about the same as LTM revenues.

Catalyst

Future acquisition by a larger aerospace player. The proposed deal by John Wood Group PLC gives an indication of what the takeout valuation might be.