Comtech (CMTL): I need to write faster…

Comtech Telecommunications offers a substantially more compelling value than a simple glance at its P/E or earnings outlook would suggest. The future outlook is a bit gloomy due to the looming expiration of its current government contracts and the stock dropped about 33% in a single day back on July 21 on the news that it was not chosen as the next vendor for one of its main programs. Unfortunately, the stock has jumped about 13% over the past couple of days and eaten up a lot of the margin of safety. This relegates the stock (in my eyes at least) to the “interesting at a price” list.

I’ve been reading through Martin Whitman’s “The Aggressive Conservative Investor” recently, so I figured the first thing I’d use to evaluate CMTL would by his “safe and cheap” criteria.

First up: simple financial integrity. This one’s a big pass – there’s three times as much cash as LT debt and almost twice as much cash as total liabilities. Even better, the company’s had a decade of continuous free cash flow production. Although it has accessed the capital markets in recent years, like when it acquired Radyne in 2008, CMTL isn’t dependent on them for survival and could fund any shortfalls or acquisitions out of its $600M store of cash. There also don’t appear to be any off-balance sheet liabilities that would impair the company.

Second/third: management honesty and disclosure. These both also appear to be covered. Not only is management forthright about the difficulties ahead but management enthusiastically bought into the decline in July, which suggests that they have faith in the company’s future prospects since they just invested hundreds of thousands of dollars of their own (about 230k shares over the last six months). I remember Peter Lynch pointing out that there are a lot of reasons for insiders to sell stock, but only one reason for them to buy.

Fourth: selling below net asset value. Unfortunately, this one is a fail. On the most basic level (P/B) CMTL narrowly misses since the market cap is around $728M and book value is currently $702M. If you look at reproduction value the numbers go a bit higher. PPE is already ⅔ depreciated and even if the newest replacements cost only ½ the original amount ($100M) , that would still add at least an extra $20M above book for the reproduction value. Also, book value in the most recent quarter is reduced $20M by a stock buyback. If you add all that back in (which might be a bit dodgy if you’re trying to be conservative) that only comes to a total value of $742M. Comtech is now selling at a premium to even that optimistic reproduction value rather than the 25%+ discount you’d be looking for under a genuine “safe and cheap” approach.

So, it’s a near-miss on the Marty Whitman scale. It still comes out somewhat cheap by a few other measures, though. P/E is 12.5, which is a bit below-average but nothing to write home about considering the uncertainty in its future. P/FCF is another story – only 6.7x. If you use Enterprise Value, which takes into account the company’s stellar financial position (that big pile of cash), the valuation becomes even more enticing. EV/E is 5.6x and EV/FCF is a measely 3.5x. CMTL is basically priced for disaster despite the fact that it has financial stability, historically strong returns on its investments, and management with clear faith and dedication.

As I mentioned, their returns on invested capital are quite good. For the last twelve months, ROIC was 23.5%. CROIC was even better, a tremendous 38%. These numbers are strong, but the best part is that they don’t even represent a peak. CMTL has performed well for many years now:

The acquisition of Radyne at the start of FY2009 seems to have been a drag on ROIC, but the returns remained above-average and have been climbing back toward their historical levels. It’s also reassuring to see that gross and operating margins over the past year have been roughly at historical levels, so there’s no indication of a drop-off or imminent reversion to the mean that would impair profitability.

As an added bonus, the company has declared its commitment to putting that cash stockpile to work. I like that the company has relatively clear and defined plans to make use of it for shareholders’ benefit. They’ve started a $1/share dividend and a $100M stock buyback ($20M already complete), and they intend to explore new acquisitions. As Damodaran points out, not all uses of corporate cash are particularly productive, but most of CMTL’s ought to be. Although stock buybacks are often done at inopportune moments when prices and profits are at their peak that certainly isn’t the case here. Earnings are high, but the valuation is pretty reasonable earnings-wise and the firm’s P/B, while not in value territory in absolute terms, is below the industry and market averages (as well as CMTL’s recent historical average of 2.4x). Total dividend payments come out to $27.5M a year, consuming less than ⅓ of the FCF of even a less profitable year like 2009 and providing a 3.46% yield. The only area of concern is potential acquisitions. The Radyne acquisition seems to have been a drag on efficiency (since revenues continued to increase post-acquisition and only ROIC declined) and future acquisitions might have the same effect.

That’s not a huge issue in and of itself – ROIC was still above their likely cost of capital – but in combination with the short-term limits on CMTL’s upside, that relegates CMTL to the “intersting a price” list. All of the $200M convertible bonds issued in 2009 have a conversion price of $36.44, which means there isn’t a huge amount of upside from the current price of $29.96 before Comtech reaches the initial conversion price. Taken together with CMTL’s expiring military contracts, that’s too much uncertainty at the current price even though the stock’s valuation is still fairly low in a lot of ways. Back at $26.50 a few days ago it was enticing, now…less so. If the stock takes another dip, I’ll probably take another look.

Current Price: $29.96
Latest 10-K:
Latest 10-Q:

This entry was posted in Analysis and tagged . Bookmark the permalink.

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Google+ photo

You are commenting using your Google+ account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )


Connecting to %s