1. Fuel system Solutions (Nasdaq: FSYS), rated a BUY by Craig-Hallum Capital
Demand for natural gas could jump by more than 50% to overtake coal as the second-most used fuel by 2035, according to the International Energy Agency (IEA). The world is choking on the stuff: we have about 250 years’ worth of reserves at the current rate of production. That opens the doors for governments to improve their energy security and to replace dirty coal and politically sensitive nuclear power with cheaper gas-fire stations.
And why stop there? What about cutting oil usage too, by converting petrol-driven vehicles to run on natural gas (NGVs)? It makes a lot of sense for consumers. Pop down to the nearest forecourt, and you’ll see that filling up with liquefied petroleum gas (LPG) will cost you about 30% less than unleaded petrol. In the US, the savings are even greater. In places like Pakistan, Argentina and Turkey penetration rates of bi-fuel cars are already more than 20%.
Better still, using LPG extends an engine’s working life, thanks to its clean burning characteristics. LPG also emits far less carbon dioxide – good news as tighter environmental rules start to kick in. In America, a collection of bipartisan lawmakers have proposed the NAT GAS Act, to provide substantial tax credits to wean America’s drivers off expensive imported oil. Over here, the European Union wants 20% of all cars to be fitted with gas alternatives by 2020.
This is where pioneer Fuel System Solutions (FSYS) fits in. It is the grand-daddy of natural gas and bi-fuel systems. It sells its proprietary kits to the transportation (74% of sales) and industrial (fork-lift trucks and power generators) sectors. Its tried and tested assemblies are bought by most of the big car makers (GM, Peugeot, Ford and Mitsubishi), with an installed base of over 5.5 million vehicles, representing a 20% share. Competition comes from the likes of Landi in Europe and Japan’s Aisan.
Wall Street is pencilling in 2011 turnover and underlying earnings per share (EPS) of $387m and $0.65 respectively, rising to $440m and $1.28 in 2012. Although North America accounts for only 13% of sales, this region is growing rapidly (up 73% in 2010), with businesses expected to start making changes with or without the passing of legislation. Indeed, with such sound fundamentals, I could see FSYS posting 2015 revenues and operating profits of $800m and $100m. Using a ten times earnings before interest, tax and amortisation (EBITA) multiple, discounting back at 12%, and adjusting for the proforma net cash of $88m (or $4.40 per share), I believe the stock is worth around $34 a piece.
So why have the shares dropped nearly 40% since November? It’s partly down to a drop in demand after the expiration of an Italian government incentive (37% of sales) programme. Investors have recently been negative about car manufacturers too, as several large “cash-for-clunkers” deals come to an end. FSYS is also exposed to the usual dangers of product recalls, country/counter-party risk, foreign currency risks, and competition from other technologies, such as electric cars.
However, I reckon the favourable cost dynamics and plentiful supply of natural gas make the adoption of NGVs virtually a ‘dead-cert’. Craig-Hallum has a price target of $32. Second-quarter results are due out in early August.
Recommendation: BUY at $24 (market cap $480m)
2. Laird (LSE: LRD), rated BUY by Goldman Sachs
There’s never a good time to lose business. Yet occasionally there can, at least, be a silver lining. Laird (LRD) makes specialist electronic components, such as antennae for mobile phones for the likes of Motorola and Sony Ericsson. In 2008, 40% of its top line was down to one customer, Nokia. But after the latter cancelled a contract to supply handset hinges in 2009, Laird’s exposure to the Finnish giant has fallen to only 11% of sales. So the dent this year will be much less than might otherwise have been in light of Nokia’s awful recent trading results.
Better still, the rest of the group seems to be firing on all cylinders. First-quarter revenues were up by a healthy 12% to £145m, aided by the booming tablet market, flat screens and other devices that require Laird’s technology. Operating margins also improved.
Elsewhere, Laird is shifting away from mobile, expanding into complementary areas such as electromagnetic shielding (EMS), which now accounts for 50% of sales. EMS stops magnetic interference affecting the performance of electrical goods, such as laptops and TVs. This diversification was accelerated in March, when the group bought German outfit Klüver – which makes cooling systems for medical equipment – for €25m. This happened just after the $90m purchase of Cattron, a supplier of industrial and machine-to-machine systems.
The City forecasts 2011 sales and underlying EPS of £617m and 16.5p respectively, rising to £650m and 18p. That puts the stock on tasty p/e ratios of less than 8.5, with a 4.5% dividend yield. The balance sheet looks robust, with proforma net debt of £125m, representing a comfortable earnings before interest, tax, depreciation and amortisation (EBITDA) multiple of 1.4.
I believe Laird should be able to grow organically at mid-single-digit rates, and achieve sustainable margins of 10% plus. I would value the stock on a multiple of ten times EBITA. Deducting the debt, this gives an intrinsic worth of about 180p per share. So what are the risks? Laird is a relative minnow compared to several of its larger customers, so pricing power could be limited. Deflation is also a key feature in consumer electronics, so unless it continues to innovate, margins could be squeezed. Next, the business’ prospects depend on the constant launch of new gadgets. While currently buoyant, these could be derailed if there’s a double-dip.
There are also the usual foreign-exchange exposures and in the short term there could be some further softness due to Nokia’s woes and the fallout from the Japanese earthquake. But all in all, Laird looks like a solid play on the future growth of mobile communications. Goldman Sachs has a target of 220p. Interims are expected at the end of July.
Recommendation: BUY at 135p (market cap £365m)
• Paul Hill also writes the Precision Guided Investments newsletter. Phone 020-7633 3634 or see
www.moneyweek.com/PGI
.