Enova Systems, Inc. - Power Trains for Alice

The origin of the saying good food, good whiskey, good gamble is not entirely certain. Many attribute it to Las Vegas casino operator Benny Binion, but for our part, we simply have no idea.

Regardless of it's origin, the term gamble and the term investing, certainly don't seem to go hand in hand. Yet, when given equal consideration, often times, all investors are actually doing is gambling.

Several years ago, we stumbled on Maxwell Technologies, Inc. (Nasdaq: MXWL). We understood the technology the company was developing, but try as we might we simply couldn't get our collective heads around what the market for an ultracapacitor might be.

Our reasoning at the time was why would anyone have a need to charge a battery that fast?

But we thought that at $7, it seemed like a pretty good gamble so we to a position and today at $16, it appears that our gamble is paying off.

Enter Enova Systems, Inc. (AMEX: ENA), another of those companies that at first made us wonder, and then made us ask why not?

Basis

Financial information for Enova Systems, Inc., is based on the company's most recent SEC Form 10-K filing, for year ending December 31, 2009 as filed with the Securities and Exchange Commission on March 26, 2010.

What They Do

The company believes it is a leader in the development, design and production of proprietary, power train systems and related components for electric and hybrid electric buses and medium and heavy duty commercial vehicles and stationary power generation systems.

It's focus is powertrain systems including digital power conversion, power management and system integration, focusing chiefly on vehicle power generation.

Specifically, the company develops, designs, and produces drive systems and related components for electric, hybrid electric and fuel cell powered vehicles in both the new and retrofit markets.

Company management believes medium and heavy-duty drive system sales offer it the greatest return on investment in both the short and long term.

In addition, management believes the medium and heavy-duty hybrid market’s best chances of significant growth lie in identifying and pooling the largest possible numbers of early adopters in high-volume applications.

By aligning the company with key customers and integrating with original equipment manufacturers (“OEMs”) in its target markets, management believes that alliances will result in the latest technology being implemented and customer requirements being met, with an optimized level of additional time and expense.

During 2009, the company continued to develop and produce electric and hybrid electric drive systems and components for First Auto Works of China, Navistar Corporation, Tanfield Engineering Plc, and the United Stares military.

The company was also successful in introducing its technology to Freightliner Custom Chassis Corporation in 2009.

Short-Term Investment

The stock closed recently at $1.06 with Resistance at $1.09, a 3% increase from its recent close, and Support at $0.83, a 22% decline for its recent close.

The Stochastic indicator is currently showing the stock to be oversold with the 13 day moving average starting to trend downward and the 50 day moving average seeming to plateau, indicating to us that the stock price may be close to a bit of downtrend.

All in all, there doesn’t seem and short-term advantage to a position at this time.

Long-Term (5-Year Hold) Investment

While we think the company’s Current Ratio at 8.5, Quick Ratio at 6, and Cash Ratio at 5.5 are all what we consider investment quality, we cannot say the say about the company’s Cash Conversion Cycle at 522 days.

Granted, the company is operating in an emerging industry that hasn’t quite caught on, but in the end, this metric needs improvement. Holding inventory for a year while perhaps necessary certainly doesn’t help.

On of the downsides to hanging on to inventory for so long is that it often times requires the holder to process its Accounts Payable well in advance of collecting its Accounts Receivable.

Such is the case with Enova, with Accounts Payable outstanding on average 33 days while Accounts Receivable are outstanding an average of 91 days. In effect, the company is providing its suppliers 60 day interest free loans.

The company ended FY09 with debt of $1.4 million paying an average annual interest rate of 14%. While not uncommon for an emerging market company, to us it is something that investors should keep a watchful eye on.

Valuations

Based on our review of the company’s latest annual financial information, we think the company currently has a Reasonable Value of about $4, with a Buy Target of $2.50, a First Sell Target of $4.75, and a Close Target of $5.25.

The company has a Market Cap of about $33 million, with an Equity Value of about $1.50 and Tangible Book Value of about $0.55, and negative Free Cash Flow.

Final Thoughts

As we said at the outset, sometimes things just seem like a good gamble. We think that is true of Enova Systems. Certainly none of the company’s financial metrics are that glowing. Still we can’t help but ask ourselves, what if?

The company has recently partnered with Smith Electric Vehicles, to provide drive systems for Smith’s Newton truck, part of a Department of Energy initiative, and back in May the company announced an order for Navistar's hybrid school buses, part of a large scale deployment of federal stimulus dollars.

Granted, these recent company announcements don’t mean the company will ever become profitable. Nor do these announcements mean that the company will even remain an on-going concern.

But at a 75% discount to our reasonable value estimate, we happen to think taking a long-term position in the stock is pretty good gamble, besides what else are we gonna do with a buck, buy a lottery ticket?

Wax

CenturyLink, Inc. – A Qwest for Growth

Back in April, CenturyLink, Inc. (NYSE: CTL) announced that the company and Qwest Communications International, Inc. (NYSE: Q) had agreed to merge, subject to regulatory and shareholder approval.

