Industrial Sector Presentation Terres Maloney Kwan Wang Roman Zeltser Nikita Zorin Student Managed...

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Industrial Sector Presentation

Terres MaloneyKwan Wang

Roman ZeltserNikita Zorin

Student Managed Investment Portfolio Class

Prof. P.V. Viswanath

Spring 2002

Objective

Identify and price potentially undervalued equity investments in the U.S. Industrial Sector, assuming that the economy is in the beginning stages of recovery.

Industrial Production Snapshot

• Jumped 0.7% in March

• Biggest increase since May-2000

• High-tech production up 1.4%

• Operational capacity up 0.6%

• Production still below 9/11 level

Analytical Approach

• Top-Down industry analysis

• Quantitative & qualitative examination

• Single out undervalued equities

Analytical Approach

Top-Down industry analysis

• Focus On Leverage:

Low leverage increases flexibility

Greater potential to increase shareholder wealth

Reduced financial risk

Better access to debt financing sources

Analytical Approach

• Develop leverage regression model by using the following variables:

Total Debt / Total Assets

EBITDA / Firm’s Market Value

CAPEX / Total Assets

Intangible Assets / Total Assets

Natural Log of Firm’s Market Value

Analytical Approach

• Under-Leveraged Sectors

Healthcare

Industrial

Consumer Discretionary

Transportation

Industrial Sector Analysis

Industrial Universe 435

Elimination Criteria # StocksStocks under $5 / shr &Total Assets under $200MM

Ratio Analysis – Top Rank 16

Implementation Of Ratios

Evaluate each of top 16 companies by looking at weighted and ranked Key Ratio Factors

Determine which company is best positioned to increase shareholder wealth.

Key Ratio Factors:

•Financial Strength / Credit Position

•Profitability

•Growth

Ratio Analysis

• Relates Income Statement, Balance Sheet, and Cash Flow Statement items to one another

• Provides clues in evaluating a firm’s current position

• Aids in spotting trends toward future performance

Credit Ratios

Measure the firm’s ability to repay its obligations, its existing leverage situation, and its resultant financial risk.

• CURRENT RATIO

• LONG-TERM DEBT / EQUITY

• EBIT / INTEREST

Ratio Categories Employed

Ratio Analysis

Profitability Ratios

Measure return on assets and equity investments.

• EBIT / TOTAL ASSETS

• NET PROFIT / EQUITY

Ratio Analysis

Growth Ratios

Measure the firm’s performance in expanding its business, a key criterion in valuation.

• EPS GROWTH

• REVENUE GROWTH

Ratio Analysis

Company Name Industry Curr. Ratio LT Debt / Eqty EBIT / Int. EBIT / T. A. Net Prof. / Eqty EPS Growth Revenue

APOLLO GROUP INCORPORATED Schools 1.60 2 1 4 1 1 3 3ESCO TECHNOLOGIES INCORPORATED DefElect 1.68 1 2 4 1 2 1 2MOLEX INCORPORATED Elec Eqp 1.78 2 1 1 2 3 1 4PRE-PAID LEGAL SERVICES INC Bus Svcs 1.90 1 2 3 3 1 2 4EDO CORPORATION DefElect 1.98 2 1 4 1 4 1 4ROBERT HALF INTERNATIONAL Employmt 2.18 3 2 4 2 1 3 2AMERICAN POWER CONVERSION CORP Elec Eqp 2.45 4 2 4 3 1 3 1GRACO INCORPORATED IndEquip 2.50 1 4 2 2 2 2 4SIMPSON MANUFACTURING COMPANY BldgMatl 2.78 4 3 1 2 2 4 1VICOR CORPORATION Elec Eqp 2.88 4 1 4 4 4 3TRAVELOCITY.COM INCORPORATED Con Svcs 3.00 3 4 2 3 3 1 3LAWSON PRODUCTS INCORPORATED InduDist 3.03 3 3 3 4 3 2 3PAYCHEX INCORPORATED DataProc 3.05 1 4 4 1 4 4 2KAYDON CORPORATION Ind Prod 3.18 3 3 2 4 3 4 1ELECTRO SCIENTIFIC INDUSTRIES Elec Eqp 3.20 4 3 3 3 4 2 2CURTISS-WRIGHT CORPORATION IndFlowC 3.28 2 4 4 4 2 4 3

Weight 15.0% 30.0% 5.0% 15.0% 20.0% 12.5% 2.5%

Profitability Financial Strength Growth

Ratio Analysis

Electro Scientific Industries Inc.

