Asmus Puhl Finance Blog

Yesterday Colfax’s stock (NYSE: CFX) traded at $ 8.35

Shares outstanding are 43.21 mil which translates into a market capitalization of $ 362 mil.

Analysts expect Colfax to grow 7% over the next years.

Danaher’s growth rate over the past 10 years was 17.5%

I think that after a difficult year 2009 we can be slighty more optimistic than analysts and expect Colfax to grow at an 10% annual rate.

I would expect Colfax to acquire at least one company per year.

They have a strong balance sheet and with the economy in recession smaller companies will certainly be available at good prices. This should make acquisitions immediately accretive to earnings.

And don’t forget that Colfax’s earnings are still impacted by asbestos liabilities. It costs them about 40% of their earnings power this year.

But those costs should rapidly decline over the next years.

Management expects EPS this year in the range of $ 1.00 – 1.07 excluding the asbestos liabilities and costs.

So with a 10% annual growth rate the company should at least earn $ 1.61 / share within 5 years.

At a conservative p/e ratio of 10 this means the share price should roughly double to $16.10 (I don’t expect a significant dilution of shareholders given the strong insider holdings).

I think at today’s prices we are able to invest in a very promising company with a significant margin of safety!

……..this blog will continue to keep an eye on Colfax!

Colfax Corporation published a new investor presentation on its website:

http://ir.colfaxcorp.com/events.cfm

It gives a comprehensive and detailed view of the company.

It’s worth reading!

So let’s have a look at Colfax’s numbers:

FY 2008:

Colfax sales in FY 2008 grew 20% to 605 $mil.

Excluding the impact of foreign exchange rate fluctuations and acquisitions sales grew 14% in 2008, 14% in 2007 and 12% in 2006.

So we already have a string of sales increases which are similar to what Danaher achieved over the last 10 years: 17.5% average annual top line growth.

In 2008 the company had to absorb one time IPO costs and build up inventory. So it swung to a net loss and free cash flow got tied up in these inventory increases.

But don’t forget that IPO costs are really one time costs and that the proceeds of the IPO were used to pay down debt. So at the end of FY 2008 the company had a healthy debt/equity ratio of 0.58.

Order levels increased 15% to 669 $ mil at the end of FY 2008 and EBIT-margin adjusted for one time events was 15%.

Certainly at the beginning of 2009 Colfax felt the impact of the recession and for the whole year 2009 economic conditions will remain difficult.

Q1 2009 still was order backlog driven: Colfax posted net sales of $ 136 mil, an increase of 4,3%. Organic sales growth which excludes the impact of foreign exchange rate fluctuations was 17,6%.

Net income came in at $ 6.9 mil or $ 0.16 EPS basic and diluted. But the company was free cash flow positive again.

Organic order decline was 25.5% and order backlog still was $ 305.6 mil.

The company lowered its guidance to $ 1.00 to $ 1.07 adjusted EPS for FY 2009 and initiated several cost reduction measures. Organic sales will be down between 2% and 4% this year.

……..continues………

Let’s start right away with a very interesting and still rather unknown small cap

(only 7 analysts are following this company at the moment / source yahoo finance):

Colfax Corporation  ( NYSE: CFX )

Website: www.colfaxcorp.com

Colfax was founded in 1995 in Richmond, VA, USA, and went public in May 2008.

It makes pumps, fluid handling systems, speciality valves for industrial, marine, oil and gas, and power generation markets, and for the Navy.

It has some of the best and most recognized brands in the industry worldwide and extensive engineering expertise. It works in some very attractive industrial markets. Just think of the future energy infrastructure needs especially in Asia.

Their net sales reached 605 mil $ in FY 2008.

Colfax is globally diversified:

51% of sales were in Europe, 25% in the US and Canada, and 15% in Asia and Australia, up from only 2.3% in FY 2007.

The current market capitalization is 311 $ mil.

Business Model:

Colfax works with a business model they call the Colfax Business System.