At the time, we didn’t think much about the announcement, nor have we paid much attention to how things are progressing, in the last 7 months.

Truth be told, had one of our clients not sent us a Worksheet Request for Qwest, we probably would not have thought about the proposed merger again.

But as we began to build the requested worksheet, we came across a Raw Value Report we had written in September 2009 for what was, at the time, CenturyTel, Inc., known today as CenturyLink.

Since our CenturyTel report, we have completed our proprietary valuation model, and curious, we applied our model to both CenturyLink and to Qwest.

What we found was, to us, good news for Qwest stockholders but not such for CenturyLink stockholders. 

Basis 

Financial information presented in this report for CenturyLink, Inc. is based on the company’s most recent SEC Form 10-K filing for year ending December 31, 2009, as filed with the Securities and Exchange Commission on March 01, 2010.

Financial information presented in this report for Qwest Communications International, Inc. is based on the company’s most recent SEC Form 10-K filing for year ending December 31, 2009, as filed with the Securities and Exchange Commission on February 16, 2010. 

Debt 

The merger of these two companies is being called “compelling”, with many “synergies”, providing the merged companies with greater “scale”, “scope”, and “expertise”.

Quite frankly the first thing we do when we hear words like these is grab our wallets and head for the exits, having learned over the years that these words generally mean something is going to cost us.

Once the merger is complete, CenturyLink, Inc. which we think should be renamed CQ, Inc., may indeed have lots of synergies, executive washrooms, and gold inlaid water closets, we have no idea.

Nor do we have any idea if the new company will be able to provide more, better, or more far reaching services that current customers, will want to buy.

But one thing we do know, is that after the merger, Century will have a mountain of debt so vast  we believe once interest rates start to increase, the company will simply not be able to service its debt and will have to seek protection through the courts.

We admit that $22 billion worth of debt may not seem like a big deal to many investors, especially considering that only $0.085 out of every Sales dollar goes to pay the interest on that debt.

But look around.

The current prime interest rate is 3.25%. Yet based on the combined companies FY09 financial statements, we estimate the interest rate for Century will be close to 6.5%, not the 4.75% that Century paid in FY09.

Why do we think this will be the case? First off, there will be a good deal more debt. Secondly, we think the merger at the very least will temporarily weaken the financial position of Century.

Accordingly, we think the company’s lenders will increase the company’s interest rate to compensate for the initial increase in risk.

Of course there is no guarantee that the company’s lenders will reduce the company’s interest rate once the company has completed integrating its new purchase.

As the matter of fact, we think that by the time Century has finished assimilating Qwest into its business model, the days of cheap interest rates will have ended.

So we seen no we see no potential decrease in interest rates for the company, maybe ever. 

Other Metrics 

Based on our review of both company’s current annual financial information, we think that after the merger, Century will have a Current Ratio of 0.84, a Quick Ratio of 0.69, and a Cash Ratio of 0.38, none of which are to us, investment quality.

We also believe that after the merger, at least 30% of the company’s Total Assets will be made up of Goodwill and Intangibles, and that Total Debt will exceed EBITDA by an almost 3.5:1 ratio.

Certainly there are potential bright spots such as Free Cash Flow, which we think will level out in the $3 per share range, and Return on Invested Capital which we believe will consistently be in the 20%-25% range. 

Valuation 

Based on our review of both company’s latest annual financial information, our Reasonable Value Estimate for the stock based on a 5-Year hold once the merger has been completed is $25, with a Buy Target of $15, a First Sell Target of $29, and a Close Target of $31.

We also believe that after the merger, Century will have an Enterprise Value of about $52 per share, an Equity Value of about $33 per share, and an Earnings Value of about $35 per share.

In addition, we estimate that EBITDA will run about 38% of sales, meaning that when our Enterprise Value estimate is considered, and assuming EBITDA stays at or near current levels, it should take Century approximately 16 years to pay for its investment in Qwest. 

Final Thoughts 

We said at the outset that we believed the merger with Qwest would be good for Qwest stockholders but not so good for Century stockholders.

Certainly we have no idea what the basis is for the current stockholders of Qwest, but coupling an entry point in the stock sometime in the past 5 years with an acquisition price of $6.02, the company’s current stockholders should recoup the vast majority of their investment.

In addition current stockholders of Qwest would be left with shares in CenturyLink, which we estimate will have a value of about $25 after the merger.

The same cannot be said for the current shareholders of CenturyLink. Considering our valuation estimate, many of them that took a position in the stock within the last 5-years are simply going to end up underwater.

In the end, Century must grow, and to do that they need access to additional markets, so merging with Qwest makes good business sense.

Our issue comes down to the assumption of more than $11 billion of debt, making us wonder if this merger is a Qwest for growth or grope for Qwest.

Wax

EnerSys, Inc. - Thoughts on Power

Power. We simply can’t function without it. The world is trying to come up with a host of different ways to produce it that are less invasive for the atmosphere. Eventually, the world may get there.

