Monday, December 15, 1997

Virco Manufacturing Corp.
Phone: 310-533-0474
Price (12/12/97): $24 5/8


Making tables and chairs for schools and churches isn't a sexy, fast-growing business, but the example of Virco proves that an investor can enjoy astonishing profits by spotting a solid manufacturer that's working hard to nudge ho-hum net margins just a point or two higher.

In August 1996, Virco's stubs were trading for a split-adjusted $5 1/4. The five-bagger from there has followed from stable material costs, improvements in production efficiency and distribution, and a deliberate effort to add higher-margin business.

For the education market, the company has created some pricier mobile table lines and new computer-related furniture. It's also focused commercial sales on pre-schools, churches, banquet halls, and cafeterias while reducing less profitable sales to mass merchants.

Virco's run began with 93% EPS growth in the second quarter of FY96. In the five quarters since then, the company's moderate sales growth has unfolded into rising gross margins and phenomenal EPS gains. For the first nine months of FY97, Virco's 12% sales increase has been good for a 85% earnings jolt, thanks to net margins that have soared from 3.7% to 5.7%.


Virco makes furniture for the education market (57% of sales in FY96) and the commercial market (38% of sales). Its primary furniture is basic institutional fare: tubular metal legs and frames with wood or plastic tops and plastic or upholstered seats and backs.

For the education market, it makes student and teacher desks, computer stations, folding tables, and mobile storage cabinets and tables. Commercial sales come from banquet tables and chairs, convention sets, and hospitality furniture. Unlike some competitors, Virco has its own sales force that markets furniture directly to school officials.

In FY95, Virco built a new manufacturing and distribution facility in California. Its Arkansas plant has benefited from $19.1 million in capital expenditures between 1994 and 1996 that expanded manufacturing capacity for hard plastic components used in educational furniture and more fully automated production. Since these factories have performed so well, Virco closed its Mexican plant in the second quarter (taking a $2.6 million pre-tax charge).

The furniture business is seasonal, with the second and third quarters being by far the strongest, due to education sales. The stock split 3-for-2 on September 30. Members of Chair/CEO Robert Virtue's family control nearly half the shares: that's why they call it Virco!


Income Statement
12-month sales: $259.2 million
12-month income: $15.4 million*
12-month EPS: $1.70*
Profit Margin: 5.9%*
Market Cap: $226.1 million
(*Excludes nonrecurring, after-tax loss of $1.6 million or $0.18 per share for shutdown of Mexican facility)

Balance Sheet*
Cash: $1.7 million
Current Assets: $99.8 million
Current Liabilities: $30.5 million
Long-term Debt: $41.1 million
(*As of July 31, 1997)

Price-to-earnings: 14.5
Price-to-sales: 0.87


Virco should have been easy to spot. An investor screening for companies delivering rising profit margins and sales gains of at least 5% could have found Virco following the August '96 earnings report. Competitor Mity-Lite (Nasdaq: MITY) has also been a star performer.

Even after the first quarter earnings this past May, Virco shares traded at just 10 times trailing earnings of $1.25 a share. The only mild concern would have been the hefty debt.


After more than a year of strong results, it's only proper to wonder whether Virco can squeeze out more profits or whether it will start to face some particularly tough earnings comparisons.

Yet, this isn't entirely a margins story. Due to strong sales trends, the company has begun a $15 million, 20-month expansion and re-configuration of its Arkansas facility along the lines of its California plant. This move will support volume growth for the next several years.

The downside: there's always the risk that this expansion could disrupt operations (and profits) in the near term. Also, it certainly means Virco won't be paying down any more of its debt for a while. The leveraged balance sheet has helped the firm deliver 21.4% return-on-equity over the past year, but the level of debt is a bit troubling since furniture sales are sensitive to economic conditions.

Virco, though, should have no problem making the $1.71 per share high-end earnings estimate for FY97 (ending in January). Indeed, that estimate assumes fourth quarter earnings are flat. PEGs and YPEGs are a bit suspect with a consumer cyclical. Still, the company PEGs out at 1.08. YPEG fair value based on the FY98 EPS projection of $2 and 18% long-term growth would be $36. Even these high-side estimates may be conservative if the firm doesn't stumble.

Another five-bagger isn't around the corner, but Virco still appears to have some legs.

-- Louis Corrigan

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