In the face of a tough second-quarter economy, these two portfolio holdings managed just fine. Here's why looking out a year or two, these businesses should really flourish…
It is purely coincidental that two of my favorite companies delivered decent second-quarter results on the evening of Thursday, Aug. 2. Both companies are dealing with the near-term economic challenges in decent fashion, posting quarterly profits and laying out the case for robust growth in the years ahead. Yet these stocks remain really undervalued when you look at where their businesses might be in a few years. For investors who haven't checked in with these stocks, now is the time.
Let's take a closer look at each one…
Maxwell Technologies: Remaining profitable, even in a slow economy
I added this stock to my portfolio less than a month ago. Maxwell makes "ultracapacitors," which can pack in much more energy than traditional capacitors, opening up the door to many new applications for a seemingly old technology, as I noted back then.
At the time, I noted that shares had plunged from $21 in the spring to just $6, and that "at this point, the stock price clearly reflects expectations that business will remain muted for the rest of 2012. Well, second-quarter sales of roughly $40 million were nearly in line with forecasts, and based on management's just-reiterated guidance, sales are likely to average about $50 million in each of the next two quarters.
As I wrote a few weeks ago, "If Maxwell simply reiterates forward guidance, then shares could post a powerful snapback rally." As a result, shares opened up above $7 for the first time in a month (before seeing mid-day profit-taking). Frankly, I'm surprised to see shares post only a modest gain in today's trading (Aug. 3). After all, Maxwell earned nine cents a share in the quarter, well ahead of the consensus forecast of a penny. The fact that the company remains profitable (for the ninth straight quarter), even as economic headwinds are in place, removes a great deal of risk from owning this stock. (The only red flag I spotted that might account for the weakness was a comment by management that some customers have become slow to pay their bills).
Of course, this stock is really built for the next few years, and not for 2012. As I noted a month ago, demand for Maxwell's ultracapacitors had been steadily rising until this spring. I also said the current year likely represents a pause before growth resume. Though analysts see sales rising at least 20% in 2013 and again in 2014, I wouldn't be surprised to see the top line expand at a more modest 10%-15% pace -- assuming a still-weak global economy. Then again, ultracapacitors are getting designed into so many new products that this company could easily outpace the consensus growth forecasts, as had been the case from 2008 through 2011.
Right now, Maxwell's ultracapacitors are being primarily used in Chinese transit systems, Chinese wind turbines and French cars (as part of a stop-start system). The company noted that a U.S. auto maker is testing the technology, and a contract win with a large auto maker would give the stock a significant boost. On a recent call with investors, management ran through a series of other systems that ultracapacitors are being designed into. In light of this company's robust long-term outlook, the recent stock price plunge from $21 to a recent $6.75 makes little sense. Yet this affords new investors to this stock a great entry point.
Zoltec: Wind is back
Curiously, Maxwell spoke of a rebound in demand for its electronics that go into wind turbines. "Q1 was bigger than Q3 and Q4 last year and Q2 was bigger than Q1 of this year. So we're starting to see that market come back," said the Maxwell's President David Schramm.
And that's a sentiment echoed by carbon fiber maker Zoltek, which has just posted a solid 10% gain in Friday, Aug. 3, trading on the heels of rising demand from wind-turbine manufacturers. Zoltek is positioned perfectly for this market for a pair of reasons. First, it is the leading supplier to Vestas, the world's largest maker of wind turbines. This company has recently noted a growing backlog, which bodes well for Zoltek's order book. Second, the wind industry is slowly migrating offshore, which allows for bigger wind blades. And this spells a higher need for carbon fiber per turbine.
Zoltek had $48 million in second-quarter sales -- right in line with consensus forecasts -- while the profit of 16 cents a share was three cents better than expected. Still, this business needs even higher sales to really impress investors. That's because a quarterly sales base in the $47 to $48 million range, which has been the case for the past three quarters, yields only modest operating leverage. Management has made it clear that additional revenue carry much higher incremental margins, so a $5 million hike in quarterly sales would lead to very strong profit growth.
I'm waiting around for that day to come. It may be later this year, or perhaps some time in 2013, but when such a quarter arrives, this stock has traditionally zoomed into the mid-teens. Shares are up only modestly since I bought them at $9.15 on May 11, but I see much more upside ahead.
Risks to Consider: These two companies are in the small-cap class of stocks, and investors tend to feel them when the going gets especially tough. So these stocks could see 10% pullbacks in a market rout.
Action to Take --> For sharply undervalued stocks like these, you need to have considerable patience. Each management team is currently taking all the right steps to build great businesses down the road. The tough economy may mask those efforts, but behind the scenes, I like these stocks more and more with each passing quarter.