Monday, April 16, 2012

Foraco ( Toronto - FAR ) -- Scouting for Mineral Deposits

Foraco ( FAR $4.75) is a leading provider of exploratory drilling services for mining companies.  The company is hired by resource producers to delineate potential targets, estimate the degree of difficulty involved, and resolve any water issues.  Foraco operates about 200 rigs around the world.  It trains and provides its own crews, which generally are in short supply due to surging exploration activity.  Industry spending has expanded more than 200% over the past decade, fueled by booming demand for metals in Third World markets.  Foraco added nearly another 100 rigs in March when it purchased 51% of a major drilling services provider in Brazil.  Approximately 85% of revenue is generated by contracts with major mining companies.  The balance is derived from smaller operators that typically sign short term deals, enabling Foraco to keep its crews busy between major engagements.  More long term contracts are being signed, which is bolstering revenues and margins by reducing downtime.  Demand for exploratory drilling is continuing to grow despite the threats posed by economic uncertainty and volatile commodity prices.  That trend is apt to continue as consumption of metals outstrips production over the next several years.

Foraco specializes on the most technically challenging targets.  That's enabled the company to earn above average margins throughout its history.  It now is helping to expand market share, as well.  Like in the energy business, new discoveries increasingly are being found in remote locations that involve specialized talent.  In 2011 South America accounted for 42% of revenues; Africa, 28%.  Russia and Canada represent most of the balance.  Foraco has established a presence in those geographies through a combination of internal growth and effective acquisitions.  Most of those transactions, similar to latest deal in Brazil, involved purchasing a partial controlling stake to begin with.  A few years later, an option to buy the rest was exercised. 

Growth has been explosive.  Sales and earnings were unchanged in 2009 following the worldwide banking crisis.  Sales climbed 37% in 2010 as the industry regained its footing.  Another 84% gain was registered last year.  Earnings recovered from a temporary dip in 2010, jumping 162% to $.34 a share last year.  Backlog expanded 44% to $418 million, laying the groundwork for another strong performance in 2012.  Bolstered by the recent acquisition in Brazil, we estimate sales will improve 38% to $415 million to provide earnings of $.55 a share (+62%).

In 2-3 years income could attain $1.00 a share on sales of $600 million.  Applying a P/E multiple of 15x to those earnings suggests a target price of $15 a share, potential appreciation of 215% from the current quote.  A higher valuation is possible if environmental stress creates water shortages in Africa or elsewhere.  Foraco currently generates 5%-10% of sales by drilling wells for drinking water.  That business has the potential to exceed mining over the long haul if global warming creates substantial droughts.  Management owns 42% of the stock.  Foraco is based in Marseilles, France.

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Monday, April 9, 2012

Sevcon ( Nasdaq - SEV ) -- Boosts Battery Performance

Sevcon (SEV $6.50) is a leading provider of microprocessor based controls that maximize engine output in electric and hybrid vehicles.  The alternative vehicle market has bogged down in recent years due to economic reasons.  But a bigger factor has been the lack of progress in battery technology.  Incremental improvement is likely over the next several years.  But major breakthroughs are not in the pipeline and are unlikely to enter large scale production through the end of the decade.  Despite that, the electric vehicle market is poised to deliver substantial growth.  And those gains are likely to be amplified by hybrid vehicles, a market the company also serves.  Electric vehicle manufacturers are improving their products's price performance by introducing a higher concentration of computer controls.  Those microprocessor based units regulate temperature and other variables to minimize wasted power.  They also regulate the environment so batteries retain their ability to charge up at full capacity.  With the addition of more software electric vehicles promise to become increasingly powerful and long lasting.  Gasoline powered cars and natural gas fueled trucks and buses are likely to dominate the high volume transportation market for the foreseeable future.  But plenty of niche markets remain to be exploited. 

Most of Sevcon's business historically focused on off-road and industrial vehicles.  Sales reached $39.2 million in 2008, most of which was generated by work machines.  The subsequent recession collapsed demand, forcing Sevcon to develop new markets.  The company landed a large number of small deals with on-road electric vehicle makers, aided by its track record in the industrial area.  Most of the rebound witnessed over the past three years was produced by those relationships.  Last month Sevcon landed its largest partner to date (Renault).  The contract calls for the company to supply controls for two new lines of city-cars the auto giant plans to manufacture.  Sevcon also recently signed a manufacturing subcontracting arrangement with Flextronics.  That relationship will cover new business signed either by Flextronics or the company.

Growth is threatened by near term economic and political factors.  Sevcon's traditional off-road and industrial markets have gained momentum in recent quarters.  The company didn't lose any customers during the downturn -- just order volume.  That business now is coming back, albeit gradually due to the weakness in Europe and around the world generally.  The on-road market still is advancing.  But government subsidies are still required to underpin that segment.  And those are being threatened by deficits and other fiscal problems.

Sales advanced 24% in Q1 (December) to $8.52 million.  Earnings improved to $.08 a share from a break even showing the year before.  The near term outlook is difficult to predict due to the political and economic headwinds.  Despite those obstacles we estimate fiscal 2012 (September) sales will climb 24% to $40 million to provide earnings of $.40 a share (+90%).  Longer term margins promise to expand on rising sales.  Assuming no real change in character in the electric vehicle industry we estimate sales will attain $75 million in 2-3 years to produce earnings of $1.20 a share.  We use GAAP figures because stock option expense is minimal and there aren't any other material adjustments that need to be made.  Applying a P/E multiple of 16x to those earnings suggests a target price of $20 a share, potential appreciation of 200% from the current quote.

Sevcon is based in the United Kingdom.  It's official corporate headquarters are in Southborough, Massachusetts.

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