Should You Buy this Security Stock?

By Demitri Kalogeropoulos - August 23, 2012 | Tickers: ASEI, ALOG, LLL, OSIS, SAI | 0 Comments

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Sometimes you find the best stocks hiding in plain sight. Security tech producer OSI Systems (NASDAQ: OSIS) isn’t a household name but with a $1.5 billion market cap, it’s not tiny either. And with shares up over 100 percent in the last year, it is clear that OSIS has made it on to at least a few investors' radars. Reflecting that market love, the company’s P/E ratio has surged to over 32 times earnings. Given those last two figures you might be tempted to wave the company through your stock screen and move along to the next prospective investment. But that would be a mistake.

Just like for the thousands of airline bags, cargo pieces, and people that OSIS devices scan each day, a casual glance isn’t enough here. Take a closer look and you’ll see that OSIS is primed for sustained growth from here.

Company profiling

Even at a quick glance, it’s obvious that OSIS stands out from its competitors:

OSIS' rich forward P/E ratio looks a lot more reasonable when you factor in sector-beating revenue growth, a strong profit margin and low debt levels. And keep in mind that the company delivered those solid numbers against the backdrop of declining spending by the U.S government, a key security customer for all the biggest market players. OSIS' revenue is more diverse than these competitors, with only 49% devoted to security tech, followed by a 30% contribution from healthcare electronics.

The pat down

A closer exam uncovers even more reason for optimism on OSIS' business. The company is still run by its founder, CEO Deepak Chopra, who has a big stake in his company's future as he owns nearly 4% of OSIS' shares. Its growth has been strong across product divisions, with healthcare tech a particularly large contributor to revenue gains over the last few quarters.

But the main source for confidence in OSIS’ future is the company's growing security services portfolio. OSIS already provides security hardware for venues as diverse as Buckingham Palace, the Vatican, and the Olympics. Now the company is expanding into the turnkey security business by providing full security solutions that include all the construction, hardware, and staffing that clients need in order to lock down their locations. That’s a higher margin business with more dependable, long-term income. Security services also promises to open up a new set of potential customers.

To that point, the company recently bagged a huge six-year contract with the Mexican government to provide security services along the country’s borders and in ports and airports. The contract won’t benefit OSIS in its 2012 fiscal year, but should boost revenues in 2013 and beyond.

Risky business

Unfortunately, no security system is foolproof and no investment is without risks. OSIS is taking a big gamble on its turnkey solutions and on this major contract in particular. If things don’t go according to plan the company’s revenue – and share price -- could dip.

Also, while OSIS isn’t as exposed to government cuts as competitors ASEI and SAI, a shrinking defense budget would hurt profits across the industry. And losing a U.S. government client is doubly painful in this sector because many smaller clients choose their devices knowing that the government has put them through rigorous quality testing. So if that implicit guarantee should drop, small customers may run for the exits, too.

Bottom line

But despite these risks OSIS looks set to continue growing its business at both the top and bottom lines over the coming years. It boasts strong management that is committed to long-term growth and has a reasonable plan to achieve it. That’s why I think OSIS deserves a spot on to your watch list, if not in your portfolio; after you give it the full body scan, of course.

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