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GHM Crackers, In My Soup

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June 01, 2013 – Comments (10) | RELATED TICKERS: GHM

If you paid attention in 2010, you bought Graham (GHM) stock at 13 and change on my recommendation - and you're sitting on about a 110% gain.  

GHM is an engineering company; they have a few teams of specialized engineers who will come onto your site and use their know-how to optimize a very particular set of industrial processes.  Oil and nuclear processes are their major specialties, but they also have some divisions that have to do with pipes and pumps in other kinds of industries.

GHM popped 16% on Friday and closed at 28.00 - a witching day close, but in any event, a major upside bump, on a fantastically strong earnings report.Of note, the earnings were right smack in the middle of GHM's guidance for the year.  

I love reading GHM transcripts - Lines and Gljach come on with a neat little powerpoint, give a very concise maybe 5 minute summary of past, present and future, and then they're done.  One of my favorite things about them is that their summary of Graham's future (near term, 1-3 years) is generally as accurate as their past and present summaries.

Right now they are telling you that we are expanding in the business cycle and their goal is to make GHM's revenue double from 105 million a year to 200 million a year by the top of the next cycle.  They are set to make good - their major customers are US Navy nuke ships, nuclear power plants, oil power plants, and refineries - a lot of the refineries are out of the US.  Think about it; can customers like this pivot on a dime and bring new engineering consultants in at the drop of a hat?  No, not really; information flow is two-way in the consulting business and a lot of organizations are not going to risk downtime while a new set of unknown engineers get up to speed.  (Imagine the US Navy, having to get security clearance on a whole new team of engineers!  Not going to happen unless GHM drops the ball pretty hard; and I have never once seen a report that a GHM team failed to execute.)

So here's the issue.  Trailing P/E on this close is 37.  If GHM were to double revenues immediately - which they haven't promised - and keep their EBIDTA margin about the same - which they haven't promised, but which is a reasonable assumption - forward PE might be in the neighborhood of 18.Wall Street keeps looking at stocks like this and wanting them to be growth names.  In the last froth-rally that took place around, what, 2007, GHM hit $77 a share because they'd put in a couple years of 40% earnings growth.  But they're not a growth name. They are a cyclical. Are GHM going to get another customer the size of the US Navy?  Well, think about it for a moment - how many more English speaking navies are there in the world that run that many nuclear ships?  (Answer: none.)  Is Saudi ever going to come through with that $300 million Saudi Jubail refinery upgrade order?  (Obviously not; GHM hasn't mentioned it in years, Saudis were tire kickers.)

Cramer says, don't take tips from your barber, because, is your barber going to tell you when to sell?  So I am asking myself, when do all my readers, who got in at 13 on my advice, want to sell this stock?

I think GHM, as a cyclical name that pays a negligible dividend and has nothing much in the way of long-term debt, may be about fairly valued here for its next cyclical run.  But does Wall Street think as Mr Lines and I do?  Last time we played this record - 2007, was it? - GHM was briefly selling for $77.  Wall St may look at PEG and EPS growth and decide they want a piece of this small-cap name that is taking off like a rocket; they may not recall that Mr Lines said their goal is to boost revenue only to $200m at the peak of the next cycle.  They may not know that it is actually hard work to assemble a bunch of new engineering teams that are competent and can execute, especially in the middle of a fired-up economic cycle where talent of all flavors sells for a high premium!

My gentle readers already know my opinion, which is that the Bernank and the Fed have over-goosed this economy already and that we are in for some froth as the market absorbs this new reality.  Those of you who are strict value investors, I'd invite you to consider the proposition that GHM might be fairly valued here.  The rest of you, who, along with me and Jesse Livermore, desire not to fight the tape, might hold out for a while longer - $40?  $50? - until you feel like the froth on your beer is about to blow away in the winds of change. 

10 Comments – Post Your Own

#1) On June 01, 2013 at 6:29 PM, dragonLZ (99.59) wrote:

Thanks.

+1 

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#2) On June 01, 2013 at 6:37 PM, ElCid16 (95.70) wrote:

Congrats on the good call.

