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Author: khrushchv Two stars, 250 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 19393  
Subject: Methodology, PLPC Date: 12/12/2012 9:15 AM
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I’ve been meaning write up something one of my favorite companies here for a while: Preformed Line Products (PLPC). Now I can do so in the context of an idea I’ve been kicking around for a while…

PLPC is based in Ohio and has a high degree of inside ownership (about 52% is held by insiders, according to Yahoo! Finance). It has a market cap of $320 million and trades about 6,200 shares per day on the NASDAQ…liquidity could be an issue for you aquatic Value Hounds out there (e.g. London Whales).

So what does PLPC do you ask? They make products for networks involved in the transmission of electricity and data. Look at all the junk hanging off of your nearest power pole and you’ll see the product space that PLPC occupies (although not necessarily a PLPC product). Or, if you feel like taking a nap, take a look at one of their catalogs for cabling and the section on “Aeolian Vibration” (Actually, I find this stuff fascinating…who knew that power lines could be so exciting!):

http://www.preformed.com/index.php?option=com_phocadownload&...


Some basic metrics I always run on any company:

Tangible Book Value = Equity – (Goodwill + Intangible Assets) = 235 – (15.4 + 14.2) = $205.4 million…the company could be sold for something if they just decided to quit operating.

Quick Ratio = Total Current Assets / Total Current Liabilities = 208/68 = 3.05…no impending cash crisis!

Next, before I jump into Earnings Per Share (EPS) numbers I usually glance at the dynamics of the share count over the last few years to get an idea of how dilutive things have been.

Year Share Count
2008 5.22 million
2009 5.25
2010 5.27
2011 5.33
Q3-12 5.43

Only about 4% (cumulative) dilution over the last four years…that’s just noise so let’s assume the share count has remained static. Also, if one chooses, this lets you ignore per-share numbers and focus on aggregate numbers.

Year Revenue (millions USD)
2008 270
2009 257
2010 338
2011 424
YTD-2012 335

Earnings…

Year Aggregate Earnings (millions USD)
2008 17.6
2009 23.4
2010 23.1
2011 31.0
YTD-2012 24.0


Year Net Margin (=Earnings/Revenue)

2008 6.5%
2009 9.1%
2010 6.8%
2011 7.3%
YTD-2012 7.2%
Avg. 7.4%

(Note: equal weight is given to the YTD-2012 margin even though it should be 3/4…I’m lazy…)

Not a business to write home about in terms of marginal profitability (certainly nothing near the 22% net margin you get out of Altria!). But you’ve got to give them some credit for their reliability: the top-line growth is translating into bottom-line growth.

Moving on to some current valuation metrics…PLPC trades at about $60 per stub which implies a P/E of 9.9. One valuation measure I’m becoming fond of is the ratio of a 5-yr avg. net margin to current (ttm) P/E. The idea here is that this gives you a rough idea about how much of a “prevailing market-level risk-preference premium” you’re paying for the marginal profitability of a company. I know that’s convoluted so let me unpack it a little bit using PLPC and MO as examples…

From the above PLPC has a 5-yr average net margin of 7.4%. Compare that to a net margin (ttm, anyway) of 22% for MO. So all else equal I would prefer to invest in MO. But this isn’t the laboratory. And given the disparity in net margins it should be the case that MO trades at a higher P/E ratio than PLPC since for every $100 of revenue MO moves $22 to the bottom-line while PLPC only moves $7.40. And this differences in P/Es is borne out in the market…MO’s P/E of 17.2 is almost double PLPC’s 9.9 P/E.

That’s all well and good. But, the choice problem of invest/don’t invest in PLPC isn’t made in a vacuum…I have lots of alternative investments available to me (including MO!). So how do I deal with this disparity? Well, taking the ratio of the marginal profitability of a firm (sort of the “marginal utility” associated with an investment dollar) and divide it by the price of the firm’s earnings (i.e. the P/E ratio) then I have a somewhat normalized scale I can use to compare investment alternatives against each other. The basic idea comes straight from introductory microeconomic theory…for my portfolio choice problem I “should” purchase PLPC instead of MO if the following inequality is true:

Marginal Utility(PLPC)/Price(PLPC) > Marginal Utility (MO)/Price(MO)

You’ll recall that (interior) solutions to the “Utility Maximization Problem” result in a set of equalities in which MU_j/p_j = MU_k/p_k for all the goods under study.

The punch-line here is in terms of allocating a marginal dollar in my portfolio PLPC may not be that bad of a choice if the relative valuations on it are low relative to my alternatives (e.g. MO). That’s a lot of relativity but in any case, here are the data with PLPC on the left and MO on the right:

7.4/9.9 = .75 < 1.25 = 22/17.2

So the opposite inequality holds here…relative to investing in MO I should probably NOT be allocating money to PLPC.

I’ve cherry-picked MO for a reason…it’s a tough criterion to overcome…MO is so marginally profitable and (relatively) cheap that most alternatives available pale in comparison. What about the S&P? Well, taken from Bloomberg.com I see that margins were 9.3% across the S&P 500 in early 2012 and it’s current P/E is around 14. So SPY sports a ratio of 9.3/14 = 0.66. Thus, for the choice between PLPC and SPY, allocating money to PLPC would be a better use of an investment dollar!

Obviously this isn’t the whole story…the world is a dynamic place…growth happens…the ratio comparison between PLPC and MO may just be a reflection of the fact that PLPC is expected to grow revenues at a reasonably positive rate over the next few years while MO is expected to shrink revenues over the same time horizon. But the ratio can be modified to use Net Margin / PEG or something of the sort, just to give you an idea…

Please feel free to throw tomatoes…I could really go for a salad…
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Author: kelbon Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 12652 of 19393
Subject: Re: Methodology, PLPC Date: 12/12/2012 12:23 PM
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Look at all the junk hanging off of your nearest power pole and you’ll see the product space that PLPC occupies (although not necessarily a PLPC product)

From my perspective, the most important question is is there something special about their widgets that gives them a "must have" advantage over the competition or is one company's piece of junk hanging off a power pole as good as another company's?

kelbon

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