Manufactures equipment for production of key electronic components and circuitry for:

• Wireless Communications

• Computers & Personal Digital Assistants (PDA)

• Automotive Electronics

• Home Entertainment Devices

Product Line

Semiconductor Yield Improvement Systems

• Increase manufacturing yield for memory manufacturers.

Electronic Component Production Systems

• Test and termination equipment.

• Used in multi-layer ceramic capacitors (MLCC’s).

Advanced Electronic Packaging Systems

• Advanced Packaging Equipment for High Density Interconnect (HDI) circuit boards and advanced integrated circuit packages.

Vision and Inspection Systems

• Critical enabler in the processing and packaging of semiconductors and other electronic components.

• Circuit Fine Tuning Systems

• Help electronic device manufacturers tune devices to precise electrical tolerances.

Product Line

Competition Market Share

• GSI Lumonics• Tokyo Weld • Kanebo and

Humo• Hitachi • Excellon• Vision• Cognex• NEC

• DRAM Repair

• Laser TrimmingSystem

• Capacitor Test &TerminationEquipment

50%50%

Customers

• IBM• muRata• Hyundai• KEMET• Samsung• Siemens• Motorola• Hitachi• Altera

North America

Europe

FY 2001 GEOGRAPHIC REVENUE DISTRIBUTION

Valuation Model

Two-stage Dividend Discount and Free Cash Flow to Equity (FCFE) discount model *

Source: www.damodaran.com

Key Elements of The Valuation Model

• Current Beta 1.98• Projected Beta 1.10

• Risk-Free Rate 5.05%• Risk Premium 4.00%

• Last Fiscal Year EPS $3.25• Historical EPS $0.68

• Projected Growth Rate in Earnings 23.00%• Stable Growth Rate after High Growth 3.50%

Estimates Of Growth Weight• Fundamental Growth 70%

Confidence in our analysis Fundamentals are structured to screen

out under-valued stocks

• Analyst Projection of Growth 20% Biased towards positive estimates, but Also should be taken into consideration

• Historical Growth 10% Already incorporated into current prices

Sensitivity Analysis of Estimated Growth

Fundamental Analyst Historical Stock Price

70 % 20 % 10 % $94.0450 % 30 % 20 % $101.6530 % 30 % 40 % $106.1510 % 40 % 50 % $113.69

Stable Growth Period Beta Sensitivity Analysis

Future Beta Stock Price

1.0 $105.431.1 $99.041.5 $80.242.0 $65.60

Institutional OwnershipInstitutional Holders 90.20

Total Shares Held24,623,562

Number of Institutional Investors 138

3 Months Net Change in Shares Purchased1,928,758

Top Institutional Holders:• Capital Guardian Trust• EQSF Advisers• J. & W. Seligman & Co.

Source: Multex.com

Insider Trading

Source: Multex.com

DATE WHO SHARES TRANSACTION

March-02 DIRECTOR HORSELY -50,000 Sale @ 38.98March-02 DIRECTOR MESSINA -6,409 Sale @ 41.75March-02 DIRECTOR MESSINA -138 Sale @ 41.75March-02 DIRECTOR HORSELY -2,500 Sale @ 40.46

January-02 DEJESUS -5,000 Sale @ 36.13January-02 DIRECTOR SEBO -24,580 Sale @ 34.60January-02 DIRECTOR CLARK 140,830 Purchase @ 34.60

December-01 DIRECTOR MESSINA -30 Sale @ 35.64December-01 VP TUREK -1,670 Sale @ 35.53December-02 CEO GOLISANO -248,895 Sale @ 34.50December-02 DIRECTOR CLARK -4,000 Sale @ 35.93

October-02 DIRECTOR SEBO -1,500 Sale @ 33.40October-02 DIRECTOR MESSINA -58,000 Sale @ 33.47

-30.00%

-20.00%

-10.00%

10.00%

20.00%

30.00%

40.00%

50.00%

60.00%

70.00%

1993 1994 1995 1996 1997 1998 1999 2000 2001-200.00%

-100.00%

100.00%

200.00%

300.00%

400.00%

500.00%

1993 1994 1995 1996 1997 1998 1999 2000 2001

-20.00%

-10.00%

10.00%

20.00%

30.00%

40.00%

50.00%

60.00%

70.00%

1993 1994 1995 1996 1997 1998 1999 2000 2001-15

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001

Revenue Growth Income Reported Growth

R&D Expense Growth Pre-Tax Margin Growth

Ratio Comparison Electro Scientific Industry

• Sales – 5yr Growth 21.24 15.60• Current Ratio 26.19 3.56• NI / Employee 9,689 6,453• Net Profit Margin 6.15 -2.49• ROA 3.47 -1.79• ROI 3.76 -2.22• Inventory Turnover 1.97 4.71

