Sutron is a company that makes equipment to measure various hydrological and meteorological data such as tsunami warning systems or airport weather monitoring equipment. I had this company in my "to do" pile and saw that it was mentioned in one of those "PROFIT FROM DISASTER: GREAT WAYS TO PLAY THE JAPANESE EARTHQUAKE!" articles that the media loves to crank out. Well quite frankly, I don't think so and the market doesn't seem to think so either. That is not to say that the company does not possess some positives.
The company only has a market cap of $34m and should earn a shade past $2m for fiscal 2010 (only 9 months of 2010 reported so far and $1.7m earned, and the company hasn't lost money in any quarter for at least 5 years). There's about $10m in cash on the balance sheet, of which at least $5m seems excess, but the cash balance seems inflated due to fluctuations in working capital. At ~15x earnings net of cash the company is not cheap. The company requires very little capex, has achieved a cash adjusted ROE north of 20% for the past several years excluding the hiccup in 2008.
I don't think that the barriers to entry into the scientific instruments business is difficult on the face of it. From the sole perspective of product offering, how hard can it be to make a comparable measuring device? Despite this, a lot of companies that make scientific instruments and measuring devices trade at high teens or low 20s multiples and at a level that ignores hard assets. The reason for this is that people become accustomed to using certain tools and it just makes sense not to change because of relearning a new system as well as hoping that a product with a shorter track record works as well as the old one. The entire scientific instrument sector has come back very strong in 2009-2010 from 2008 lows. While they serve different end markets, a brief glance at OSI Systems, Measurement Specialties, and OYO Geospace should give you an idea of the valuations of a lot of these companies.
Why might the market not be willing to pay up for Sutron's earnings to the same degree they do for the 3 aforementioned companies? Sutron seems to largely earn its bread from government projects. Even the international projects, such as those in Iraq and Afghanistan have the whiff of US involvement due to the political situation. There are other projects they have worked on and provided equipment for, such as one for the Three Gorges Dam in China. The company is headquartered in a suburb of Washington, DC. While I might be full of shit, many companies located in such close proximity to government and the largess it entails tend to depend on the government for their survival. Northtrop Grumman is moving its headquarters to the Washington DC area from LA for this very reason. I don't know if this is really that great of a risk.
I'm not sure I exactly buy the above reasoning that it is the heavy concentration of government revenues. Certainly it could play a role. Most of the customers for Sutron's products are going to logically be governments. They play a key role in monitoring weather, tsunamis/water based weather events, and data on river flows. There's definitely pressure on government budgets around the world, but Sutron's products seem to be part of the guts of the "system" and necessary for any long-term project involving water flows.
What does any of this have to do with Japan? Well, one thing the company makes it the sensors for tsunami alerts. While Japan had sensors that were aware of the tsunami, there might be the halo effect of other countries looking to bulk up their systems or set one up. If you were to buy stocks based on Japan right now, it should be on price relative to current operations as opposed to price relative to potential future operations. Furthermore, the company hasn't done much business in Japan, where they do have some tsunami early warning systems. It's definitely not a foregone conclusion that Sutron will get any business as a result.
One nice thing about the company is that they have been spending 7-9% of its revenue on R&D for several years, which indicates they are focused on maintaining their position in the industry. While I was peaking at other scientific instrument companies, I was trying to figure out if there were any direct competitors. The risk section of the 10-K alludes to them, but never mentions one by name. I wondered if the company might make a nice tuck in acquisition for a larger instrument manufacturer (not a reason to buy a stock), but the CEO owns 18% of the company and has been involved since just after the company started. I have no insight into his intentions, but I suspect he is more likely to prefer to stay at the helm than cash out. At the same time, he is 71 and he could retire and cash out which would put the company in play. I simply have no idea.
The company does have a subsidiary in India which is interesting. A lot of people focus on China exposure as some kind of gateway to corporate success. Regardless of where a company makes it, money is money, so I'm quite impartial to geographies. That being said, having a footprint in an emerging market that can grow substantially is an attractive characteristic. It's not a reason to buy a company, but it's certainly not a reaosn not to. It isn't difficult to imagine Sutron generating a lot of profits in India, but I have no ability to handicap that possibility and I wouldn't want to pay anything for such an option when I purchase a stock.
While I wouldn't be surprised if someone concluded there was some upside in the stock based on relative valuation, I'd rather not bet solely on someone paying up for the earnings from a 15 to a 20x earnings multiple. It's much safer to play that game with a stock going from 5 to 10x earnings to 10x to 12 or 13x otherwise your margin of safety is eroded. The entire scientific instruments sector is definitely interesting because the companies usually have minimal capex and high margins, but I'd wait until irrational selling or something ugly happens before I would step into this area. There's definitely some interesting small caps in this space though, but more as businesses than stocks at this point.
Disclosure: None
Talk to Andrew about Sutron
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