NPK -- “Da Bulls” Part II

In the previous post I discussed my calculation that place the downside price target for National Presto (NPK) shares at $45 which is approximately $25 or 35% below today’s closing price of approximately $70 per share.

So what is the upside potential for NPK shares?

If we make an assumption that the company can grow revenue in the small apps business in line with inflation of 3% and stabilize EBITDA margins, the small apps business becomes a “going concern” and the valuation increases substantially to $54 per share.

If you assume that the defense business turns into a “going concern” and has annual free cash flow similar to 2007 and apply a below market average multiple of 10x the defense business value jumps to about $32 per share from the worst case scenario of $5 per share.

If the absorbents business every shows and operating profit or the company can sell it for more than 50% of what it cost to build the factory and buy equipment just a few years ago this also increases the upside for NPK shares.

Simply assuming that this 100 year old company's two main business lines are going concerns with no growth beyond inflation puts the target price close to $100 per share which represents about 40% upside from current levels.

If one is to assume that the company’s small apps business can grow even slightly above inflation or the company uses its cash to continue to build out the defense business or to make an acquisition with decent ROE potential the upside keeps growing substantially beyond $100 per share.

* DISCLOSURE: I or accounts I manage may be long or short any and/or all stocks mentioned in this post. This is not a recommendation to buy or sell any security. For informational and educational purposes only.

NPK -- "Da Bulls" Part I (Corrected)

I noticed that I made a pretty substantial error in the calculation of per share value for the small apps business posted yesterday.

Instead of subtracting tax expense from free cash flow, I was adding it back and therefore substantially inflating free cash flow estimates. The other change I made is to decrease the amount spent on CAPEX as the small apps business declines in revenue.

These changes produced a substantially lower per share value for the small apps business of $15 which lowered the worst case scenario share price estimate for NPK to $45 from previously estimated $61. Under this new worst case scenario the worst case scenario downside increases to aproximately 30% from the previously posted 8% downside risk.

Instead of reposting with the correct numbers here is the new calculation.

* DISCLOSURE: I or accounts I manage may be long or short any and/or all stocks mentioned in this post. This is not a recommendation to buy or sell any security. For informational and educational purposes only.

NPK -- “Da Bulls” Part I

The bull case for National Presto (NPK) is simply that at current levels the downside risk is very small.

To calculate the downside price target I did a sum of parts valuation using VERY conservative assumptions. Under this valuation methodology, NPK is worth only the value of the small apps business plus the liquidation value of the defense and absorbents business plus the cash on the balance sheet.

I assumed 1.6% revenue growth rate and an annual 50 bps decline in EBITDA margins to estimate the value of the small apps business which means that cash flow declines every year until the business is break even and assumed to be worthless. The net present value of estimated cash flows from the small apps business using a 7% discount rate is $30 per share.

In calculating the value of the defense business I assume the worst case scenario under which NPK delivers on its $250 million stated backlog for 2008 with similar margins as in 2007 which would produce $22 million in after tax free cash flow. At the end of 2008 the business is assumed sold at ½ the dollars invested in CAPEX over the most recent 4 years. Under this worst case scenario the defense business is worth $5 per share.

For the absorbents business I simply assume that its dumped on someone else’s lap at ½ CAPEX over the last 4 years which produces a $2 per share business value.

The last two pieces are the working capital from the two liquidated businesses as well as the current cash on hand which combined is estimated to be worth $24 per share.

My detailed calculations can be viewed here.

The sum of parts valuation under these assumptions is $61 per share which is $5 or 8% below the current price of approximately $66 per share. A worst case scenario downside of 8% is substantially smaller than the potential upside under even modest positive assumptions which will be discussed in the next post.

* DISCLOSURE: I or accounts I manage may be long or short any and/or all stocks mentioned in this post. This is not a recommendation to buy or sell any security. For informational and educational purposes only.

NPK -- “Da Bears”

As with all the stocks profiled on this blog the laundry list of problems with National Presto (NPK) is long and deep. NPK’s second largest business is facing both short and long term pressures, success of the company’s defense business is based on large government contracts that may not be renewed, the company’s management has invested both time and money into the diapers business with very poor results thus far, and the stock is highly illiquid.

National Presto’s appliance business has experienced 1.6% annual sales growth over the last 8 years with the company constantly stating that it cannot raise prices fast enough.

While the decision in 1999 to outsource manufacturing to China was certainly a positive it means that NPK will be negatively effected if the dollar continues to fall and/or inflation continues to stay high in China. These items have already taken their toll with EBITDA margin falling from a peak of 19.7% in 2005 to 18.7% in 2006 and 15.8% in 2007. With the company unable to raise prices fast enough its likely that operating margins in the appliance business will continue to contract.

There is very little visibility in the defense business. Management has not indicated what percentage of defense revenue comes from the Department of Defense (DoD) and what percentage from other sources (police force, etc.). The company has not provided any indication of whether they expect the Department of Defense (DoD) to expand the $1.3B contract after it is filled.

NPK’s fillings state that it expects to deliver $550M of the $1.3B contract (up from initial award of $300M) and based on my calculation the $550M will be mostly filled by the end of fiscal 2008. If this business is not replaced, company EBITDA will fall by approximately 50%.

