ADDvantage technologies (AEY) is a distributor of electronics and hardware for the cable industry. Despite a history of consistent profitability and decent ROIC, the company currently trades at multiples that imply a bleak future where they will basically destroy shareholder value.I first discovered this idea from the excellent barelkarsan.com, and I encourage you to read his thoughts on the company.
Currently, the company trades for a market cap of ~$30m, slightly below its book value of $34m. Most companies that trade at a discount have a history of poor returns and a future of, at best, modest profitability. However, this isn’t the case with AEY- pretax ROA has average over 17.5% over the past five years, and the company has been profitable every year for the past ten. Operating income over the past five years has average just under $8.5m and never come in below $5.8m. With a current EV just below $35m, the company trades at just over 4 times EV / average 5 year EBIT and around 6 times EV / trough EBIT.
There’s a lot to like about AEY. Management seems rational (direct quote from Q4 2010 conference call “we chase profits and we don’t chase revenue) and owns ~50% of the company (split pretty evenly between the Chairman and the President / CEO). The company also recently modified their relationship with Cisco. Now, instead of buying directly from Cisco, they will buy from Cisco’s primary stocking distributor. While this will result in “slightly higher product cost” (Q1 2011 conference call), they are now a “Premier Partner” which will allow them to sell IT equipment in addition to Service Provider Video Technology Group (SPVTG) products. The increase in product cost should be somewhat offset by a decrease in inventory costs.
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The company is really, really cheap. Even if it was in a dying industry or faced a future of bleak ROIC, it’d likely be too cheap. However, it doesn’t seem to be a dying industry; actually, as the economy continues to improve, the industry could enter a period of strong growth. One of the most interesting things is the new distribution agreement. It’s possible the agreement could result in lower profits but still increase the share price. How? AEY currently holds ~$29m in inventory, over 50% of their assets. They note that the new agreement will allow them to reduce their investment inventory, which would free up cash for potential share repurchases or dividends and increase their ROIC by reducing their invested capital. I’ve initiated a small position in AEY, and would increase my position if the share price pulled back or as cash from other investments gets freed up.
Note- some of you may worry about investing in a company that distributes technology products. With a huge portion of their assets in inventory, a new technology shift could wipe out most of their assets and cause huge losses. While this is a risk, I don’t think it’s a huge one. Management notes that very little of their inventory has software in it (software is what makes inventory really exposed to obsolescence, and over 90% of their inventory has no software), and most of their inventory has VERY, VERY long shelf lives (they still have some inventory of products that were discontinued 5+ years ago that companies are ordering). Management does not seem concerned with it and notes that it’s never really been a problem for them (in over 20+ years in business), so I’m not terribly concerned with it.
Disclosure- Long AEY
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