The little company from South Carolina has been ramping sales and stealing headlines from better-known defense contractors like Oshkosh (NYSE: OSK ) and General Dynamics (NYSE: GD ) for close to a year now, thanks to its famed IED-proof Buffalos and Cougars. But news that the firm lost out on a crucial second tranche of mine resistant ambush protected vehicles (MRAPs) to NYSE-delisted truck maker Navistar late last month sent Force Protection's stock into a tailspin. And news last week that body armor specialist Ceradyne (Nasdaq: CRDN ) had developed an armored vehicle called "BULL" seemed to give the stock of already-down Force Protection just one more kick, sending it down as much as 8% in reaction in under 24 hours of trading.
But was this sell-off justified? Let's review what we know.
The poop on BULL
What we know about Ceradyne's BULL is precious little at this time. (You're going to love the reason: Management says it's "classified," yet at the same time this mysterious, classified product is also a "clear technological leap forward in crew survivability.") Unsurprisingly, the secrecy of this technological wonder seems to be sowing confusion about what exactly the BULL is. Is it an actual armored vehicle per se -- a contender for MRAP contracts and a rival to Force Protection's products -- or just an up-armor package that can be affixed to vulnerable vehicles?
Reports that the BULL, described in Ceradyne's June 7 press release, was a heavily armored Ford (NYSE: F ) F750 suggest the latter theory. The press release itself, however, which describes the BULL as "a high-threat vehicle," a "vehicle ... designed for close urban terrain," and a "commercial derivative of a vehicle that successfully passed limited testing by the U.S. government" (emphasis added all three times), strongly implies that the BULL is a vehicle in its own right -- and hence, a real competitive threat to Force Protection's offerings.
What to do
Which raises the question: If a dark horse like Navistar can deprive Force Protection of a large portion of its hoped-for sales, if another dark horse (in the form of Ceradyne) has just cantered over the horizon, and a whole herd of horses of a different color -- everyone from Armor Holdings (NYSE: AH ) to BAE to Israel's Rafael -- are stampeding in Force Protection's general direction, is it time to put Force Protection out to pasture from your portfolio? And another question: Does Ceradyne's surprise entry into this race in the form of a coy press release mean it's now time to invest in that company instead?
That depends. Let's take the questions separately:
Question No. 1: Is it time to sell Force Protection?
No. Or at least, not if you've already spent the time necessary to determine Force Protection's intrinsic value, based on how profitable the firm is, how profitable you expect it to become, and generally speaking, how much its future profit streams are worth when discounted back to present value.
Needless to say, I'm guessing there are more than a few investors in the firm who bought into Force Protection on the strength of its story alone and haven't a clue how much the stock is really worth. I know I'm stumped.
Force Protection just turned profitable a year ago, sports an operating margin that's less than half the industry average, and has burned cash every year of its existence -- never generating a single penny of cash profit. On the other hand, it just turned profitable and is ramping its sales rapidly and gaining economies of scale that could keep those profits growing -- both good omens. But on the third hand (the third hand?), to achieve the kind of scale it wants, it has been signing partnership agreements with larger rivals left and right -- agreements that are confidential, and give us not a clue as to how profitable the resulting additional sales will be.
Anyone out there who's managed to make sense of this jumble of data deserves (1) hearty congratulations and (2) encouragement to stick with this investment and not be frightened off by a press release from a would-be competitor that hasn't yet won a contract for its product.
Question No. 2: Speaking of that would-be competitor -- should we buy Ceradyne?
Not necessarily. Investors who buy Ceradyne today in hopes that last week's press release will turn into anything more than good PR are, well, investing in hope. That said, there are plenty of reasons to invest in Ceradyne that rest on more solid grounds. For example, it:
- has been in business for 40 years, and has an established track record.
- works in multiple lines of business. Even if BULL fails to pan out, this firm is not going away anytime soon, and it will still profit from selling body armor, auto parts, and any of dozens of other ceramic products it makes for the semiconductor, solar power, and nuclear power industries.
- earns an astounding 29.6% operating margin (incidentally, more than eight times what Force Protection is pulling down, nearly three times the norm in Ceradyne's home industrial equipment industry, and nearly four times the norm in the "trucks and other vehicles" industry).
- can be purchased for less that 13 times trailing earnings, against estimated profits growth of 13% per year over the next five years.
For all of these reasons, I continue to think Ceradyne a fine investment. No BULL about it.
To learn more about the company causing Force Protection's latest headache, read:
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