This article is part of our Rising Star Portfolios Series.
I love coming across an amazing company I've never heard of. I was fortunate to experience such a thrill of discovery a few months ago, when I encountered Landauer (NYSE: LDR ) , a company that has appreciated in value fivefold since 1990. Landauer operates in a sleepy industry, yet boasts a return on capital of more than 25% and operating margins topping 30%. I don't know about you, but those numbers set my pulse racing.
Landauer produces the badges that detect radiation in hospitals, laboratories, nuclear facilities, and other areas. It distributes these badges to its customers, analyzes their data, and reports its findings. Landauer also advises radiation therapy centers on safety and treatments.
This is a really good business. First, it's incredibly profitable: Landauer's operating margin is 34%, and its net income margin is a strong 22.5%. Second, it doesn't require a bloated asset base: Return on assets clocks in at a peachy 17%. Third, it's predictable: Radiation monitoring is essential, and customers enter into annual contracts with a high renewal rate.
Of course, metrics are just manifestations of underlying reality. We need to understand why these metrics are so good.
Small is beautiful
For one thing, this is the very definition of "market niche." At roughly $120 million in sales among Landauer and sole rival Mirion Technologies, this is a tiny market without enough potential reward to justify a new entrant. Thus, competition is limited to existing players, an area where Landauer has the edge over Mirion. The latter generates $30 million in annual sales in its dosimetry business (compared to around $90 million for the same business in Landauer's most recent trailing 12 months), and it's an agglomeration of a few companies that has struggled with debt over the past few years. As a result, Mirion's been consistently less profitable than Landauer.
In addition, the technology needed to produce radiation badges isn't easily replicable. Even if it were, manufacturing capacity would still be constrained. Finally, Landauer sells to a fragmented base of 67,000 customers, with no customer representing more than 2% of revenue. That means those clients have little buying power.
After heaping on all that praise, I have to concede that Landauer has a few blemishes, too. Its domestic business is mature, and pricing pressure is creeping in. In addition, it relies on one plant to produce a key crystal material for its radiation badges, and it relies on Panasonic (NYSE: PC ) to manufacture the badges and their components. A fire or other shutdown in its plant, or a decision by Panasonic to exit its relationship with Landauer, could throw the company for a loop. While many people wouldn't consider this a big risk, I think it is. I'd prefer to buy the stock after a negative event, should there be one. After all, there's no penalty for sitting and waiting for a great entry price.
Alas, here's where my interest in Landauer as an investment came to a halt. Even with a couple of flaws, Landauer is still a very good company, but it's simply too expensive for my taste. Market capitalization is $620 million, and net income is about $24 million annually, putting the earnings yield at a paltry 3.9%. Despite net income growth of about 5% per year (earnings grew 5.5% over the past five years), the numbers just don't stack up for an excellent investment that will return 10% to 15% annually. I see more value in other areas of the market, such as defense contractors L-3 Communications (NYSE: LLL ) and Raytheon (NYSE: RTN ) .
When I first looked at this company in September, I had two main concerns: manufacturing concentration and price. I'm no less worried now. Landauer is a very nice company, but the market agrees with my favorable opinion a bit too much, leaving little room for the company to generate great returns.
Still, this exercise hasn't been a complete waste of time. I've learned about a new market sector, and I'm prepared in case the stock falls to more attractive territory. Best of all, I've banked a few more moments of sheer joy at discovering a hidden market superstar.