Description
Twin Disc (ticker TWIN) is a name I have written up in each of the past two years and even though the stock is up 5x (split adjusted) from my initial write up in January 2005, I believe this still undiscovered stock is a very compelling investment with some near term catalysts. In addition, it now has a larger market cap and a more liquid stock which may make it interesting for more investors.
Twin Disc, Inc. designs, manufactures and sells marine and heavy-duty off-highway power transmission equipment. Products offered include: marine transmissions, surface drives, propellers and boat management systems, as well as power-shift transmissions. The company sells its products to customers primarily in the high end pleasure craft, commercial and military marine markets, as well as in the energy and natural resources, government and industrial markets. Twin believes it has the #1 or #2 market share in virtually every segment in which it competes. For a more detailed review of the business your can read the company’s presentation (filed as an 8k on 10/30) or call management who is very accessible. The company has 3 segments. While the company does not disclose segment breakdowns, directionally, Marine represents 50%+ of TWIN’s business and its important to note this segment has limited exposure to the low end boat markets which are getting hurt as consumer spending weakens. Marine’s biggest markets are high end pleasure, commercial and military boats. Transmission is the 2nd largest segment, representing 25- 35% of the biz and Industrial (the weakest segment) is by far the smallest segment.
We remain highly enthusiastic about TWIN because:
1) Attractive valuation: The figures used by many information services are incorrect. Based on my calculation, excluding non-recurring items, LTM EPS was $4.16 (3.98 in last fy + .88 for Q1 this yr – (.62+.08) for q1 last yr), which implies a 15x ltm p/e. Last quarter, organic revenue increased 12% (8% excl f/x) and organic EPS (excluding all charges) increased 25%, illustrating the significant operating leverage inherent in the business. Conservative management has guided to approximately 8%-9% percent top line growth for this fiscal year (ending june 2008), which it exceeded in its seasonally weak q1. Backlog of orders to be shipped over the next six months increased 12% y/y. Management expects to continuing increasing margins with increased outsourcing of non-core tasks and from the benefits of operating leverage. While the current valuation is not as cheap as it once was, we think it is still attractively priced considering its growth, healthy balance sheet and catalysts discussed below. Management also increased the dividend 27% in October, which, while not financially significant (yield is 1%), reflects their confidence in the company’s prospects.
2) Exposure to growing markets: Much of TWIN’s organic growth has come from strength in the oil field services (biz continues to be strong as oil remains high), military (high margin legacy business with no projects currently subject to government discontinuation) and high end megayachts (for the increasing number of affluent people in the usa, europe and asia).
3) Significant international exposure. For a small company based in Wisconsin, TWIN remarkably generates 50% of its revenue from abroad
4) Healthy unlevered balance sheet
5) No subprime, CDO, housing, financials, or retail exposure
6) Significant insider ownership, primarily by CEO who owns 20% of the company’s stock and has barely sold any stock despite its phenomenal run.
7) Limited institutional ownership: Despite its strong performance, the stock is not heavily owned by institutional investors. This may change as the company increases its investor relations efforts.
8) Highly accretive nature of stock buyback – Last quarter the company repurchased over 4% of its outstanding shares. We estimate that had the repurchase occurred at the beginning of the quarter (rather than the middle) fd eps would have been closer to 91c rather than the reported 88c. While we realize the effects of buybacks are non-recurring, reported eps for the rest of the year will benefit from this buyback.
Recently there are been 2 significant developments:
1) On September 11, 2007, Clarus Capital filed a 13d on the company and sent a few letters to the board requesting that it explore strategic alternatives including a stock buyback and the outright sale of the company. Twin rejected the notion of selling itself but did eventually buyback over 4% of its shares. Clarus filed its 13d when the stock was at $51 and the stock is now at $65. In mid October, Clarus announced that it now owned less than 5% of Twin, but we do not believe Clarus has exited its position. Instead we believe Clarus sold some shares in order to allow another investment entity to establish (and grow) a position in the somewhat illiquid Twin. Twin’s stock has continued to trade up (despite the markets overall decline) since Clarus announced it no longer owned 5% (the stock has gone from $58 to $64). We believe there are strategic and financial buyers studying TWIN but our bullishness on the stock is not predicated on a buyout.
2) This past summer, Twin’s stock caught the attention of the momentum crowd and the stock ran up significantly. The stock subsequently tanked as these investors dumped the stock just before and after earnings were released in late July. Momos were especially concerned when the (very conservative) CEO stated that revenue growth would “moderate” over the coming year. This is to be expected because revenue had grown 30% in the previous fiscal year, thanks largely to a highly accretive acquisition. Since that “moderation” comment, the company announced Q1 results in which revenue (organically) grew 11%...I wish more of my company’s had such a high level of “moderating” growth. I believe the downward pressure on the stock during the summer was also attributable to certain quant funds selling their shares.
Catalyst
1) Increased investor relations – TWIN has finally begun a more aggressive investor relations effort. Management recently did a non-deal roadshow in several cities on the west coast and also presented at the Baird industrial conference. We believe they have additional i.r. efforts planned which will further get the word out about this still undiscovered name. Educating the investment community is especially important since the company had significant non-recurring charges which negatively impacted LTM earnings.
2) Analyst coverage – Twin currently has no analyst coverage; however we believe a few sell side firms will initiate on the name within the next few months. This again will help get the word out.
3) Continued strong results. In a market where many companies are struggling to show growth, TWIN continues to do so, thanks to its international exposure and demand from the oilfield services, military and megayacht markets. Twin’s incredibly conservative management remains very upbeat about the company’s prospects.
4) Value enhancing move from activists – It is unclear what additional steps Clarus or other funds will take to further enhance shareholder value. We note that the company’s balance sheet remains remarkably underlevered, allowing for additional (and accretive) buybacks and dividends. Management could also sell a division or the entire company.
5) Stock Split – The company has announced a 2:1 split effective next January. This will improve liquidity and reduce the stock’s excessive volatility, which has deterred investors in the past.