“‘Inevitable’ disaster erases 117 years of American progress…” Motley Fool

by Travis Johnson, Stock Gumshoe | February 9, 2010 3:56 pm

This teaser starts, as so many of them do, by drawing a picture of the horrible future that a chosen stock can prevent …

“On a hot summer day, just after the sun reaches its highest point, it begins…

“Within minutes, cell phones go silent. Oil refineries shut down. Flights are grounded. Assembly lines grind to a halt.

“America is paralyzed. But not by an act of terrorism. Or a devastating hurricane.

“The richest nation in history is brought to its knees by a tiny flaw hidden somewhere in a 250,000-mile-long labyrinth of wires that twist through every city in the U.S.

“Impossible? According to scientists from Carnegie Mellon, it’s inevitable’…”

So yes, today’s teaser, which comes in the name of the Motley Fool[1]’s Hidden Gems[2] newsletter, now edited by Seth Jayson[3] and Andy Cross[4], is all about the horrible state of our ancient power grid … something that typically comes to mind in the summer when we have a huge blackout, but which we conveniently tend to ignore the rest of the time.

We’ve seen smart grid and power grid teasers before — Untapped Wealth[5] has been teasing Xcel Energy with the “smart grid” angle for months now, and in some ways the Fredonia Reactor teaser I wrote about last month[6] touches on this stuff, too, with their big new power transmission lines now in the planning process.

But today, thanks to the Foolies, we’re looking at something a bit different and quite a bit smaller. They tease us about a special report they’ve concocted called “Bigger Than the Internet: 3 Undiscovered Grid Stocks Ready to Rocket!” … but unfortunately, they really only get into mentioning one of the specific stocks that’s in that report. So if you feel like speculating about other “grid stocks” that they’re likely to pick, have at it in the comments section below … but for today’s Gumshoeing adventure, we’re going to identify the one stock that they do actually hint at with a few sketchy clues.

“a fast-growing high-tech manufacturer that already has more than 30 manufacturing facilities in 16 states…

“I’m not talking about GE here. Rather, a company that makes the highly specialized mission-critical parts that GE simply can’t function without…

“In the past three years, revenues have doubled on exploding demand for its relay panels, switches, buses — the high-quality parts necessary for the generation, transmission, and distribution of electrical power.

“And to make absolutely certain it seizes this historic opportunity, this small company actually acquired its own steel business, in order to galvanize its own products — boosting margins and ensuring that it can keep up with demand.

“Of course, like almost every profit opportunity you’ll hear about from Seth Jayson and Andy Cross, this company’s stock has been quietly paying off for its investors, too — smashing the S&P 500 over the past five years.

“Yet, with a market cap still under $500 million, it’s still small enough to grow — with its most explosive growth ahead. In other words, it’s in the perfect position to help investors like us cash in on the $200 billion smart-grid build-out.”

I know, it’s not a lot of clues — but rest assured, the mighty, mighty Thinkolator chews up this kind of stuff for breakfast. Who is it? This must be …

AZZ Incorporated (AZZ)

This is a company that’s primarily known for electrical equipment — here’s how they describe themselves on their website:

“AZZ incorporated is a multifaceted enterprise providing essential products and services to global industrial markets with emphasis toward
the generation, transmission and distribution of electrical power and the expert application of hot-dip galvanizing to prevent the damaging effect of corrosion in steel products.”

And yes, they do have 30 facilities in 16 states, sort of — you actually have to throw in Ontario to get to the 30, but they are in 16 US States as well. The market cap is well under $500 million at about $370 million. And it has certainly clobbered the S&P 500 over the past five years (though timeframe makes a big difference, of course — it has done far worse than the S&P over the last six months, for example).

AZZ was quite high on Forbes[7]’ list of America’s 200 Best Small Companies last October, and they released a profile of them at the time that’s worth reading — it also talks about the fact that AZZ is essentially awaiting a windfall from all the necessary grid and electrical infrastructure work that’s required.

