ADDvantage Technologies Group has been the subject of a number of write-ups on value investing oriented blogs the past month. With the stock only going down I thought that it was a good idea to do some research, and figure out if it is indeed an opportunity. Addvantage is classified as a technology company, but that’s a bit misleading. They are distributors of spare parts and keep a big inventory in multiple locations: making them the company to do business with if broken equipment needs to be replaced in a hurry.
While I’m going to try to write an article that is readable without prior knowledge on the company, it is still a good idea to read the various cases presented online elsewhere. NZhedge has an excellent analysis including nice graphs suchs as the historical P/E and P/Tangible Book ratios. It’s important to realize that just because a write-up looks well researched and include nice graphs, it doesn’t make it true. Pretoria Investment and Whopper Investments both also provide a long case, while Oddball Stocks is more critical. Some key statistics on the company:
Last Price: 2.02
Shares outstanding: 10.21M
Market Cap: 20.62M
Trailing P/E (ttm): 7.73
Price/Book (mrq): 0.58
EV/EBITDA (ttm): 4.08
The basic long case behind AEY is the fact that the company is trading at $2.02 while NCAV is roughly $2.55 per share and is at the same time profitable with good returns on equity. The majority of this value sits in their inventories. They have 12M in cash, 10M in debt and an inventory valued at 26.7M (and you also get the properties and equipment that’s on the books for 6.9M for free). The inventory turnover ratio is currently around 1.4 which would imply that most of the companies assets could be converted to cash in a relative short period, giving the investor in AEY downside protection.
I actually think that’s a bit too simplistic and optimistic. The only scenario where it makes sense for the company to try to liquidate is when the business is strongly declining, and they are unable to sell sufficient amounts of network equipment. If that’s the case, liquidating the inventory without big losses is surely going to be a difficult exercise. Having a high inventory value provides a fake illusion of safety, because exactly at the moment that the safety is needed, it’s not there.
Correct me if I’m confused with another book, but I think it’s in The Intelligent Investor that Benjamin Graham talks about the liquidation value of property such as factories or real estate such as a hotel. If a company is is unable to turn a profit with it, odds are that it is simply not a profitable business to run a hotel at that spot, or produce product X. And having a factory that can produce a certain product that no-one wants doesn’t have a lot of value. It’s not quite the same with inventory, but the same principle applies. If the company is unable to sell it, it’s not going to have a lot of value.
Due to the business model of AEY they are also forced to keep significant inventories, so it’s also not really an asset that can be converted to cash without hurting the business (they have reduced inventories since the peak in 2008 slightly while income has dropped hard). So I think it is more appropriate to value the company on the cash flows that it is able to deliver. If we take historical averages the company is absolutely undervalued. Average return on equity for the past 10 years is almost 20 percent (great!), but things have been deteriorating since 2008 and the latest quarter was not pretty when the company reported 0.05 EPS. If we would translate that to PE-ratio we would get a 10x ratio.
It seems to me that buying AEY is mainly betting on profits and margins returning to long term averages. I don’t think that is necessarily a bad thing, but I don’t think there is a real margin of safety here. If the business deteriorates further a permanent loss of capital is in my mind a very real probability and at current levels it more or less looks like a fair price.
Hi, thank you very much for referring to my post on AEY. I admit that I like to create pretty charts. More generally as a student of data visualization I believe charts (if done correctly) can convey useful information/relationships/insights about a particular dataset. I absolutely agree that none of that makes an investment thesis more true.
Regarding AEY: With an inventory turnover ratio of 1.4, it would take AEY around 9 months to sell everything off. In such a situation, it would likely take considerably longer. Liquidiation, in my view, implies a situation where AEY is forced somehow to sale everything and close shop. As you said, this could make sense when the business is quickly declining. Now I can’t see a scenario where AEY would be forced to do so.
– AEY remains profitable, generating free cash flow
– Has a very healthy balance sheet
– the $11m in debt will likely be paid off in 2012 as AEY will have sufficient cash and Management indicated that there is an early payment penalty, which is why they haven’t paid it off yet.
Therefore, I think we can savely exlude a disorderly winddown, given the lack of potential catalysts.
Even in a orderly winddown, they may be able to sell most of their inventor at a profit.
By the way, business has been very difficult over the past 3 years for AEY, yet they maintained profitability generating healthy FCF. At current prices I find the risk of loss of capital is extremely low.
On the other hand, if Management is correct that companies have been holding back much needed capex and upgrades then there is significant upside embedded in AEY.
Yeah, agreed that charts; if done correctly can add a lot of insight. It’s a part of your write-up that I really like, but I always try to be as sceptical as possible 🙂
I agree with you that a liquidation is unlikely, but I don’t think that necessarily implies that the inventory has a whole lot of value. If the company is not liquidating the big inventory is an asset that the company needs to have to produce income; their big inventory is their competitive advantage. So then basically the question is; how much can they drop inventory levels in an environment with dropping demand? And do they need to start making write-downs for old inventory that they didn’t sell? The amount of inventory on the balance sheet hasn’t really changed the past year, while quarterly earnings growth (yoy) is -66.50% (numbers from Yahoo Finance). So I’m not convinced that they will be able to realize the book value of the inventory. What I would have wanted to see is that as a result of dropping demand they managed to drop a big part of the inventory, and turn it in cash.
And yes, totally agree with you that it’s going to be a great stock if management is right on capex and upgrades. But don’t want to speculate on that.
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