Future Investment Outlook• Healthy and Liquid Balance Sheet

• Positive Leading Indicators

Net orders of $33mm were up 19% sequentially

Backlog is down 14% sequentially to 19mm

The Electronics Components business is up 26%

Vision business is up 54% sequentially

Business has reached a bottom of the cycle, in our view

STRENGTHS

• Worldwide Presence Over 90% of sales generated through foreign offices

• Direct sales in Asia eliminate brokerage costs

• ESI has 95% Market Share in Semiconductor Yield Improvement

• Experiencing growth in its capacitor production and vision business Early sign of recovery of company’s overall business Production equipment business up 26% during this quarter

• Dominates memory repair market with 90% Market Share Posting sequential growth in this market Decreasing cancellation and backlog

WEAKNESSES

• Lingering inventory over capacity in passives continues to limit near-term upside

• Some of the production components are obtained from exclusive suppliers

• ESI’s customers’ markets are cyclical and historically experience periodic downturns

OPPORTUNITIES

• Expanding Markets• Embedded memory for logic devices and voltage regulators• Continued consumer demand for smaller and lighter phones

and PDA’s

• Dominant Market Share• Pursuing an aggressive strategy to capture capacity expansion

in China

THREATS

• Slackening in demand due to the global slowdown in electronics manufacturing

• Unfavorable foreign exchange rates

5-Year Price History

Our Recommendation• ESIO is undervalued

• We recommend to take a Long Position in ESIO

• Current Stock Price is $30.47

• Model Price is $94.04

• Set Limit-Stop order at $27.00

Paychex Corporation

Paychex Corp.

National provider of payroll processing, human resources and benefits outsourcing solutions for small-to medium-sized businesses

Major Products & Services

• Payroll Processing• Tax Services• Employee Pay Option• Workers’ Compensation• State Unemployment Insurance Service• Handbook Services• Retirement Services• Paychex Administrative Services• Paychex Business Solutions

Valuation Model

Paychex Corp.

• Current Beta 0.87• Projected Beta 1.10

Paychex Corp.

70 % 20 % 10 % $25.7550 % 30 % 20 % $23.0430 % 30 % 40 % $21.2210 % 40 % 50 % $19.30

Paychex Corp.

1.0 $17.451.1 $16.271.5 $12.952.0 $10.50

Paychex Corp.

SWOT Analysis

Strengths• More than 100 locations nationwide• Small employer markets = Greater Growth Potential• Excellent management of costs• Strong client retention, new payroll & HR services• Fully functional Web-Based Payroll solution

Opportunities• Expansion into international markets

Paychex Corp.

Pre-Tax Margin Growth

10.00%

15.00%

20.00%

25.00%

1993 1994 1995 1996 1997 1998 1999 2000 20010.00%

10.00%

15.00%

20.00%

25.00%

30.00%

35.00%

40.00%

45.00%

50.00%

1993 1994 1995 1996 1997 1998 1999 2000 2001

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001

Paychex Corp.

Ratio Comparison Paychex Corp Industry

• Sales – 5yr Growth 21.15 17.17• Current Ratio 1.32 2.42• NI / Employee 37,483 28,579• Net Profit Margin 29.13 10.00• ROA 9.49 6.97• ROI 33.79 9.27• Inventory Turnover N/A 25.99

Paychex Corp.

Future Investment Outlook• Balance Sheet strong with 760m in cash and no debt

• Positive Leading Indicators

Eventual rebounds in employment levels and interest rates

The small-employer payroll market has the best long-term growth potential.

Positive news about economy in the near future may put an upward pressure on the price of the stock.

Paychex Corp.

Institutional OwnershipInstitutional Holders 56.70 %

Total Shares Held 212,696,272

3 Months Net Change in Shares Purchased 2,745,093

Top Institutional Holders:• Janus Capital Mgt.• TCW Group• Barclays Global Investors

Source: Multex.com

Paychex Corp.