While they await that work, or position themselves for growth (they’re doing more selling of their most advanced stuff overseas as well), they’re actually in a bit of a rough patch — because while there’s clearly a need for more electrical grid work, there’s also a lot less industrial activity right now than there was two years ago, this is certainly a company that takes a hit in a recession, when industry slows down or when state and local governments stop ordering new galvanized light poles and such. They came out last month and told analysts their earnings expectations were way too high, giving guidance with a midrange of about $2 a share for 2010 versus the analyst expectations of a bit over $2.50. That’s not terrible for a stock that’s hovering just under $30, you get a forward PE of 15, but it does mean that earnings are likely to shrink rather than grow for at least a little while, which no one likes to see … and which goes a long way toward explaining the stock’s fall of 25% since hitting recent highs in the low $40s back in October. A Reuters article at the time noted that the company’s guidance for FY2011 (just about to begin) is for worse results than the current fiscal year, that margins should shrink, and that their key electric utility and oil[8] and gas customers are being very cautious right now for both regulatory and economic reasons.

This one actually looks pretty appealing to me, as long as you’re not too impatient — they’ve got a price/sales ratio of under 1, but still manage to run a double digit profit margin, which is fairly unusual (though that margin might shrink), and they do appear to have a pretty strong national business with their large number of manufacturing and galvanizing plants, so they’re not completely stuck riding the regional trends if one of their areas sinks further into this recession.

The forward estimates by analysts are for very strong growth in the next several years, which gives them a price/earnings/growth (PEG) ratio of .59, which usually indicates a screaming value — but I’d be cautious about those future growth estimates. Just because “everybody knows” we need a dramatically upgraded grid doesn’t mean we’re going to get one right away, and they’ve already experienced five years of torrid growth (50% a year). The analyst expectations are for 16% growth per year over the next five years, which is certainly possible, but this year’s going to bring, they expect, a drop of at least 25%, so it might not be a smooth ride. The analysts clearly have some difficulty getting it right for this stock, their numbers were beaten handily in the first and second quarter of this fiscal year, but they overshot in the third quarter, part of the beginning of the slide for the shares — analysts, despite the cautious guidance, now expect $2.25 in earnings per share for the year that’s about to begin (they’re on a February fiscal year), which is a nickel[9] above the top range of the company’s guidance, so on analyst estimates they’re valued at a PE of about 13.

They do have a substantial debt position of $100 million but also have plenty of cash on hand, so net debt is close to zero, and they do now pay a decent dividend — they’ve paid a dividend somewhat consistently over the past 20 years, but generally a very small one, and not necessarily every quarter. They did declare .25 as a quarterly dividend when they announced it last month, so if that continues that’s a yield of 3.4% on the current share price, which is very solid and amounts to roughly a 50% payout ratio (paying out half of earnings as a dividend). If you can catch a small company that’s on the verge of steady and impressive growth, and that’s committed (though they may not be) to paying a dividend, you’re often going to end up in pretty good shape in the long term … and sometimes do spectacularly well (reference Wal Mart, one of the oft-cited examples of quiet small cap dividend-payers that grew and compounded like crazy over the past few decades).

There is a decent but not huge amount of insider ownership, and from a quick look at the recent transactions it looks like insiders bought up quite a bit when it fell to $15 and have been selling in the high $30s and when it hit $40, so that might give some idea of the valuation that the insider owners place on the shares (or it might just mean they wanted to buy a few boats, you can never tell).

That’s what I know about AZZ Incorporated from my quick gumshoe work, but I’m pretty certain that this is the one example the Motley Fool is teasing in their latest ad … if you’ve got guesses or suggestions for some other “grid stocks,” or an opinion on AZZ or their prospects, let us know with a comment below.

And Hidden Gems has been an investor favorite on occasion over the past several years, sometimes outdoing the market according to Hulbert, but reviewers have been less charitable about them more recently after their small cap value picks took a big hit in the market crash — if you’ve subscribed to Hidden Gems, either under Tom Gardner[10] or under the newer guys now at the helm, let us know what you thought by clicking here to share your opinion with your fellow investors. Thanks!

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