There is not much to say about the absorbents business other than it’s a mess, no pun intended.

After combing through old SEC fillings, I calculate that since 2001 NPK has invested $36M in CAPEX for total EBITDA of $8M. The annual rate of return has been 3% and that is without including working capital in the equation. This is a very low margin, highly competitive business that is exposed to severe swings in commodity costs (wood pulp and energy) and NPK is never going to be a cost leader in this industry.

* DISCLOSURE: I or accounts I manage may be long or short any and/or all stocks mentioned in this post. This is not a recommendation to buy or sell any security. For informational and educational purposes only.

NPK -- First Look

Current Price: $51
Market Value: $350M
Enterprise Value: $210M
Investment Type: Classic Value

NPK (National Presto) is a designer of small electric appliances and housewares, produces armaments for the U.S. defense department, and absorbent products. Yes, this company makes toasters, bullets, and diapers.

While operating income from the defense segment now accounts for almost 2/3 of total, NPK has been an innovator in the small appliances category for almost 100 years (a very interesting history can be found here).

The last couple of years have been eventful for NPK, to say the least. Most importantly, the company defeated the SEC in appeals court reversing a decision forcing NPK to be classified as an investment company due to NPK’s large cash hoard. Being classified as an investment company means more government oversight and reporting costs. Keep in mind that the original SEC action in 2002 was not due to accusation of destruction of shareholder value or executive wrong doing, rather due to SEC’s jihad on public companies prompted by the still fresh memory of the Enron and Worldcom debacles.

NPK hired and than promptly fired its new auditors 12 months later. According to this press release from the company, it hired one firm to perform the audit and another to perform the tax work. It is common practice to have the same firm do the audit and the tax work so NPK asked for bids and the firm originally hired to do the tax won.

On top of all that, the company’s CFO resigned “to pursue an opportunity as a financial advisor.” While I have no evidence to the contrary, I have a hard time believing someone would willingly resign a high paying executive position to be a cold calling stock broker.

Despite all the “noise,” NPK had an outstanding operating year. Revenues grew 38% (on top of 65% growth in the previous year) and operating income great 50% (after growing 83% the year before). The company ended the 2007 fiscal year with $142M in cash & securities and no long term debt after paying $4.25 per share dividend on 3/2008 and $3.80 per share a year before.

In the posts to follow I will discuss the bullish and bearish aspects of NPK.

* DISCLOSURE: I or accounts I manage may be long or short any and/or all stocks mentioned in this post. This is not a recommendation to buy or sell any security. For informational and educational purposes only.

The Quintessential Buffet

I was cleaning out some old emails and ran across this NYT article dated 12/29/07 regarding Buffet’s decision to enter the bond insurance business but published prior to the offer he made to buy the municipal bond business of the troubled monolines.

This article follows the basic boiler plate for Buffet related articles, mentioning that Berkshire is doing well while others are suffering, that buffet has added to his positions in USB and WFC, and talks about new positions in BNI and KMX (it was later released that KMX was bought by Lou Simpson who is the CIO at GEICO and a Superinvestor in his own right).

However, about half way through the piece came this gem of a quote from the maestro himself:

"We had no compulsion at the start of the year to do anything ….. On the other hand, there was no limit to what we could do."

I think most agree that Buffet and a select few other professional investors are simply better at their chosen profession than everyone else, much the same way that Michael Jordan and Tiger Woods are better and will always be better than everyone else.

However, what many don’t realize and this quote again proves is that Buffet is playing a completely different game than everyone else. I feel lucky to be able to watch and learn.

FTAR Makes it Official

Yesterday morning FTAR filled the long expected 8K stating that the KMart contract will not be extended beyond 12/31/08 which effectively means the company will wind down and cease to exist shortly after the end of this year. KMart will pay $13M for FTAR’s intellectual property (i.e. ThomMcAnn) as well as honoring the post-bankruptcy master agreement which stipulates that KMart will buy all inventory at book value. Also, the company will be terminating retiree benefits and life insurance which will remove $14.7M of long term debt from the balance sheet and result in a one time earnings gain.

This announcement essentially puts in writing what everyone already knows and makes the investment thesis even simpler. I have updated my figures ( for the most recent news and believe that at worst FTAR is worth $7 per share (up 45% from current levels) and at best $8.4 (up 75%).

[**I am still trying to figure out how to post Excel tables in Blogger so I will add my calculations for the $7 and $8.4 price as soon as I get a hang of this. If you have any suggestion on how I can do this other than posting a picture file that is all but unreadable let me know at offthebeatenpathinvestments@gmail.com]

The biggest difference between the worst and best case scenarios is my estimate of 2008 FCF generated by FTAR. In the worst case I assume sales down 10% over 2007 and some margin erosion while in the best case I assume flat YoY sales and slight margin expansion.

There could also be upside if FTAR sells its HQ for higher than book value, if the non-KMart business is worth more than $0, $80M in NOLs are worth more than I expect, and wind-down costs are less than I estimate.

FTAR currently represents 10% of the “Best Ideas Portfolio” (and roughly that much of my own account) and I plan on raising the stocks weight to 15%.

* DISCLOSURE: I or accounts I manage may be long or short any and/or all stocks mentioned in this post. This is not a recommendation to buy or sell any security. For informational and educational purposes only.