Semcon: Time to jump in when others head for the exits?

First a bit of background on Semcon, a Swedish small cap stock with a market cap of 1.1bn SEK ($170m). Despite being fairly small it has operations all over the globe in 45 sites including Sweden, Germany, UK, Brazil, China, Hungry, india, Spain and Russia.

The following is a summary of their own description of operations
"The company is active in the areas of engineering services and product information, developing products, plants and information along the entire development chain."

Well, what does that really mean? The graphs below highlight pretty well their business, it can be mostly summarised as industrial services to car manufacturers in Germany and Sweden. These services provided include Automotive R&D, Design & development and Informatic.

The stock price peaked in July at around 80 SEK and has since been in a down trend where it is now at 61 SEK, down 23%.

In July the company came out with their half years report and gave a positive view to the market here, increased profits in the third quarter here but then in Decemeber gave a warning that profit expectations were too high here, as there would be one off costs due to project delays and restructuring executed earlier in the year.

It looks like the stock price got ahead of itself at the start of the year, shooting up 50% and is probably over reacting now on the downside. Here's possibly why

The P/E ratio for 2013 is now a reasonable 12.4, below market average, and the free cash flow yield (FCF= operating earning - CapEx) is an attractive 10%. The enterprise value ratios are also all under single digits (remember these figures still include the one off charges from restructuring and project delays).

That is not to say the company is struggling to return cash to investors, both ROE and ROIC (calculated from EBIT/(total assets minus non-interest bearing liabilities minus goodwill minus intangible assets) look very healthy. Last years dividend was 2.00SEK which will be increased to 2.5SEK (4.1% yield) this year.

Even better the company has paid off all its longterm debts and has a current ratio of 1.5. As an addition to understand the current valuation of Semcon the following is a valuation of the stock using an Earnings Power Valuation here and here. No future growth is predicted, only past performance is used as a guide.

Revenues and EBIT is shown for the past 6 years which captures the financial crisis of 2009. It's clear to see that earnings are can be volatile, however uncertainty can provide opportunity.

One time charges are added back to EBIT and an average margin is calculated (here I actually ignored 2008 in order to get a more conservative estimate). This margin is then applied to current revenues to give a normalised EBIT.

Tax and last years depreciation are deducted to give the 'earnings power' of Semcon. The enterprise value of the company is then obtained by dividing by the cost of capital of the firm, here I've used 7% (one data source has 6.85%). Adding in cash and removing debt gives an equity value of 56 SEK per share, just 8% below the current price.

Book value of equity has grown at a compounded rate of 13% per year from 385.4 MESK (2009) to 633.4 (2013), mostly as a result of paying off debts.

At this point it would be prudent to explore the risks and 'non-bull' case with this stock by following Charlie Munger's advice to 'Invert. Always invert'.  Some of Semcon's biggest customer are Volvo and Scania, companies that are currently undergoing difficulties of their own. This puts uncertainty on some of their future revenues.

Amazingly the company was trading at P/E 6 at the end of 2011 and 2012, this seems extremely low in the current environment. There was a multiple expansion in 2013 to around 12 with inflated 2012 earnings, which have since then fallen but the P/E ratio has held at the historically high 12.

The earnings multiple expansion was probably also a reaction to the first dividend payment in 2012 of 2.0 SEK. The proposal by the board is to increase this to 2.5 SEK, which should act as a floor to the share price.

P/B is currently 1.74, higher than in 2012 (1.5) and in 2011 (0.98); the book value of equity per share is currently 32 SEK, 50% below the current price. Although I doubt it will fall this far, that would result in a dividend yield of 7.8%!

Putting this altogether suggests a good price for Semcon would be between 1.5x BV, 48 SEK; 2.5 SEK dividend at 5% yield, 50 SEK; and from EPV 56 SEK. It's now a waiting game but I suspect the moment has passed.