Value Find: Portec Rail Products, Inc.
Given the smart money that has been piling into shares of North American railroad operators in recent months, now might not be a bad time to look at a little-known micro-cap play in the sector.
Back in May, billionaire investor Warren Buffett caused quite a market stir after it was disclosed that he had taken several large positions in U.S. railroad stocks. While more recently he has moderately reduced his sector bet, he still retains an outsized position in Burlington Northern Santa Fe Corporation (NYSE: BNI). Other well-regarded investors that have amassed stakes in rail stocks include Carl Icahn, Jana Partners, Atticus Capital and The Children’s Investment Fund.
While one way to “shadow” the smart money is to simply purchase shares in big-cap rail names like Burlington Northern, CSX Corporation (NYSE: CSX), Norfolk Southern Corp. (NYSE: NSC) and Union Pacific Corporation (NYSE: UNP), another strategy is to look for small or microcap plays in this sector.
One name that has recently caught our eye is $98 million market capitalization Portec Rail Products, Inc. (Nasdaq: PRPX). Pittsburgh, Pa.-based Portec is a provider of a broad range of railroad products, including rail joints, rail anchors and spikes, railway friction management products, railway data collection and management systems, and load procurement systems.
Portec certainly isn’t glamorous, but the rail infrastructure company has posted solid growth in recent years on a combination of organic and acquisition-driven growth. The company believes it has the “dominant market share” in most of its lines of business. The users of Portec’s rail products include Class I railroads, short-line and regional railroads and transit systems. For calendar year 2006, Portec’s two largest customers were Canadian Pacific Railway Limited (NYSE: CP) and Canadian National Railway Company (NYSE: CNI), which collectively accounted for 19% of total sales for the year. In addition to its Pittsburgh headquarters, Portec maintains operations in Ohio, West Virginia, Illinois, Canada and the United Kingdom.
For 2006, Portec posted revenue of $99.2 million and net income of $4.62 million, or $0.48 a share. Most recently, for the third quarter ended Sept. 30, 2007, Portec reported revenue of $28 million, up 15% from a year ago, and net income of $1.89 million, or $0.20 a share, a 57% increase from a year ago. For the first nine months of the year, Portec’s sales have risen 11% to $84.6 million, while earnings have increased 33% to $4.98 million, or $0.52 a share. Portec ended the most recent quarter with approximately $15.7 million in net debt on hand.
The management and board of directors of the company both look solid and motivated. Portec’s CEO and COO have a combined 60 years of experience working for Portec and its predecessor. The company’s directors and officers as a group collectively own a 30% stake in the micro-cap name. Other notable shareholders include institutional investors Heartland Advisors and hedge fund Tontine Associates. Portec represents a tiny holding for Tontine’s Jeffrey Gendell, but we still like seeing him in the stock since he has a great record investing in the industrial sector.
Portec doesn’t hold quarterly conference calls, nor does it provide guidance, but the firm did say in its last earnings release that its backlog at the end of September was 7% higher than a year ago. The company also said that it remained “optimistic” about its future, given the healthy outlook for the rail sector. The rails have seen a slight drop in freight demand recently, amid higher fuel costs and a slowing economy; however, pricing seems to be holding up. In addition, the rails stand to gain market share from the trucking sector, which is being hit hard by rising fuel costs.
Looking at the longer-term for the North American rails, Buffett was quoted earlier this year as saying, “what was a terrible business 30 years ago (is) a better business now.” A less cyclical industry is, of course, key for the earnings predictability of rail infrastructure suppliers like Portec. Barring a sharp sector downturn, Portec looks like an unglamorous micro-cap play that should be able to post high-single-digit-to-low-teens top-line growth and mid-to-high teens EPS growth.
After hitting the $13 level in mid-October, Portec shares have recently retreated more than 20%. Shares of the company closed at $9.99 on Monday. Over the last 52 weeks, shares have ranged between $9.50 and $14.05. Assuming the growth rates I’ve outlined above, Portec could post earnings of $0.75 a share in 2008. Placing a 17 to 18 times earnings multiple on the stock would value it at $13 or more. Portec also pays out a $0.24 a share annual dividend, good for a decent 2.4% yield at current levels.
Bottom line, after its recent pullback, Portec (PRPX) looks like an interesting “value find” for medium-to-lower risk oriented investors. I would look to accumulate positions around the $10 level.
About the Author
Contributing author Matt Ragas is an investment writer and analyst with ten years of experience analyzing small and microcap stocks, with a particular emphasis on value and turnaround situations.
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