Regardless, there will still be a need for power in places the world simply can’t go. Submarines come to mind, as do race cars, coal mines, automobiles, airplanes, and ships. All of these things require power to be able to do the things they do.

As brilliant as we wish we were, we simply don’t sit around thinking about power. Like many investors we need something to steer us in a specific direction, which in the case of power, came from one of our private money management clients.

They were requesting worksheets for companies that make batteries, and while the first thing that may come to mind for many of us when we think of batteries is the Energizer Bunny, that wasn’t what our client was interested in.

In the end, we sent our client a worksheet for EnerSys, Inc. (NYSE: ENS), as well as a worksheet for Exide Technologies, Inc. (Nasdaq: XIDE). Nor were we surprised when several days later, we were asked for a report on EnerSys, Inc. 

Basis 

Financial information presented in this report for EnerSys, Inc. is based on the company’s most recent SEC Form 10-K filing for year ending March 31, 2010, as filed with the Securities and Exchange Commission on June 01, 2010. 

What They Do 

With approximately 7800 employees, the company is the world’s largest manufacturer, marketer and distributor of industrial batteries, with additional interests in the manufacture, marketing and distribution of related products such as battery chargers, power equipment and battery accessories, in addition to providing related after-market and customer-support services for industrial batteries.

The company markets and sells its products globally to over 10,000 customers in more than 100 countries through a network of distributors, independent representatives and their own internal sales force focusing on two primary industrial battery product lines: reserve power products and motive power products.

Reserve power products are used for backup power for the continuous operation of critical applications in telecommunications systems, uninterruptible power systems, or UPS, applications for computer and computer-controlled systems, and other specialty power applications, including security systems, for premium starting, lighting and ignition applications, in switchgear and electrical control systems used in electric utilities and energy pipelines, and in commercial aircraft and military aircraft, submarines, ships and tactical vehicles.

Motive power products are used to provide power for manufacturing, warehousing and other material handling equipment, primarily electric industrial forklift trucks, mining equipment, and for diesel locomotive starting, rail car lighting and rail signaling equipment.

The company operates in three geographic regions, the Americas, Europe and Asia. Its business is highly decentralized with manufacturing locations throughout the world. More than half of its manufacturing capacity is located outside of the United States, and approximately 60% of its net sales were generated outside of the United States.

The company and its predecessor companies, have been manufacturers of industrial batteries for over 100 years with their reserve power batteries marketed and sold principally under the PowerSafe, DataSafe, EcoSafe, Hawker, Genesis, Odyssey, Varta, Oerlikon Battery and Cyclon brands.

The company’s motive power batteries are marketed and sold principally under the Hawker, EnerSys Ironclad, General Battery, Fiamm Motive Power, Douglas and Express brands. 

Short-Term Investment 

The stock closed recently at $29.27 with resistance at $29.90, a 2% increase from a recent close, and support at $25.73, a 12% decline from a recent close.

The stock has been in an uptrend since the first week of September, and while the stock price may well continue it’s upward trend, we think basis its current overbought condition, that a pullback in the stock price is very likely. 

Long-Term (5 Year Hold) Investment 

Overall of the financial metrics we follow, those of EnerSys were about average. While the company’s Current Ratio at 2.13, Quick Ratio at 1.39, and Cash Ratio at 0.48, were encouraging, what we found outstanding was the company’s Free Cash Flow at $7.74 per share. 

On the downside, the company’s debt at $7.18 per share, we felt is excessive. Nor were we impressed with the company Goodwill and Intangibles at almost 25% of Total Assets. 

Valuations 

Based on our review of the company’s latest annual financial information, our Reasonable Value Estimate for the stock assuming a 5-Year hold is $53, with a Buy Target of $31.50, a First Sell Target of $62, and a Close Target of $65.

The stock is currently trading at slightly more than 5 times FY10 earnings, and 4 times Tangible Book Value. At current levels the price has an Enterprise Value of $32 per share, and when the debt is backed out the Equity Value is $26 per share.

With EBITDA at 8.25% of sales, and Enterprise Value at $32 per share, the Merger and Acquisition return period works out to roughly 4 years, assuming EBITDA stays at current levels, perhaps making the company a potential takeover candidate. 

Final Thoughts 

Over the past several years, management has adopted an aggressive approach to acquisitions, acquiring Keystone Mountaineer Power Systems, Inc., a leading battery supplier to the mining industry, the industrial battery businesses of the Swiss company Accu Holding AG, and the industrial battery business of Douglas Battery Manufacturing Company of Winston-Salem, North Carolina.

In addition, the company recently announced finalization of plans to construct a new 400,000 square foot facility in China, where it has manufactured batteries for over 20 years.

The company is also working with the Chinese government to supply batteries for six nuclear power plants, a potential $150M contract award.

In August, the company was awarded a $39M contract to supply submarine batteries and earlier this month the company was awarded a $38M contract for storage batteries.

So while batteries may not seem like stimulating investment conversation to most of us, over the years we have come to appreciate that when it comes to certain arm’s length transactions, they can be very stimulating indeed. 

Wax