Think about it; can customers like this pivot on a dime and bring new engineering consultants in at the drop of a hat?  No, not really; information flow is two-way in the consulting business and a lot of organizations are not going to risk downtime while a new set of unknown engineers get up to speed.

I don't think this is a engineering consulting company.  They sell heat exchangers, condensers, and vacuums.  I think this is a products company.

It doesn't seem like a bad company, but the company barely squeaked out $1.11 per share thanks to some favorable income statement line items.  Operating Income and EBITDA both actually fell YOY by about 11% and they're projecting revenues for FY 2014 to be flat with 2013 and 2012.

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#3) On June 01, 2013 at 6:51 PM, ikkyu2 (99.29) wrote:

Ok, ElCid, you work for GHM now.

I'm having trouble on tower 3 of my high-crack distillate tower refinery, the new sour crude input from the Keystone XL isn't behaving like the West Texas Intermediate the tower was built for.  I don't have time for downtime - and I'm not an engineer, just like you are not an engineer - so please just ship me the RIGHT condenser and tell me at what height and pressure I need to install it.

 

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#4) On June 01, 2013 at 6:55 PM, ikkyu2 (99.29) wrote:

Ok, ElCid, I haven't seen a part number from you yet, so here's a brush up:

Understand vacuum-system fundamentals 

This is absolutely an engineering consulting company.  You can't sell these kinds of products without understanding what they're for and how they benefit your end user. 

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#5) On June 01, 2013 at 6:57 PM, ElCid16 (95.70) wrote:

just like you are not an engineer

I worked for Brown and Caldwell's Industrial Water Quality group for 3 years, after I got my MS in Environmental Engineering.  I dealt with products companies like this quite a bit.

No offense though, man.  Take it easy.  I said good call.

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#6) On June 01, 2013 at 7:17 PM, ikkyu2 (99.29) wrote:

Well, that'll larn me.

My understanding of Graham's operations was that they had to assemble teams of engineer-salesmen who had to be pretty well trained to not only know the customer's needs, but be able to justify why the product in question would meet or exceed them; and then be able to help with the subsequent install of the product start to finish.  

I feel like it'd be hard to expand revenues by just hiring more engineers and saying "OK, men, you're our new oil-gas vacuum condensers sales teams, get out there and move some condensers!"  Do I have that wrong? 

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#7) On June 01, 2013 at 8:06 PM, rd80 (98.24) wrote:

My understanding of Graham's operations was that they had to assemble teams of engineer-salesmen who had to be pretty well trained to not only know the customer's needs, but be able to justify why the product in question would meet or exceed them; and then be able to help with the subsequent install of the product start to finish. 

Graham is a manufacturing company, but the statement above is correct.  I believe Graham looks at selling a project, not just equipment, so the typical contract includes both hardware and consulting.

Still holding my GHM.  No plans to add any, but not ready to sell yet either.

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#8) On June 03, 2013 at 12:59 AM, CCharing (89.23) wrote:

Hmm from what I understand these companies will have support personel, but all the calculations are typically done by the party that  orders the equipment - You run something like Aspen (ticker: AHL) and simulate what you need, you send the spec printout to GHM and then they make design it to your specificaitons.

If the company that needs the condenser/exchanger doesn't have engineers who can do this they can hire outside help (intricate design companies, think Flour (http://www.fluor.com/pages/default.aspx) and Burns and Mcdonnell (http://www.burnsmcd.com/).  These are you're "consultants."  Most of these design/consultant companies are private.

Source: my bf works at Burnsmcd.

There are many companies that do what you think GHM does (sell equipment or distributed control systems) but derive most of their income from "service" type work.  Those would be people like CBI (berkshire recent pick) and Yokagawa (nikkei exchange).

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#9) On June 03, 2013 at 1:02 AM, CCharing (89.23) wrote:

There is a lot of activity in ethylene related processing (due to the Natgas glut/forcast).  Most of the big players are seemingly betting big by investing substantially in ethylene/propylene cracking units.

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#10) On June 05, 2013 at 10:47 PM, ikkyu2 (99.29) wrote:

Thank you for your reply, CCharing.  It was educational and just what I was interested in knowing about.

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