Pomeroy PMRY
February 07, 2002 - 3:00pm EST by
zach721
2002 2003
Price: 12.85 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 163 P/FCF
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT

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Description

Intro
Pomeroy is a large regional Value Added Reseller (VAR) and IT services company (revenues will be north of $800mm this year). The company has a very long track record of success measured in a myriad of ways (beating EPS 34 out of 36 qtrs., through early ’01, efficient operators, and highly profitable over time) due to exploiting a successful competitive niche. Pomeroy employs a Wal-Mart type strategy of competing in rural areas against undercapitalized mom and pop operators, then over time pmry usually buys competitors @ 4-6x EBIT (using cash, have not issued stock in a deal for several years, Tangible book has grown 60% in 3 years). The company has a diversified customer base selling to health care, financial, educational, government, and commercial enterprise accounts. Pomeroy distributes and integrates products from a number of technology vendors: Cisco, Dell, HP, EMC, SUNW, CPQ, NT, and IBM.

Pomeroy stock is cheap: 7.7x EPS, 90% of book value,120% of tangible book value, 20% of sales, and an 11% ROE. From 1995 to 2000, the company earned in Net Income $98million dollars or $7.60 per share (60% of current share price). While growing net income by 365% over that time frame ($6.23mm to $29.48mm).

As a distributor, the company generates negative CF in boom times (thin margins, need to expand WC) and in slow time generates strong CF and FCF as cycle reverses. For instance, first 9 months of this year CFFO was $56.73mm or ($4.45 per share) with FCF of $3.50 per share. Which has been used to pay down debt (down 54%) and reduce inventories (down 34% YTD).

I think the stock is fairly valued @ 12-13x EPS, which implies a target price of $22.20-$26 per share in the coming year. (72.6%-102% upside) with a downside target of potentially $10.63 (tangible book/Stated book is $14.50) or (-13% downside). In addition I estimate that tangible book should grow to $12 within 12 month (which provides additional downside protection.


Business:
How do they make Money (this is my understanding)
1) Value Added Reselling (VAR) side of the business; sell a product for $101, which cost them $99. Plus they will receive a vendor rebate for selling various volume levels which on the VAR side of the business contributes substantially to the gross margin. Then they will install and maintain the product with their IT services business:
2) IT services side of the business is billed on time and materials basis from written contracts and purchase orders. IT services will contribute about 50% of gross profit, even though it made up approximately 15% of total revenues. IT services business should generate $140,000,000 in revenue this year.


Balance Sheet
Inventory turns: greater than 20x in each of last 9 qtrs., and 30x over the last 2 qtrs.
Normalized ROE is 20%; this year should be near 10%
Total Debt: $75mm to $34 mm (YTD 3 qtrs.)
Inventories: $29mm to $19mm (YTD 3 qtrs.)


Competitive Advantages
1) Certifications: CSCO Gold, SUNW National solution provider and numerous others: As a company has a certain number of “certified technicians” and meets certain volume targets the company gets: various levels of certifications: (EG. CSCO has, Silver and Gold) PMRY has the Gold certification which entitles the company to highest product discounts and Cisco brings Pomeroy into deals with end users.

2) Access to capital (vs. Competitors): paid down debt aggressively this year.

3) The Company's technical personnel currently have:
180 Microsoft certifications,
300 Novell certifications,
31 Bay/Nortel Networks Specialist certifications,
19 IBM Professional Service Expert certifications,
54 Compaq Accredited Systems Engineer certifications,
20 Hewlett-Packard Network Technical Professional certifications,
2 Citrix Certified Administrator certifications,
81 Cisco Certified Network Associates certifications,
31 Cisco Certified Network Professional certificates,
6 Cisco Certified Internetwork Expert certificates,
12 Cisco Certified Design Associates certifications,
9 Cisco Certified Design Professionals,
7 Computer Associates Certified Unicenter Engineer certifications.

In second tier markets such a highly qualified technical staff leads to large enterprise wins such as all of Proctor & Gamble HQ and Worldcom HQ.

With revenues of $140,000,000 this year and should contribute about .75 in EPS, and 1428 technical personnel.


4) Low cost leader/Competitive position: Stays away from tier 1 players and areas of high competition. This has allowed Pomeroy to thrive while competitors have gone bankrupt and disappear.

5) Differentiated strategy: competes in 2nd tier markets: Alabama, Florida, Georgia, Indiana, Iowa, Kentucky, Michigan, Minnesota, North Carolina, Ohio, Oklahoma, Pennsylvania, South Carolina, Tennessee, Texas and West Virginia.
5) Survivor been in business for over 20 years

Management
Dave and Steve Pomeroy (Father and son team) have been @ the helm since inception (Steve has worked his way up through the business to the position of President). They are no non-sense-focused operators that understand the business and dynamics extremely well. They are focused on higher ROIC IT services business to build shareholder value.
Valuation:
$14.51 per share book Estimated, Earnings power of $2.50 to $3 in 2-3years.
In 2000, PMRY earned $2.37 per share.

The reason for their success is access to capital, largest competitor in small markets, with smart management. Now management is focused on higher returns on invested capital and is focused on IT services side of the business.

Risks:
1)Company has cleared the decks and written off $6.1-$9.2mm this qtr. due to impaired manufacturer rebates (which will take book value down .47 to .71 per share, from $15.51 per share): this is a one time non-recurring charge. I give management the benefit of the doubt, due to their track record of success and brutal honesty in the past.

2)Unattractive nature of the VAR business (low margin): management has proven they can successfully negotiate.

Catalyst

Catalysts:
1) Dirt-cheap way to invest in diversified sectors in technology (7.7x EPS, 19% of sales, 85% of book) combined with a successful proven management team. 2) Weak insider buying and buy back (Chairman owns 20%) 3) Additional Sell Side coverage 4) hard working management (they have returned my calls, Sunday afternoons, President has worked their since he was 17 (intern) and worked his way through the organization.
5) continued to trend to outsource IT services to third parties.

Earnings Power
As the cycle turns the company has hit $30 per share two times in the last 4 years.
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