OMEGA FLEX INC OFLX S
June 21, 2022 - 4:24pm EST by
scott265
2022 2023
Price: 115.00 EPS 2.2 2
Shares Out. (in M): 10 P/E 52 57
Market Cap (in $M): 1,160 P/FCF 51 56
Net Debt (in $M): -20 EBIT 31 28
TEV ($): 1,140 TEV/EBIT 37 40
Borrow Cost: General Collateral

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Description

Omegaflex manufactures flexible piping to carry mainly natural gas in residential construction. For example, the flexible piping is used to connect a kitchen stove to a house’s natural gas source. The main benefit of flexible piping is its ease to install relative to traditional rigid gas pipe.

Industry Background

Around the late 90’s/early 2000’, the flexible piping took share from traditional black pipes but that ceased to be the story nearly 20 years ago.

As per 2021 10-K: As a result of these advantages, the Company estimates that CSST (Corrugated Stainless Steel Tubing) now commands over one-half of the market for fuel gas piping in new and remodeled residential construction in the U.S., and the use of rigid iron pipe, and to a lesser degree copper tubing, accounts for the remainder of the market. The Company plans to continue its growth trend by demonstrating its advantages against other technologies, in both the residential and commercial markets, in both the U.S. and overseas in geographic areas that have access to natural gas distribution systems.
As per 2019 10-k As a result of these advantages, the Company estimates that CSST now commands slightly over one-half of the market for fuel gas piping in new and remodeled residential construction in the United States, and the use of rigid iron pipe, and to a lesser degree copper tubing, accounts for the remainder of the market. The Company plans to continue its growth trend by demonstrating its advantages against other technologies, in both the residential and commercial markets, in both the United States and overseas in geographic areas that have access to natural gas distribution systems.
As per 2010 10-K As a result of these advantages, corrugated stainless steel tubing now commands slightly over one-half of the market for fuel gas piping in new and remodeled residential construction in the United States, and the use of rigid iron pipe, and to a lesser degree copper tube, accounts for the remainder of the market.
As per 2006 10-k: As a result of these advantages, corrugated stainless steel tubing now commands approximately one-half of the market for fuel gas piping in new and remodeled residential construction in the United States,



There are about 10 manufacturers of the piping (Titeflex, War, Microflex, United Flexible, Hose Master along with a bunch of privates) and they somewhat specialize to end market but most will participate in residential construction which is the biggest market and the main OFLX market.

The business is clearly cyclical to residential starts and remodeling. Revenue went from $48mm in 2004 to $74mm in 2007 and then fell back to the mid $40’s following the housing bust in 2009 and 2010. From there it grew steadily from 2010 and accelerated in 2021 with Covid to $130mm.

Operating margins have run around 25% with gross margins in the low 60’s. It seems to be a nice little business and while there is always a chance things could get competitive because the branding element is quite low, I have no evidence of why that would happen now. But based on the seeming lack of branding and multiple competitors, I would not rule it out as the business is mature and has high gross margins.

The real story is valuation. In 2021, which was the perfect world of strong remodeling demand and low input costs, the business made $2.60 in EPS and traded at a 45x p/e. For years, the business traded around 20x p/e until late 2017 when the valuation doesn’t matter theme took over in the market. OFLX seems to be a hanger to a bygone era. I believe this is the result of (1) no analyst coverage (2) no conference calls and bare bones earnings releases that don’t even include an income statement (3) a relatively concentrated holder base.

In 1q, the business began to see revenues barely grow from high price increases on shrinking unit volumes with shrinking margins and operating profit. EPS fell from 62 to 54 cents and I imagine that cost pressures will continue to hit even if we never see a housing related slowdown. A return to more historical gross margins would shave 20 cents off the $2.6. If you think remodeling and housing starts take a hit (which seems to be pricing in everywhere but here), revenue declines prob hit the bottom line 3x as much with incredibly high contribution margin and a low cost base. A 10% reduction in revenues, probably resets us to around $2 in EPS. If the gross margins hit as well, you would be closer to $1.8. But let’s normalize the business to around $2 in EPS.

From 2007 (peak) to 2021 (peak), revenues grew a compounded 4.5% a year. Maybe you get a bit of operating leverage but things have been quite good and you are already running peak levels that are high on an absolute basis. If we call it mid cycle of $2.0 and put a 20x, we get $40 and give them credit for $2 in cash and you get $42. It’s really hard to justify this price so I’ll stop trying to convince anyone.

So what’s going on? As I said, I think with no analysts and scant earnings releases and conference calls, and a long upward trend, the holders remain calm in the face of housing related names trading off dramatically.

I don’t think analyst coverage or PR is changing soon so let’s talk about the holder base and why I think there is finally a chance for real price discovery.

OFLX has 10mm shares.

The business founder is John Reed. He founded Mestek (a pink sheet stock) which then spun OFLX. He was a workaholic (articles talk about him still working most days at 89) and passed in 2013 around 96. John’s son Stewart is 75 and vice chairman with no day to day role. John’s estate owns 2.6mm shares. What’s new and interesting here is that in the past year, the estate took out a margin loan against all the shares from Santander. I imagine like most estates the growing number of kids all want a piece of this now sizeable $300mm estate. My assumption is the margin loan paid many off and prevented a tax bill. We don’t know what the haircut was but clearly any fall in price will beget more selling.

Stewart himself owns 3mm shares (distinct from estate) and began to finally sell in 2021.
Kevin Hoben (74 years old and CEO) has 900k shares and began to finally sell in 2021.
Mark Albino (69 and retiring COO) has 270k shares and is selling.

So 6.77mm are held internally but all of them are sellers with a trust that will likely really start to sell with any fall in price.

The funds that own OFLX all had ridiculous runs from 2017-2021. They owned good unsexy businesses without regard to valuation and it worked incredibly well. As we know the tide has begun to turn for most of them. I believe OFLX is low on the list to sell because it has still done well and you know selling it will likely beget selling from others. My belief is that we are finally reaching the point where it’s hard to keep 50x p/e companies with declining fundamentals in your portfolio when the rest of the market is starting to look at least fair depending on your viewpoint. Between the insiders wanting to reduce exposure and the margin loan on the estate shares, you could have a perfect storm of selling and I’m not sure who the buyer would be.

Kayne Anderson (mostly through Virtus) owns 1mm shares and is slowly selling. Conestoga Capital owns 558k shares and is slowly selling (their fund is off 33% on the year and in the 3rd percentile) Both of their portfolios look similar with reasonably high quality businesses that look overvalued in any period prior to 2017.

There are 270k shares short on 3.2mm non inside held shares. My guess is we see another round of inside selling soon as the big three have sold 300k shares over the last two years. I assume Stewart would like to sell before the trust and it’s margin loan.

All these players will likely react to any material decline in the stock price and wake up.

The buyer of recent supply has been Neuberger Berman Genesis fund. They buy small cap stocks with good product lines and strong balance sheets.

The chart of all three funds (Virtus Kar Small Cap Growth, Neuberger Genesis Fund and Conestoga Capital) all look like OFLX on the way up but now wild OFLX outperformance as they have all begun to get killed.

I believe someone will break soon. If not, I guess this can stay here and spend the next 10-15 years growing earnings into $5 in EPS from today’s $2 in EPS and a 24x multiple. With almost everyone selling and experiencing some cracks, my bet is someone will crack and not sure who saves this.

Anyone with any color on any of these funds would be helpful as this does not seem to be about valuation but more when someone breaks.

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

Insider selling/Funds reallocating/Margin loan pressure

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