National Presto Industries (NPK) operates three separate businesses, each somewhat straightforward to analyze: a housewares business, an absorbents (private label diaper) business, and a Department of Defense munitions supplier. We originally looked at NPK when it was trading near the $130 range, but decided the stock was a little too expensive for us after a cursory analysis. We set a price alert at $105 and put it on the back-burner. When the price fell below our target last week, we resumed the research process. Over the coming month, we’ll try to determine a fair valuation for each segment independently. This analysis is being done real-time, meaning we’re not sure what conclusions we will draw from it. We haven’t yet made an investment and we’re not sure if we will. But the valuation appears reasonable, definitely worth taking a look at, and we hope that progressing through the research process with us will be an entertaining experience for our readers. As always, questions, comments, and feedback are welcome.
Overview
Before we dig into the segments, it pays to understand why we’re attracted to NPK. For starters, the business has grown at a very respectable rate, from $133mm of revenue in 2002 to $478mm in 2009 without any dilutive acquisitions. This is a compound growth rate of 20%. Net income has grown over the same time period at a compound rate of 26%. It looks like management is doing something right. Over this time, management has also paid substantial dividends. Most recently, shareholders were paid $56mm against a market cap of $679, an 8.2% yield. This is a payout rate in the high 80% range, so it would appear management is growing the business without risking too much shareholder capital, a sign of a strong business.
If this was the Motley Fool, we would end the analysis here. But we’re professional investors; we need to understand what this business does. And it turns out there’s a good reason for the low valuation. The DoD munitions business is responsible for more than half the revenue and net income of NPK, and it’s likely this business will decline as our military operations are scaled down. So the analysis boils down to a) what is the business worth without the munitions piece, and b) how much cash flow can we reasonably expect the munitions business to generate?
Regardless of how attractively valued the business is today, we see two possible scenarios for the future. In both scenarios, the munitions business declines in coming years. That’s a near certainty. In scenario A, the market understands this business and is prepared for lower future revenue, earnings, and dividends. As the munitions business declines, the stock price will stay resilient because investors are comfortable with the price they’ve paid for the non-munitions parts. In scenario B, investors who don’t understand the underlying fundamentals will panic when the munitions business declines, and depress the stock price, potentially well below the value of the core businesses. If scenario B prevails, Kerrisdale and our readers might be in an advantageous position to make a great investment.
This is just an introduction. Next week we’ll take a look at the housewares and small appliances business; the week after we’ll look at the absorbents business; and then in the last week we’ll take a look at the defense segment. After we’ve analyzed each individual segment, we’ll tie it together in a reasonable range of valuations and lay out our plan for monitoring the situation as it develops.
Update: Part 2 [1], Part3 [2], Part 4 [3]
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