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No. of Recommendations: 3

April Fool!

Many of you may know that I like to read the old issues of Fool Select, the precursor to Hidden Gems. And I have bought several stocks recommended from these issues, simply because the attractive fundamental do still exists even after three years of falling prices. And I suspect that a small cap company is worthy of a Hidden Gem Status if it came out of the last three years stronger.

In this email, I will examine this company called AAON. Most the quotes here are quoted ad verbatim, some of the calculations will be mine, please read up the references and make your assessment on Aaon.


* October 2000 Hunting for Diamonds -- TMF Gibson

Aaon's first debut as a Foolish 8 candidate.
Motley Fool Hidden Gems: Motley Fool Select - Vol. 1, No. 4 (July 2001)
By Whitney Tilson

* August 2001 Importance of Strategy -- Whitney Tilson

* August 2001 Innovative Compensation Ideas -- Whitney Tilson

* Sept 2001 Talks about fine examples of good quality companies -- Whitney Tilson

*Jan 2003 look at Issues of Net income rising faster than Cash. -- TMF Tom9

*March 2003 Aaon Review -- TMF Otter

* Most Recent 10K\edgar_conv_html\2004\03\12\0001026608-04-000016.html

Type of Business
Aaon is a manufacturer of commercial rooftop heating, ventilation, and air conditioning (HVAC) units. It's in a boring industry, but the industry is fragmented into opposite extremes: those that made standard HVAC units and those that built custom units from scratch (for three times the price). Many customers want some degree of customization, but are reluctant to pay triple the cost, so AAON has built a highly efficient manufacturing system that permits substantial customization at little incremental cost. This allows AAON to earn the highest margins in the industry while charging an average price premium of only 4% over a standard unit.

AAON produces five series of rooftop air-conditioning products, which offer cooling sizes ranging from 3 to 230 tons. (A typical commercial building requires 1 ton of cool air for every 300 to 400 sq. ft.) AAON also makes air handlers, condensing units, chillers, and air-conditioning coils. AAON serves the new construction (60% of sales) and replacement (40%) markets, primarily selling its units to major retail chains for use in their newly constructed stores.

There is a lag between the general business climate and slowdown in revenue, this hit Aaon only in mid-late 2001.

Competitive Advantage, aka. The Moat

* Specialised Supply Chain management system which eliminates frequent slowdowns.

* Aaon has state of the art equipment which they invest in during good times which reduces their capex during tough times.

* Selling to Wal-Mart / Home Depot instead of selling to contractors directly.

* The largest HVAC units can be as large as a bus, this reduces somewhat the threat of cheap foreign imports since transportation will be costly,conversely this may limit their international expansion.

Management Quality

* AAON acknowledges and thanks its employees by printing every one of their names in the back of its annual report

* At AAON the Bonus plan is divided evenly among all qualifying full-time employees. There is no distinction by hours, work, or salary. The CEO gets the same bonus as the lowest-paid employee. No one feels abused.

* Aaon was listed in Forbes Magazine Hot shots 200 up and comers in Oct 2003.


2003 2002 2001
Total Revenue 148,845   155,075   157,252
Net Income 14,227   14,611   14,156
Free Cash Flow 8,769 15,805 14,862
Structural FCF 13,919 14,485 9,994
Long term Debt - - 985
Flow Ratio 2.0 1.9 1.9

EV (31st Dec) 227M 235M 214M
EV/FCF 25 14.8 14.4
EV/FCF Current 27

% Insider Held 23.61

Year on Year, net sales fell 4% to $148.8M while net income fell 3%, business was tough and it reflected a slowdown in the construction market. I like Aaon because through the last few years it has managed to avoid new long term debts, while maintaining some form of free cash flow (though the reduced no is a concern). ROE is quite impressive at 22.36% while profit margin is at 9.56%.

I suspect the worst is over for AAON but I really need to do comparisons against its competitors to give a more complete picture. The challenge here is that AAON is probably the most narrowly focused in the HVAC business while it's no.1 competitor is Carrier, a subsidiary of a very diversified United Technologies.

I'd appreciate your thoughts on AAON.

ray toei
who thinks that AAON may richly valued but likes the long term aspects of this stock.

========== workings =====
FCF = Cash Flow From Operating Activities - Capital Expenditure
SFCF = Net Income + Depreciation + Amortization + Deferred Income Taxes - Capital Expenditures
Flow Ratio = (Current assets - Cash/ShortTermInvestments) / (Current liabilities - Short-term debt)
FR-2003 = (64635 - 6186 - 10000) / (29266 - 5356) = 48449 / 23910 = 2.0
FR-2002 = (46482 - 5071) / (25333 - 3566) = 41411 / 21767 = 1.9
FR-2001 = (42273 - 1123) / (22385 - 884) = 41150 / 21501 = 1.9
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