GSE Systems, Inc.: Operating near full power
To say energy production is a complicated business is to say Catherine Zeta-Jones has pleasant features: it's an exercise in the obvious and the understated. But as obvious and as understated as it may be, it's still worth noting; complicated businesses demand sophisticated technology to coordinate and manage their many moving parts.
In electrical-energy production, Baltimore-based GSE Systems, Inc. (AMEX: GVP) provides an indispensable chunk of that sophisticated technology. Specifically, GSE provides simulation and educational solutions and services to the nuclear and fossil electric utility industry. The company boasts three decades of experience, totaling 343 installations and 100 customers in more than 40 countries.
Despite all the Hosannas directed at wind, recycled cooking oil and corn squeezins', GSE's clientèle of conventional electrical energy providers still rule the roost, and will continue to do so into the relevant future. Energy pundits expect a protracted cycle of nuclear and fossil fuel generation expansion and upgrade, and so does GSE. Management presages a renaissance in nuclear power generation both internationally and domestically that will provide significant opportunities.
On the international front, China has announced plans to build 40 new nuclear plants by 2020. Russia has also announced plans for 40 new plants by 2030. New plants are on the drawing board or under construction in Finland, Slovakia and Bulgaria. On the domestic front, numerous utilities are preparing applications for construction and operating licenses under the Department of Energy 2010 incentive program, a joint government-industry effort to identify sites for new nuclear power plants, develop advanced nuclear plant technologies and demonstrate new regulatory processes that should lead to new power-plant construction.
These macro industry events are starting to materialize into micro financial results. GSE recently reported third-quarter revenue of $7.5 million, a modest 3% increase over the $7.3 million posted in the third quarter of 2006. Net income attributed to common shareholders was $303,000, or $0.02 per share, compared to $337,000, or $0.04 per share, in 2006. Despite the drop in the year-over-year comparison, the EPS beat First Call estimates for $0.01 per share.
The materialization process should gain momentum starting in 2008. GSE’s order backlog as of Sept. 30 was approximately $24.2 million compared to $18.5 million at the end of 2006. The backlog excludes the vast majority of a multi-million dollar contract relating to Westinghouse Electric's AP1000 full-scope nuclear simulator at its Sanmen facility in China.
Meanwhile, China Nuclear Power Engineering Company, a subsidiary of China Guangdong Nuclear Power Holding Company, Ltd., has authorized GSE to begin work on a multi-million dollar project to develop a simulator for verification and validation of the distributed control system design for the Chinese CPR 1000+ nuclear reactor plant design. China Guangdong Nuclear Power Company is currently planning to start the construction of a series of CPR 1000+ nuclear plants next year, the first four of which will likely be located at the Hongyanhe Nuclear Power Plant in Liaoning Province, China.
In the United States, GSE has received awards from several domestic customers, including multi-million dollar five-year extensions to two contracts with the U.S. Government to provide engineering support and simulation technology for nuclear simulator applications. Contracts have also been inked to provide simulation hardware and engineering services to Progress Energy, Inc. (NYSE: PGN), Exelon Corporation (NYSE: EXC) and PSE&G.
The glowing outlook for conventional electric production has raised GSE's expectations among the few investment houses that monitor its stock. Roth Capital Partners analyst Mark Tobin suggested a “buy” rating when he initiated coverage in July. His price target was $11 (since surpassed), with an EPS estimate of $0.09 on revenue of $32.2 million in 2007 and an EPS of $0.23 on revenue of $41.9 million in 2008. Feltl & Co.'s Richard Ryan offers a more contemporary opinion: In November, he initiated coverage with a “buy” rating and price target of $14.50.
For the lay investor, valuing GSE can be as difficult as explaining how a Chinese CPR 1000+ or Westinghouse whatchamacallit actually works. Past patterns of revenue and earnings growth resemble a random coin flip more than a linear progression, which leaves standard rear-mirror metrics like ratio and growth analysis wanting. To wit, GSE's revenue was $27.5 million, $22 million, and $29.5 million for 2006, 2005 and 2004, respectively, while operating income (loss) was $2.1 million, ($4.7 million) and $80,000 in 2006, 2005 and 2004, respectively.
A recent selling spat among directors and executives in the past four months further muddies the analysis waters. But insiders sell for a variety of reasons, and not just the bad reasons — portfolio diversification and liquidity, for instance, suffice a sell. Moreover, GSE's officers and executives haven't exactly been sagacious market timers; all who sold have left money on the table, some as much as 100% price appreciation.
Speaking of price appreciation, that's another worrisome post with a mitigating riposte. GSE's share price has nearly tripled over the past 12 months, popping to $12 from $4.26. Fortunately, GSE has a history of investor munificence. In the past five years, its stock has produced a 640% return compared to 190% for both the S&P 1500 and the S&P Application Software indexes. The stock closed at $11.27 on Wednesday, while over the past 52 weeks, shares have ranged between $4.26 and $11.29.
GSE (GVP) is in a complicated business, to be sure. Then again, it's a business that just might be worth knowing, sort of like Catherine Zeta-Jones.
