Thursday, August 9, 2012

Sevcon ( Nasdaq - SEV ) -- Legacy Business Slows

Sevcon (SEV $5.00) reported lower than expected Q3 (June) results.  The company is the leading independent provider of computerized controls for electric vehicle engines.  Revenues increased 8% to $8.88 million.  Earnings fell 75% to $.01 a share (fully taxed).  Engineering talent was added in the period to support anticipated growth.  Margins were crimped when revenues grew less rapidly than predicted.  Rising expenses were offset to a degree by better manufacturing margins.  Sevcon outsources most production work.  The entire supply chain demonstrated improving productivity. 

Industrial vehicle demand slowed due to economic considerations.  Sevcon provides the brains for a wide range of electric powered work machines.  Those include fork lifts, aerial lifts, mining vehicles, airport trucks, floor polishers, turf equipment, and a variety of other units.  The company's technology maximizes battery efficiency so the engines can hit higher speeds and last longer before recharging.  Before the recession began sales in that segment were pushing $40 million a year.  Rising energy prices and tighter environmental rules promised to support further gains.  Demand collapsed when the worldwide economy slowed.  A rebound appeared to be underway.  But the latest woes in China, Europe, and elsewhere put the brakes on that during the June quarter.

The on-road market continued to advance.  Sevcon entered the electric car segment a few years ago, building on technology it already was delivering for motorcycles and all terrain vehicles.  Bolstered by government regulations, but primarily economics, the electric car market has been expanding rapidly and is continuing to go.  Rising fleet fuel efficiency standards are accelerating demand among auto makers.  But consumers are clamoring for the product, too.  Based on the size of the worldwide car market, which is mammoth, and the regulatory path that's in place, and growing consumer support, there's a strong consensus among industry observers that unit volume could expand 25%-35% annually over the next ten years.  A recent deal to supply controls for Renault's new "city car" is generating near term momentum.

Sevcon is well positioned to grow even faster in the on-road segment.  Even if it doesn't, though, overall performance should be reinforced by a return to normal by the industrial segment.  That would entail a 100% jump just to get back to to 2007 levels (an extra $20 million a year in sales). 

These shares require a long term orientation.  The share count is so low, however, and the potential market is so big, a patient investor could enjoy enormous appreciation.  A rebound by the economy likely will drive conventional energy prices higher, making electric cars increasingly attractive.  In 2-3 years income could attain $.75 a share.  Applying a P/E multiple of 20x suggests a target price of $15 a share, potential appreciation of 200% from the current quote.  Beyond that, it might be a long runway.

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