Graham Corporation: Looking golden
Trading at just over $90 per barrel, the price of crude oil has skyrocketed more than 60% over the course of the past year and benefited major oil drillers such as Transocean Inc. (NYSE: RIG), Diamond Offshore Drilling, Inc. (NYSE: DO) and Noble Corporation (NYSE: NE), which have all seen stock prices rise along with the trend.
Investing in these oil exploration companies is not the only way an investor can play this boom, though. Graham Corporation (AMEX: GHM), based in Batavia, N.Y., is one of many companies that have been cashing in on the strength of the energy sector. Fresh off of 2007 where the company saw its stock price surge an astonishing 297%, Graham now wields a market cap of $169 million.
The company, founded in 1941 in upstate New York, started out with its production efforts focused primarily on producing surface condensers and heat exchangers for the U.S. Navy in World War II. It was after the war that the company made its push into the commercial market.
Today the company designs and builds vacuum and heat transfer equipment that is utilized in a wide array of industries. The key industries that the company serves include the chemical, petroleum refining and electric power generating industries. Graham’s products are used to produce everything from gasoline and electrical power to fertilizers and processed foods.
Graham has come a long way since 1941 and its transition into the commercial market has been a notable success. In 2008, the company is looking to continue where it left off in 2007. It has already rang in the new year with a $3.7 million oil refinery order that was locked up at the beginning of January. The company will be installing an injector system for a refinery that is being reconfigured to process synthetic crude oil.
Earlier this week, Graham announced the results of a lights-out quarter. For the third-quarter ended Dec. 31, management reported net income of $3.8 million, or $0.74 per diluted share, on $20.6 million in sales. These figures were in line with analysts’ estimates. The results also marked major increases versus the year-ago quarter with net income rising 465% and sales up 42.2%.
As might be expected, demand from the oil refining industry has continued to be a driver behind this growth. In this most recent quarter, the refining industry accounted for 38% of Graham’s total sales and made strong contributions towards the company’s towering backlog. Although refining work contributed 42% of total sales in the year ago quarter and was surpassed by the company’s chemical and petrochemical work which contributed 42% of total sales in the most recent quarter, refining sales still climbed 31.7% over the prior year’s third-quarter. The company now has a record backlog of $63 million, which represents a 32% surge versus a year ago. Approximately 50% of this backlog pertains to refinery work.
Other factors that should play a role in the company’s future success are a growth in exports and productivity gains. Export revenue has risen 64% over the course of the past three fiscal years and accounted for 48% of revenue in Graham’s third-quarter. The company’s improved efficiency has been striking. Operating margins now rest at 26.2%; up sharply from just 5.9% in the same quarter of the prior fiscal year. These positive trends not only bode well for the future, but they also have caught the eyes of one analyst.
“Graham is on fire right now,” said Robert Maltbie, an analyst for Singular Research. “The company is well positioned to continue to experience strong growth in each of its markets.”
For the fiscal year ending Dec. 31, Gregory Garner, an analyst also with Singular Research, is forecasting EPS of $2.95 on revenue of $83.2 million, up 102.1% and 26.4%, respectively, from the previous year. The momentum is expected to continue from there. Garner then sees EPS growing another 8.8% in 2009. In early November, when Graham shares were trading around $63 per share, he had a 12-month price target of $83 for the stock.
On Friday, shares of Graham closed at $34.05 following a recent pullback. The stock has ranged between $11.11 and $60.96 over the last 52 weeks.
“It’s almost like a value stock right now,” said Maltbie.
Two notable risks that investors should consider are the cyclical fluctuations in demand that Graham customers face in the energy markets as well as the potential for a plateau in its chemical processing business. In a research note, Garner wrote, “We expect revenue growth from chemical processing to decline in two to three years.”
All in all, Graham has a portfolio of products with the diversity to protect it from a downswing in any one of its markets. For a company that has been around since before the World War II era, Graham Corporation is battle tested. Should the energy sector continue to add to its gains of recent years, Graham (GHM) is one small cap that will play a strong, supporting role in the sector’s prosperity. In turn, it will also be likely to provide healthy returns to investors.
