No. of Recommendations: 8
Hello Fools

I'm an intern for the summer working with HG. As part of the experience we have to write up a company from their 10-K and explain the various aspects to other interns and analysts. I'm going to steal a page out of David's (TMFPencils) book... or as Monish Pabrai would say, "clone" his good idea and post my write up.

SNHY was my first stock in the 10-K challenge and at the time I didn't realize it was in HG. This write up is probably a bit long for a board post, so I apologize. I hope you find it useful.

Company: Sun Hydraulics (SNHY)

Business in one (long) sentence: Designs and manufactures hydraulic components (valves and manifolds) used in regulating fluid pressures that transmit power for controlling force, speed, and motion in industrial machinery (oil rigs, windmills, bucket trucks, winches and hoists).

Value Proposition: Sun Hydraulics competes on quality, reliability, price, value, speed of delivery and technological characteristics of its products and services. Products are offered in various sizes and versions, providing a wide selection to meet different conditions and requirements. The valves and manifolds manufactured by Sun Hydraulics are generally more reliable and are able to operate at higher flow rates and pressures than similar offerings from competitors. Additionally, they also create custom offerings for customers who may need smaller components.

Company Strategy and Advantage: Sun Hydraulics is a prime example of a high quality company. They have no debt, steady free cash flow, and great return on capital metrics. The ROA average over the last ten years is 16.6%. ROE averages 22% over the last 10 years, demonstrating a durable competitive advantage. The well above market ROE’s aren’t because they’re juiced by leverage. Did I mention they have no debt? This is despite opening a new factory in Florida and renovating an older one in England in 2013 and purchasing two smaller companies outright since 2011.

Sun offers a large variety of standardized screw-in cartridge valves and manifolds to help other businesses that purchase Sun’s product improve efficiency with installation and maintenance. New products are also created, but are designed to complement existing products. They’ve also ventured into electrically actuated valves through the acquisitions of two companies that design and manufacture electronic control modules, expanding their capabilities and offerings.

Most sales are made through independent distributors; however, the company sells directly to other businesses within the hydraulics industry, including competitors. Sun believes that making it easy for other hydraulic manufacturers to buy their products leads to less direct competition for the products they produce. This strategy increases revenue and makes Sun components more ubiquitous.

In addition to selling individual hydraulic components, Sun is taking advantage of integrated package opportunities, selling a complete package of screw-in valves with a manifold. It is their belief that customers in the future will increasingly require integrated packages more than isolated components.

Other Business Details: Sun has operations in the US, England, Germany, France, South Korea, China, and India. They have 89 distributors, 67 of which are located outside the US. Sales to the largest distributor were less than 6% of net sales in 2013.

Sun has an expanding customer base, particularly in Asia and Europe, adding to the diversity of customers. Despite a turn down in the mining market in 2013, the larger customer base in other business areas and improved economic conditions in geographic markets such as China offset the decreased demand from mining distributors in Australia. Greater focus is being placed on the market in China with an office in Shanghai to develop new business opportunities.

Of note, there has been significant consolidation in the industry in recent years. Larger, full-line producers have acquired most of the independent screw-in hydraulic cartridge valve companies. This may be seen as a positive if a large competitor offers to buy Sun at greater than market prices. For long term holders who like the consistent compounding this company offers, a sale of the business would likely end this wonderful benefit.

Finally, and maybe most importantly, the company appears to have not just great management, but great leadership. Here’s a paragraph directly from the 10-K. See if it doesn’t sound familiar to another company in Alexandria, VA that you’re familiar with: “Since its inception, Sun has operated as an entrepreneurial enterprise, with an emphasis on individual employee empowerment and a disinclination to create bureaucracy, a formal management structure or administrative impediments to innovation, efficiency and customer service. Accordingly, the Company’s organization, management structure, and reporting and decision-making systems are highly unified and unlayered.”

Risks: The standard risks, such as another economic downturn or competitors offering comparable products at lower prices, certainly exist. In particular, look alike products have begun to emerge from Eastern Europe and Asia. Since Sun prides themselves on high quality components, it is probably unlikely that these competitors offer the same superior products; however, without further information on the copycat products, it is difficult to assess risk.

The bigger risk to the investor may be the price at which SNHY currently sells. The stock price of $41.45 translates to a P/E of 27.5 and an EV/EBIT of 17. Like most high quality companies, this one sells at a premium.

Big Few:
1. For further research, I recommend reading about competitors, particularly Sauer-Danfoss. It would be interesting to see if they have the same types of margin and returns on capital. Additionally, it could be helpful in better understanding the business of hydraulics and how it works. Furthermore, it would be very beneficial to know about the quality of products being produced by the imitators in Eastern Europe and Asia.

2. More information about products and literature on the company is located at sunhydraulics.com. Additionally, any information on customers who use Sun Hydraulic products could provide valuable insights into the company.


If you've read down this far, well, I'm shocked but happy.

Foolish Regards,
Brian
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