Insider Trading

Source: Multex.com

DATE WHO SHARES TRANSACTION

March-01 OFFICER BELTER 100 Purchase @ 26.81April-01 OFFICER HARPER 1000 Purchase @ 26April-01 SECRETARY REINHARDT -1500 Sale @ 36.58April-01 VP BELTER -5000 Sale @ 33.65May-01 VP BELTER -10000 Sale @ 36.23July-01 SECRETARY REINHARDT -650 Sale @ 37

August-01 OFFICER GLASGLOW -6228 Sale @ 34.10January-02 OFFICER LONGE -404 Sale @ 33.03January-02 SECRETARY REINHARDT -1600 Sale @ 30.92

March-02 CFO DOOLEY -3870 Sale @ 36.06March-02 SECRETARY REINHARDT -9760 Sale @ 36.60March-02 OFFICER KAPRAL -480 Sale @ 36.74March-02 OFFICER LONGE -5000 Sale @ 36.74March-02 VP KURDOCK -5484 Sale @ 36.74

Paychex Corp.

Our Recommendation• PAYX is overvalued

• We recommend not to invest into PAYX

• Current Stock Price is $38.10

• Model Price is $25.75

Paychex Corp.

Curtiss Wright Corp.

Curtiss Wright Corporation operates through its consolidated subsidiaries as a designer and manufacturer of motion control, metal treatment and flow control products for the aerospace, defense, automotive, construction, oil, petrochemical, metal working and other industries. The Company operates three segments:

• Motion Control: designs, engineers and manufactures actuation components and systems

• Flow Control: provide valves for nuclear submarines and aircraft carriers.

• Metal Treatment: provides protection against corrosion and longevity in metal products.

Product Line

• Perimeter intrusion detection systems

• Flight control computers

• Aiming systems for armored vehicles

• Suspension systems

• Flow control products

• Reed valves

• Inductive position sensors

• Digital panel indicators

• Hydraulic

Business Segment Diversification

9.66.7

Commercial Aerospace

Military/Defense

General Industrial

Pow er Generation

Process Industry (Oil &Gas)

Automotive/Transportation

STRENGTHS

• Diverse business segments• Niche leader in industrial technology• Improved position in the military defense industry

WEAKNESSES

• Commercial airspace markets• Expected below average economic activity

OPPORTUNITIES

• Growth through acquisitions• Pursue defense electronics market – key strategic initiative and will

provide a compelling long-term growth opportunity• Expected growth in defensive spending• Continually expand its geographic network of metal treatment

facilities• Expand further into markets company currently serves and position

the firm to exploit niche opportunities as a supplier of high value-added products and services.

Valuation Model

• Current Beta -0.06• Projected Beta 1.10

70 % 20 % 10 % $278.7950 % 30 % 20 % $319.8430 % 30 % 40 % $365.8510 % 40 % 50 % $417.46

1.0 $298.401.1 $278.791.5 $222.612.0 $180.32

Institutional OwnershipInstitutional Holders 39.40

Total Shares Held4,090,225

3 Months Net Change in Shares Purchased(4,331,023)

Top Institutional Holders:• Royce & Associates• Gabelli Asset Management• Gabelli Funds LLC.

Source: Multex.com

Ratio Comparison Curtiss Wright Industry

• Sales – 5yr Growth 15.01 10.94• Current Ratio 2.97 1.16• NI/employee 23,954 9,449• Net Profit Margin 18.32 3.58• ROA 14.47 4.16• ROI 16.55 6.81• Inventory Turnover 4.2 6.34

Ratio Comparison Con’t CW Industry

• P/E Ratio 12.11 21.6729.33

• Beta -0.08 0.47 1.00• Price to Book 2.14 3.52 5.13• Sales growth *15.01 10.92 12.60• EPS growth * 31.25 -1.77 8.13• Current Ratio 2.97 1.16 1.66• TD/Equity 0.06 0.97

1.06• Gross Margin * 35.25 15.00

47.45• Op. Margin * 15.05 7.96 17.97

R & D Expenditures Growth

1993 1994 1995 1996 1997 1998 1999 2000 2001-150%

1993 1994 1995 1996 1997 1998 1999 2000 2001

1996 1997 1998 1999 2000 2001

-50.00%

50.00%

100.00%

150.00%

200.00%

250.00%

300.00%

M-01 J -01 S-01 D-01

Income Reported Growth (Quarterly)

Industrial Sector Presentation Terres Maloney Kwan Wang Roman Zeltser Nikita Zorin Student Managed...

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