This article is part of our Rising Star Portfolios series.
It's been less than two months since the Young Gun Portfolio opened up -- and then quickly added to -- our position in Ampco-Pittsburgh (NYSE: AP ) . The specialty steel equipment manufacturer's recently released annual report offers us insight into how this 5% of the portfolio is doing.
Ampco brought in 9% more revenue last year than the year before, but look closer for the real story. Sales in the forged and cast roll division -- the larger of the two segments, and the one on which our thesis rests -- jumped 26%, driven by higher demand for the company's steel production equipment internationally. Operating margins in this division remained high, clocking their fourth consecutive year at more than 20%. This is a cyclical business, so don't expect those steady margins to last forever. Still, you can credit the overall improvement in margins over the last four years to the $60 million that management has spent to boost factory efficiency and improve the company's ability to maintain and repair its equipment in-house.
Ampco's other division, which manufactures air and liquid processing equipment, turned in a net loss as operations turned sour. The business faces more than 8,000 outstanding claims for damages related to asbestos, and it incurred nearly $20 million in settlement and legal fees last year -- enough to put the net result from the division in the red. These settlement figures seem to make investors wary, judging by the stock's current cheap price. Just remember that those settlements get paid out over time, not all at once, and that the company has insurance to cover most of them. Furthermore, this division is both smaller and sports a much lower margin than the forged and cast rolls division. When looking at the bigger picture, we should rightly focus our attention on the latter.
Cash coming in
Looking as far back as the financials allow (1991), Ampco has never been cash flow-negative. Let me repeat that: The company has never lost money on its operations. For a company in such a cyclical industry, "impressive" just doesn't do that feat justice. It owes as much to the business model -- Ampco makes orders to specifications, rather than stockpiling and selling inventory -- as to management's focus on long-term profitability and growth. Last year, the company's operations generated $43 million in cash flow. The past year also saw the completion of the aforementioned $60 million capital expenditure program, which should free up more cash flow for investors going forward.
Since the company will have higher free cash flow this year, isn't acquisitive, doesn't repurchase stock, and is limited in its ability to reinvest capital, I expect that management will increase the dividend this year. That might just draw some more attention to this well-run but unknown stock.
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