To understand this we have to look at the business model of another very successful company: Danaher Corporation (NYSE: DHR) website:www.danaher.com

Danaher was founded by Steven and Mitchell Rales in 1983. They started to acquire industrial businesses to form a conglomerate. By applying the principles of „kaizen“ the Japanese word for continuous improvement, they made the acquired companies much more efficient and profitable than they were before.

Exceed customer expectations, defining delivery performance, improvements in costs, innovation in products and services are the goals.

And they called it the Danaher Business System. They implemented this business model so well that they delivered an impressive annual return of 22% to shareholders since 1991.

Colfax follows this model and calls it the Colfax Business System. They are a serial acquirer of small complementary industrial businesses like Danaher.

Mitch Rales founded Colfax together with the actual CEO John Young in 1995.

He and his brother Steven today hold each 21% of Colfax stock.

Mitchell Rales serves as chairman of the board. Also board members are Patrick Allender, the longtime CFO of Danaher and Thomas Gayner, the chief investment officer of Markel Corp., one of the best investors in the US. Some talked of him even as a successor of Berkshire Chairman Warren Buffet.

So Colfax could evolve as a strong core business together with the implementation of its acquisition strategy, backed by the excellent expertise to value these acquisitions among their officers and board members

….continues with the financials….

This blog favors stock picking of small and midcap companies.

… so good….

but what are the criteria to evaluate a company?

For me four criterias are the most important:

Strong balance sheet, earnings power and cash flow

I would not invest in companies which have a debt loaden balance sheet or which even in good times do not generate strong cash flow. They would be too vulnerable in difficult times (as we can experience right now…..)

Certainly, a dividend can add nicely to the investment return over time but if a small fast growing company has better use internally for the money it should reinvest it in the business.

A sustainable competitive advantage:

The best companies to invest in are surrounded by a wide moat filled with crocodiles as Berkshire Chairman Warren Buffet puts it.

Those competitive advantages can be strong brands, patents, de facto standards, or low cost production processes which can not easily be duplicated by competitors.

Long standing good relationships with important clients belong here too.

These factors normally lead to above average earnings and cash flow power.

Honest Management:

This is perhaps the most difficult criteria to assess but the most important too!

I do like intelligent capital allocation (and not risky and exaggerated M&A activity), reasonable executive compensation (and not exaggerated option grant).

The perfect match is certainly when founders and/or executives are still large shareholders so the interests of them are more aligned with outside shareholders.

The share price is cheap

which can happen when p.e.

– the company already is a great business but so small that it is unknown and does not have the attention of many analysts,

– the company faces a temporary setback caused by bad news from its business or caused by a general negative stock market sentiment.

This blog not only favors stock picking over investing in funds but also favors investments in small and mid cap companies over large caps.

Why that?

There are generally speaking better return possibilities.

If you invest in a large cap company like p.e. Siemens (mkt.cap of € 46 bil) or in McDonalds (mkt.cap of § 59 bil) it is hard to imagine that the value of the company grows significantly more than the general GDP growth, if not there is a special situation like p.e. a turnaround or a temporary crisis.

Large caps are more interesting for dividend seeking investors because in most cases they offer a stable dividend which rises every year.

But small or midcap companies (we are talking about a market capitalization of 200 mil up to 1,5 or 2bil $ or €) can double, triple or even grow bigger than that. Some investors even made 10 or 20 times their money over time!

Certainly the risk that something goes wrong is significantly higher with small and mid caps, so it is recommendend that you diversify more. I think 10 is a minimum number of stocks you should invest in.

Most institutional investors often do not look at small caps.

If an investment fund is not specialized in small and mid caps its sheer size often makes it impossible to invest in stocks under a certain market capitalization.

Most small companies are only followed by few analysts too.

So there is a compelling chance for individual investors to discover promising companies that the stock market does not accurately price. Their intrinsic value can be much higher than their actual market price.

……..buy good underfollowed small companies and wait patiently until the market discovers their real value!