Processing a Tough Economy – Graham Corporation (GHM) Earnings Review
Graham (GHM) is a small company that was just included in the Russell 2000 this past summer. GHM manufactures processing equipment; the big heat exchangers, ejectors and vacuum equipment used in refineries, chemical processing and other process industries. This was by far my biggest dollar and percentage winner from the two Strategy Lab Open rounds. The stock has been very volatile over the past year with a split adjusted 52-week trading range of $12.50 - $54.91. The 6 November close was near the bottom of the range at $14.15.
GHM reported earnings for their fiscal 2009 2nd quarter on Mon, 3 Nov. The numbers were only fair and the forecast wasn’t as strong as the market would have liked. Earnings were 43 cents per share, missing analysts’ estimates by 10 cents. CEO Jim Lines added, “Bookings this past quarter were down considerably and totaled $17.5 million. We believe the third quarter bookings may be light as well.”
Nearly half of second quarter sales were to the refining industry and much of the business was outside the US. Refineries will continue to need repair, maintenance and upgrades, but it’s tough to imagine that business gaining a lot of strength until the economy starts to improve.
Chief Accounting Officer Jennifer Condame presented the order backlog, “At the end of the second quarter, backlog was $69.7 million up 23% compared with $56.8 million at the end of the second quarter of fiscal 2008.” However, the backlog decreased from $76.0 million at the end of the 1st quarter. Still, a nearly $70 million order backlog is great news for a company with a market cap of just over $140 million.
During the Q&A, an analyst noted that in past years, bookings for the next year nearly always accurately predicted sales for the year. However, this year, the company’s guidance is slightly below the 2009 orders that were in hand at end of fiscal 2008. Mr. Lines explained that orders aren’t being canceled, but some customers are extending projects.
The company has a strong balance sheet and is interested in pursuing acquisitions at the right price. When asked about plans, Mr. Lines stated, “…the acquisition size would be below $100 million, it would be engineered to order products that fit our brand, that are in the energy sector. Now in the energy sector, we are not just talking about oil refining and petrochemical. We are talking about power generation, alternate energy, [waste] energy, geothermal, areas where the Graham brand is exceptionally strong…” GHM has nearly $43 million of cash on the books and virtually no debt. With a balance sheet like that, they don’t need to worry about tight credit markets. But some of their customers do.
Oil sands are a potential growth area for GHM, but many of those projects may be on hold at current oil prices. It wasn’t mentioned in the call, but many alternative fuel processes require the type of equipment GHM sells.
In both my Marketocracy virtual portfolio and real life, I sold off most of my GHM holdings during the spring-summer run up, but have kept a few ‘trophy’ shares to participate in future growth. GHM does pay a small quarterly dividend, but even with a raise in Sep and the share price drop over the past few days, the yield is below 1%.
GHM trades at value stock type multiples with a forward PE below 6. Unlike many companies, the strong backlog and long order-build-deliver cycle make earnings projections fairly believable. Countering that is a weak economy. At prices near $14 a share, the company looks cheap. It may stay cheap or get cheaper, but should be a good stock to average in and wait for the economy to improve. The stock is fairly volatile, so an active trader may be able to do well with it. With over $4 a share in cash and no debt, the company isn’t in any danger of failing. Add in EBITDA of 3.6 and the company might look attractive as an acquisition target.
In summary, a former high flying, IBD momentum stock that’s corrected to value territory. GHM probably isn’t in the right business for the present economic cycle, but seems to be very well managed, has an outstanding balance sheet and could turn into a double or triple from current prices when the economy picks up again.
All conference call quotes from the transcript at SeekingAlpha.com