Floundering Operations and Lack of Catalyst at National Presto
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National Presto (NYSE: NPK), despite its rather unusual choice of individual business segments, is a company that appears to offer an intriguing value opportunity on the surface. With no debt burden and almost $74 million in cash/equivalents, the corporation’s balance sheet is eerily clean. Working through three divisions that sell everything from medium caliber ammunition and tear gas grenades to adult diapers to small kitchen appliances including griddles, popcorn makers, and bacon cookers, one can picture National Presto as being well diversified despite the lack of similarities between each segment. Lastly, following a 21+% share price decline in late February following its 2011 annual report filing, National Presto now sells significantly less expensive (5x enterprise value, trailing twelve months) than its past two year price average of well over $100/share.
In looking at the corporation’s past ten-year history, however, it is clear that the pressure under which National Presto has come over the past five years makes it far from a screaming buy.
Sales in Thousands
Huge Customer Dependence
National Presto, largely through business acquisition, has done a swell job diversifying its operations not only in terms of the breadth of individual silos it controls, but also in terms of the individual accounts it now serves within each of those divisions.
The housewares segment, which has long been the corporation’s core business, has historically relied on a handful of very large general merchandise retailers for the bulk of its sales volume. Well over 40% of the housewares segment’s revenues in the early 2000s were solely reliant on Wal-Mart (NYSE: WMT) locations, and an additional 10-12% of the volume was pushed through Target (NYSE: TGT) stores. National Presto has since expanded its total customer portfolio and no longer relies on one retailer for more than 10% of its total revenues.
Looking at the corporation’s total portfolio, however, tells a different story. National Presto (coincidentally) acquired AMTEC Corp, a manufacturer of ammunition and precision mechanical and electromechanical products for the U.S. Department of Defense, several months before the 2001 World Trade Center attacks and the subsequent United States push into the Middle East. Since the acquisition, National Presto has become more of an ammunitions manufacturer with a small appliance segment than a small appliance manufacturer with a large ammunitions division. Although the growth in the corporation’s Absorbent Products segment (diapers) has since alleviated some of the reliance on the Defense segment, the latter has consistently represented more than 50% of the corporation’s revenues over the past five years.
Likewise, in looking at the performance chart above, a significant portion of the increase in operating margins and return on equity was driven by efficiency improvements in the Defense segment. Between 2006 and 2011, gross and operating margins in the Defense segment have expanded from 22.7% and 16%, respectively, to 30.6% and 27.2%. What should be most concerning is the division’s reliance on the U.S. Department of Defense. Although National Presto was awarded a renewed five-year contract to control the Department of Defense’s 40mm Ammunition System (after its previous five-year contract beginning in April 2005), the contract is highly reliant on the continued fight in the Middle East region. As opposed to a mutually beneficial long-term agreement between both parties, the Ammunition Systems agreement should be viewed as a revenue stream that will continue to wane as time progresses and peace (hopefully) comes to the conflict regions.
Limited Customer Captivity
Although National Presto won the majority of the Department of Defense’s 40mm Ammunition Systems multi-year contract, the customer captivity in its other two divisions is almost nonexistent.
First, both the Housewares and the Absorbent Products divisions operate in highly fragmented markets. Marketed under the Presto brand name, the corporation’s small appliance products compete against other popular brand names including Hamilton Beach, Keurig (NASDAQ: GMCR), Mr. Coffee, and KitchenAid. Products including coffee makers, pressure cookers, skillets, kettles, and slicers/shredders are generally purchased by consumers once (maybe twice, if broken) and are not prone to recurring revenue streams. This being said, there are generally two different consumer types along the continuum – those who will simply look for value (highly based on price), and those who will actively seek out the most fashionable/quality goods.
Gearing its products towards the former segment, National Presto is going to gain little consumer captivity points in the long run, as its products are simply displayed on general merchandise retailer shelves amongst similarly priced and constructed goods. It is the more prestigious brand names including those found in higher-end kitchen stores like Crate and Barrel and Williams-Sonoma (NYSE: WSM), or even the private label goods found in Target, that will keep consumers coming back for the future purchase of complementary product lines.
Aside from the high reliance on several consumers and the limited customer captivity National Presto can establish due to its operations in highly fragmented spaces, one must also consider that there is a lack of catalyst to raise its share price with an estimable timeframe. With the likelihood that the Defense segment will continue to wane with the decreased spending by the U.S. Government, and with the lack of historical growth in the Housewares segment (2011 revenues equivalent to their 2007 level), an increased dependence on the growing Absorbent Products division is necessary. Although revenues have been growing at a near 13% CAGR since 2006, margins in this division are still under extreme pressure due to the capital intensiveness of the operations as well as the huge amount of competition in the space. Even after the fast growth in the division’s top line, Absorbent Products still represent less than a quarter of National Presto’s total revenues, and the continuous problems in the segment will prevent it from becoming a company-saving division in the near future.
There is also a minimal likelihood that multiple expansion will push the stock back to its $100+/share historical levels. Although the P/E (ttm) of around 11x is relatively inexpensive compared to other players in similar fields, the market is unlikely to pay more for each unit of National Presto earnings due to its stagnant performance over the past five years. It will undoubtedly take several consistent quarters (or years) of new customer account creation, a revamping of the Housewares/Small Appliances segment, and a continued diversification away from the Defense division before National Presto can right size its operations to the degree where the corporation can begin enjoying a prolonged period of above-average profitability once again.
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