NN, Inc.: Keep on rolling
There is something nostalgic about companies that manufacture hard tactual things that exist in the physical world. Such manufactures conjure images of the robber-baron years of yore, where huge industrial monoliths created blush-inducing wealth and powered the U.S. economy at a pace China can only imagine.
Of course, those days have long been relegated to historical contemplation; U.S gross domestic now trundles along at a 3% to 4% annual pace (if we're lucky) and most of the industrial manufacturing might has been supplanted by things ephemeral and ambiguous like cyberspace and silicone.
But that's OK; plenty of U.S. companies still thrive on manufacturing hard, tactual things—they just do it on a smaller, more environmentally friendly scale. NN, Inc. (Nasdaq: NNBR) is one of these smaller, more environmentally friendly manufacturers. Specifically, it manufactures high-precision ball-and-roller bearings, steel balls, cylindrical rollers, and plastic and metal retainers. The company's output can be found in such diverse machinery as automotive gearboxes, wheel bearings, hydraulic pumps, electronic instrument and fluid control components.
Since its formation in 1980, NN has grown primarily by acquiring other bearing manufacturers (think an ArcelorMittal (NYSE: MT) strategy, but on a more modest scale). Today, the business encompasses a diversified customer base spread across Europe (59% of sales), North America (30%) and Asia (11%) that's served by an equally diversified production base spread across the United States, Europe and China.
This production base was further spread and diversified last November with the purchase of Whirlaway Corp., a manufacturer of precision metal components and fluid control assemblies, for $45.6 million. Whirlaway is expected to add another $70 million to $75 million to a top-line that has grown at a 17.8% average annual clip over the past decade.
Unfortunately, the new kid hasn't exactly made a good first impression. Yes, Whirlaway contributed $35.1 million to a top line that increased 26.9% to $215.2 million in the first half of 2007 from 2006's $169.6 million, but it also contributed to a first-half net loss of $8.1 million, or $0.47 per share. The 2007 results included approximately $14.9 million, or $0.87 per share, in after-tax restructuring and other one-time charges related to the Whirlaway acquisition. Excluding Whirlaway, net income for the first six months of 2007 would have been $7.3 million, or $0.43 per share.
Many acquisitions are fraught with these one-time integration charges and those related to the Whirlaway acquisition seemed like child's play. In May, NN management reiterated that fiscal 2007 revenues would post at approximately $400 million and full year EPS would post in the $0.98 to $1.04 range. But then two months later, management recanted and revised its EPS guidance to $0.70 to $0.74 before restructuring and other one-time charges. The higher-ups blamed unexpected sales weakness in the precision metal components division (read Whirlaway) tied to slacking HAVC and diesel-engine demand for the shortfall.
Since investors generally dislike surprises, especially those of the negative variety, the stock unsurprisingly dropped like a sucker-punched drunk, sinking to $9 a share from $12.50. On Wednesday NN closed at $9.71 a share.
Then again, investors also generally overreact to spats of negative news and that appears the case with NN, for the few analysts following the stock view the lower price as a buying opportunity.
On Aug. 20, BB&T Capital Markets analyst Holden Lewis raised his recommendation from “hold” to “buy,” giving a 12-month price target of $15 a share. Ten days later, Ferris Baker & Watts analyst John Rogers initiated coverage with a “buy,” but with a less optimistic price target of $12.50.
Neither price target should be readily dismissed. At the current price of around $10 a share, Rogers' price target equates to an annual return rate of 25%, while Lewis' equates to a 50% annual rate. Split the difference and you get 37.5%, and that's serious appreciation.
Lewis and Holden's recommendations were likely influenced by the implied value found in a few of the standard ratios. On that front, NN's 13.6 forward P/E ratio, 0.44 P/S ratio and 1.33 P/B are all below the industry (miscellaneous fabricated products) average, while its annual dividend (which appears to be set in concrete; it hasn't budged over the past decade) of $0.32 per share produces an above-average yield.
They were also likely influenced by NN's business model. Though NN sounds like a run-of-the-mill commodity producer, it isn't. The company offers one of the industry’s most complete lines of commercially available precision bearing components. What's more, the engineering and high-tolerance required to manufacture these bearings on a meaningful scale create a formidable economic mote.
Management also believes they have a bargain on their hands. While they are working to incorporate a somewhat obdurate sibling into the fold, they will also be busy purchasing NN stock. In September, the board of directors authorized a $25 million stock repurchase program, which will expire next September, meaning NN is committed to purchasing 15% of its outstanding shares based on current prices. Of course, the preferred scenario is that the company purchases much less than 15%, because that means the share price will have significantly appreciated.
