|May 17, 2012|
Abatix Corp. (ticker: ABIX) manufactures safety, disaster recovery and construction supplies. The company operates branches in the Southeast and West Coast, as well as Texas, but also sells internationally. The company was founded in 1983 and deregistered its stock in 2007.
Abatix's revenues are strongly tied to natural disasters and other catastrophes. The terrible tragedy and human suffering of these events is not to be diminished or ignored, but somebody still has to provide products to help mitigate damage and rebuild afflicted areas. In 2010, the Japan tsunami and Haiti earthquake combined with other disasters to inflate Abatix's revenues by more than 40%. Hurricane Katrina affected revenues similarly in 2005. In some ways, Abatix's business model is the mirror image of that of a property & casualty insurer. Rather than suffering occasional, unpredictable losses due to hurricanes and miscellaneous calamities, Abatix experiences occasional, unpredictable and exceptional profits from the same events.
Abatix has been consistently profitable for the past decade and carries no debt. Still, the company trades at a 20% discount to net current asset value. Here's a look at historical earnings. The company has not provided cash flow data in recent years.
Abatix is a slow grower, compounding revenues at just 2.2% over the past decade. Earnings growth has been a little better at 3.2%, compounded. Neither of these figures account for exceptional environments like 2010 and 2005. The company's operating leverage is significant, evidenced by years such as 2010, when a 51.5% increase in revenues propelled operating earnings higher by nearly 1,100%.
Like a lot of small manufacturers I look at, Abatix has used its recent cash flow to pay down debt and accumulate significant excess assets. I don't know whether it's simply laziness in capital allocation, or the secure feeling that comes of holding excess cash in an uncertain economy, but the trend is clear.
Abatix has succeeded admirably in putting itself on firm financial footing. Unfortunately, the deleveraging process has also resulted in anemic returns on equity.
DuPont analysis is a useful tool for examining the drivers of return on equity. In its basic form, the DuPont analysis formula incorporates three terms: asset turnover, equity multiplier and profit margin.
Asset turnover is defined as revenues divided by assets. Higher asset turnover means a company is using its assets more efficiently and generating more dollars in revenue for each dollar of company assets.
Equity multiplier is defined as assets divided by equity. A higher equity multiplier indicates higher leverage. Using leverage can improve return on equity greatly, but also puts the firm at a higher risk of bankruptcy.
Profit margin is simply net income divided by revenues and measures a company's success in managing costs and selling profitably.
The reason for Abatix's gradually declining returns on equity is clear. The company has failed to grow revenues as fast as it has grown assets, so the asset turnover ratio has declined from 3.59 in 2001 to 2.29 in the twelve trailing months. Over the same period, the company's continual deleveraging has reduced the equity multiplier from 2.11 to 1.20. Profit margin has held steady.
It seems evident that Abatix's poor returns on equity are largely responsible for its low market valuation. On the positive side of things, the company has begun to take action to reduce its large cash balance in a shareholder-friendly way. In July 2011, the company announced a $2 million share repurchase plan. Since then, the company has repurchased 7.4% of shares outstanding at prices far below book value. Assuming that shares were purchased around the current price, the company has around $700,000 remaining under the share repurchase authorization.
While shares outstanding have declined moderately, the size of the company's float has been reduced dramatically. As of May 9, only 240,331 are freely trading, just 14.3% of shares outstanding. These shares have a market value of just $2.8 million, less than the cash on the company's balance sheet. I have to wonder if the company won't someday make a tender offer for this small number of shares and be free of the hassle of public ownership entirely.
With a current market cap of $19.5 million and trailing income of $1.66 million, Abatix has an earnings yield of 8.5%. That may not seem outstanding, but keep in mind that disasters will occasionally cause the company's earnings to rocket. Average annual earnings for the past five years were $2.82 million, a 14.5% yield on current market cap. Abatix Corp. is not the next Facebook, but investors interested in purchasing a steady company at a strong earnings yield and at a discount to net current assets may do well with Abatix.