Frank Voisin is the author of the popular value focused website Frankly Speaking, found at http://www.FrankVoisin.com.
I wrote about National Presto Industries Inc (NYSE: NPK) back in November (Is Performance About to Go Poof?), questioning whether the company’s performance was heading for a dive due to its extreme reliance on its defense segment (a segment wholly unrelated to its traditional business of selling bacon cookers, deep fryers, pizza ovens and similar products for home users).
Since publishing that, the company’s stock has declined by about 15%. The bulk of the decline came in the days following its full year earnings release on February 21. The market was unimpressed, and for good reason. Revenues for the year declined 10% and earnings 24.5%. The company also cut its famously volatile dividend by 31%. Unfortunately, these full year aggregate figures paper over the larger issues which relate to the rapid decline of the company’s Defense Products segment. Recall this chart from back in November:
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This chart illustrates the importance of the company’s Defense Products segment to the rapid growth in its performance in recent years. As I noted in November,
NPK is not a appliance company. Rather, it is a defense supplier with an appliance business on the side.
This fact reveals the surprising amount of hidden risk that exists in an investment in NPK. Just like we would be wary of any company with high levels of customer concentration, an investor in NPK must recognize the company’s reliance on the Department of Defense. …
By looking at the company’s performance by segment, we see a very different company, fraught with risks and reliance on a single division that has contributed almost all of its recent success. Moreover, this division is almost certain to perform worse in the future than it has in the last four years.
Well, it appears the risks inherent in NPK’s reliance on defense sales have come to roost. In Q4 of 2011, defense revenues declined by 23% year over year, which comes on the heels of a decline of 17.8% in Q3 and 25.4% in Q2 (though, in this quarter the prior year presented a uniquely tough comparison). Revenues from the defense segment have simply fallen off a cliff. Let’s look at how the company explains the declines.
For Q4, the company’s press release says (emphasis added):
In contrast, the Defense segment’s decline was primarily one of shipment timing, which has deferred sales to a later date.
For Q3, the company’s press release says (emphasis added):
Both the Housewares/Small Appliance and the Defense segments’ net sales declined, 8.7% and 17.8%, respectively. The former reflected reduced sales in the category at retail, as well as increased emphasis by retailers on private label products, while the latter was largely a function of the timing of shipments.
For Q2, the company’s press release says (emphasis added):
Defense segment’s net sales were also down significantly (25.4%) when compared to 2010’s second quarter, primarily a function of the timing of shipments.
One begins to wonder whether only another war will cause the company to stop blaming the “timing of shipments” for declining demand.
Seriously though, there are ways to verify whether the issues are related to the timing of shipments, as the company claims, or whether the real issue is declining demand for this segment’s products. If demand for the company’s products had been similar to the previous year but shipment simply had not taken place (and, consequently, revenues could not be recognized), we would see this demand show up in the segment’s backlog. Simply put, we would expect the company’s defense-related backlog to grow by approximately the decline in defense sales.
Unfortunately, this is not the case. From December 31, 2010 to December 31, 2011, the company’s defense backlog grew by $13 million. Its defense sales over fiscal 2011 declined by almost three times this amount: $38.4 million. This suggests that the company is being disingenuous in blaming the timing of shipments for the rapidly declining performance of its Defense Products segment.
While on the topic of the backlog, there is one more scary thing to note. From the company’s Q4 press release (emphasis added):
The Defense segment’s backlog is sizable. Its volume thus would appear largely assured for 2012. Its customer does, however, retain the right to cancel or modify orders.
Translation: translating the company’s backlog to sales is far from being a certainty. Given the rapid decline in actual sales versus relatively meager growth in its defense backlog, if demand really is collapsing, we may see this backlog decline at the DOD’s (the customer it refers to) option.
Beyond collapsing defense sales, we are starting to see more signs of weakness. The company’s gross margin in Q4 2011 was 33.52%. The same figure for Q4 2010 was 35.26%, or 174bp higher. Its operating margin showed an even more pronounced contraction, from 32.35% to 28.76% or 359bp. This was the first quarter since defense sales began their rapid decline that the company’s defense margins also signaled problems at hand, and it has contributed to investors’ rush for the exits.
All of these figures are up to date as of December 31, 2011, which is also the date the United States committed to having withdrawn from Iraq. One would expect this to signal even less demand for the company’s defense products going forward. So unfortunately for NPK shareholders, these issues are likely to be just beginning.
What do you think of NPK?