Royce & Associates Likes This Identification and Security Company

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Royce & Associates recently filed a 13G which discloses that it owns 3.8 million shares of Brady Corp (NYSE: BRC), up from 3.5 million shares roughly three months ago. The new position represents a little over 8% of the outstanding shares. Brady is a $1.8 billion market cap company which primarily provides identification and security software; it also operates direct marketing and precision die-cut products businesses. Royce, which is managed by Chuck Royce, likes to take relatively large stakes in small-cap and mid-cap companies and has been managing money for 40 years. Find more of Royce's stock picks.

Brady’s fiscal year ends in July, and so its most recent quarterly report was for the first fiscal quarter (which ended in October). Revenue declined 3%, with slight increases in Asia-Pacific being offset by declines in the Americas (the largest segment at 44% of revenue) and EMEA. With the company also taking a small loss on the sale of certain businesses, earnings were down 17%; we estimate that if it were not for the loss pretax income would have fallen a more modest 6%.

If we annualize the 51 cents per share that Brady Corp earned, we get a P/E multiple of 17 at current prices; that’s a bit higher to what we get from analyst expectations, as consensus is for EPS of $2.27 in the fiscal year ending in July 2013. Looking out one year further, the forward P/E slips to 14. So the Street is expecting at least some earnings growth over the next couple years. That’s certainly not the trajectory the company is on, and Brady will have to improve even over the next few quarters to hit earnings targets for the current year.

Royce had the largest position in Brady Corp out of all the funds and notable investors we track in our database of 13F filings. Ariel Investments, which is managed by John Rogers, reported owning 2 million shares at the end of September, roughly unchanged from three months earlier (see Ariel's favorite stocks). David Dreman’s Dreman Value Management initiated a position of a little over 500,000 shares (check out more stocks Dreman was buying).

Some other security software and services companies which we can compare to Brady are Check Point Software Technologies (NASDAQ: CHKP), Sourcefire (NASDAQ: FIRE), Mantech International (NASDAQ: MANT), and Symantec (NASDAQ: SYMC). Sourcefire is the outlier of this group in that it has the most growth priced into the stock: the forward P/E, for example, is 46. While sales were up strongly in the third quarter of 2012 versus a year earlier, net income was down 39%. 17% of the outstanding shares are held short, so a number of market players think it is overvalued. We think it’s best to avoid the stock.

The forward earnings multiples of the other three peers cluster between 11 and 13, so they seem to be trading at a discount compared to Brady. Mantech is another struggling company: its most recent quarterly report showed lower revenue and earnings than in the same period in 2011, and that forward earnings multiple reflects an expectation that net income will be even lower in 2013. It is another popular short. The larger Checkpoint and Symantec are more stable from a business standpoint, and combined with their cheap multiples they might be worth taking a closer look; even in terms of trailing earnings they are cheaper than Brady’s annualized P/E from its first fiscal quarter.

Of course Brady has other businesses and even within security it’s possible that its product mix is superior to what Checkpoint and Symantec offer. However, the recent financial performance has not been good and so we’d advise against following Royce into the stock.

This article is written by Matt Doiron and edited by Meena Krishnamsetty. They don't own shares in any of the stocks mentioned in this article. The Motley Fool recommends Check Point Software Technologies and Sourcefire. The Motley Fool owns shares of Check Point Software Technologies and ManTech International Corp. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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