The Idea List: Issue #3
This week I analyze Burnham Holdings, Polaris, Hurco Companies
In this post I want to share three stock ideas that appear to be undervalued. These companies came from the “top of the funnel” of my research process, meaning they came from stock screeners, or recommendations from Twitter and Substack. What I want to do here is present some qualitative and quantitative metrics that determine if I should keep researching the stock or take a pass on it. Further, I want to do a basic valuation to verify that the company is actually undervalued. The end goal is to have some semi-vetted stock ideas that I can add to a watchlist and start doing more thorough research on.
Burnham Holdings (BURCA)
Burnham Holdings is a company that I stumbled on that is trading at a quite large discount to book value and has a dividend yield over 7%. BURCA has a market cap around $56M, and trades at $12.00 a share. The company has a few subsidiaries that operate in the HVAC industry, primarily manufacturing oil boilers that are used in the North East. While revenue has increased a bit in 2022, I looked at some old annual reports and it looks like BURCA has made about $200M a year each year for the past 20 years. It appears the residential boiler industry is a melting ice cube and depends on the housing market. Burnham is usually profitable, but its margins are pretty small and the company does not earn more than its cost of capital.
This company is a case study on double checking financial data. At first I did not notice my data provider only had financial data to the end of 2022. Then looking at Google finance was misleading because the share count was off. I looked at Burnham’s most recent earnings release to get an up to date balance sheet and share count. The company has 4.659M shares outstanding, which produces a book value of $20.0 a share.
Now that I have the right data, I can take a stab at valuing the company. Doing a quick earnings power valuation shows that the company is overvalued, but the low profit margins hurt BURCAs earnings power. Looking at the balance sheet, Burnham trades about 2.6x net current asset value, so its not a super cheap net-net. The company does look cheap if we add in the book value of their long term assets such, which includes $63.7M in property and plant.
While it can be argued that Burnham Holdings is undervalued, there two things that I noticed that may be grounds for passing on this company. First is that nice dividend yield. Looking back, BURCA has consistently paid out about $4M a year in dividends since 2015. The problem is that Burnham spends most of their cash from operation on capital expenditures, requiring the company to increase debt to afford the dividend. This is poor capital allocation for a company that is in a troubled industry. The second concern is that Burnham’s stock price has had a slow decline starting at $19 in late 2013 to its present $12 a share. The company has been increasingly trading below book value over the past 5 years. This suggests the stock is not temporarily out of favor by the market, and if it has been declining for this long there probably is not a catalyst for the stock to trade at book value unless the company gets bought out. Based on my analysis, it seems like Burnham is a value trap. The melting ice cube nature of its business can be fine if management had good capital allocation, so maybe I would be interested in this company if they cut the dividend and reduced debt.
Polaris (PII)
Polaris is a stock that Morningstar currently has a 5 star rating for, meaning that they believe it is quite undervalued. The company makes of off-road and marine powersports vehicles like ATVs and snowmobiles. The company has a market cap of $5B, and trades at $91 a share. The stock price peaked in July 2023 at $135 a share and has declined since. My guess is that the company is cyclical and depends on a healthy consumer. Increased interest rates and persistent recession fears probably have turned this company off to investors. Some key stats are P/FCF 17.0, P/E 10.2, P/B 4.4, 5 year median ROA 7.6%, D/E 1.75. Polaris’ has been profitable every year for the past 10 years, although profits declined 50% in 2016 but have been growing back to a new peak. Revenue has grown from $3.8B in 2013 to $9B at present.
For Polaris, I am going to use the earnings power method of valuation. For my estimate, I’ll use $9B in revenue, 8.5% operating margin based on their 5 year average, 25% tax rate, and a 9% discount rate. This produce an enterprise value of $6.38B. Converting the enterprise value to equity gets us a value of $5B, or $86.50 a share. Based this analysis, I would say that Polaris is fairly valued. Additionally, since the company is cyclical and we haven’t had a big recession since 2008, I would go back to see how the company’s financials did during that period.
Hurco Companies (HURC)
Hurco is a company that showed up on my net-net screener, trading about 0.9x of net current assets. Hurco is a $157M company that specializes in manufacturing machining tools like CNC machines. Over the past 10 years, HURC has been profitable except for 2020. The company’s share count has been steady over the past 10 years, which is a good sign when looking at small net-nets. Looking at Hurco’s latest earnings release shows a NCAV of $28.84 a share. Zooming in on their current assets, Hurco’s inventory makes up about 60% of its current assets, while cash is 17%. Typically with net-nets you would prefer more emphasis on cash than inventory. Despite this, Hurco looks like a quality microcap stock and is definitely a company I would buy if it sold off a bit more below its net current asset value.