DHB Industries, Inc.
My view again: BETTER LAYOUT

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By Naicinvestorz
March 17, 2005

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Here is my view (written in "we" form as it was written together with someone") not because I feel I'm a king and have to speak in "we" form:) just to get that out of the way

Full Year 2004 Results Full Year 2003 Results
Revenues: $340M +47.9% $230M
Gross Margins: 27.7% 27.5%
Net Income: $30.4M +114% $14.17M
EPS: $0.67 +103% $0.34
EPS '05E: $0.77, P/E '04: 18, PE '05E: 15.5, Earnings Yield: 6.5%, ROE: 44%, Operating Margins: 14.6%

DHB posted excellent full year 2004 results. On its conference call (which overall wasn't the best conference call we have heard from the company) DHB said it had increased market share in all of its operating segments. CEO Brooks noted that this was the 20th consecutive quarter of year-over-year growth. During 2004 DHB received 544 million in new orders.

DHB's backlog (products that have been ordered but not yet delivered) stands at an all time high of $415M. Backlog has increased from $57M in March 2003; to $132 in March of 2004.

Accounts receivable increased slightly to 58 days in '04 (from 54 days in '03). According to CFO Schlegel this is due to sharp demand and tendency of government agencies to be slow payers. The biggest constraint of the company continues to be having enough raw materials. COO Hatfield noted that results would have been better IF DHB would have had access to more raw materials. It has since contacted its suppliers and they have confirmed that they will ramp up production to meet DHB's rapidly growing demand. Management re-iterated that it sees "very strong demand" for virtually all of its products. It expects the raw material environment to gradually improve in April, May and June.
Hatfield also noted that even though the company had seen strong demand it continues to submit bids for new business. When a question was asked about international demand the company stressed that it was its obligation to first meet the needs of the DoD and other US law enforcement agencies before it could actively pursue international growth opportunities. Brooks later admitted that international growth opportunities could be "tremendous".

Brooks also noted that apart from new sales to the military and law enforcement agencies people were forgetting about a potential replacement cycle for old vests which in his opinion could be quite "substantial". The company continues to spend money on R&D to come up with new products in the future.

Brooks also said that proposed defense spending bills should have "strong positive effect" on DHB's business going forward. When asked about the ongoing SEC investigation, Brooks said that the company hadn't heard from the SEC in several months and couldn't comment further. Going forward Brooks said that the company will actively consider a Nasdaq listing, hire 3-5 new people to increase the company's awareness to investors (extra road shows/more coverage) and increase its PR staff.

NAIC Valuation (SSG explanation/special comments):
Our current NAIC valuation gives us a BUY zone up until $13, with an estimated EPS growth rate of 12% over the next 5 years. We have lowered our EPS growth rate target from 15 to 12% due to the fact that management doesn't provide guidance and this increases our need for a larger margin of safety. DHB could in fact grow much faster than this (as evident from this year's numbers) but we feel 12% offers us a large enough margin of safety.


What a ride. We have no better way to describe DHB's share performance over the last year. While results have been stellar in almost every quarter DHB's stock has traded to $22.5 in December of 2004 and as low as $11 in March of 2005.

From an operating basis all news has been very good. DHB continues to win large contracts and is well positioned to continue to supply body armor to the military and law enforcement agencies in both the US and abroad.

So what has caused this incredible price swing in DHB's stock? It is our belief that large insider selling at the end of December has made the market anxious about possible problems. These insider sales were really a non-event in our view. In fact it is funny how the market seems to interpret insider selling by an executive, who previously owned close to 30% of the company, as a "bad" thing while only a year ago they were complaining how CEO David Brooks had to sell some shares and lower his control of the company!
After reviewing the book by Prof. Nejat Seyhen "Investment Intelligence from Insider Trading" we conclude that according to his research insiders selling after a stock has had a substantial rise are far less significant than insiders selling when the stock has been declining. Brooks remains DHB's largest shareholder with approximately 7.6% of shares outstanding. All insiders own 22.2% of the company (according to Thomson Financial).

So has DHB's stock been declining? No, in fact it has risen sharply over the last 12 months. The stock has increased by approximately 100% since March 16th 2004. This is a very large increase in a one-year period!

As investors we try to separate fact from fiction and in case of DHB this is sometimes a little harder than with our 'average' company. While we "should have known" to sell our stock at $22.5 in December of 2004 and bought back two months later at $11...we did not. While this might sound stupid to some it is our belief that share prices will fluctuate widely in the short term (yes, 1 year is still very short term) but at the end of the day they will follow sales and earnings progression. While we are sometimes tempted to be frustrated by the wild swings in DHB's share price we believe that instead of being frustrated we should be happy as the market offers us great entry points without a fundamental change in our investment thesis.

What about sales and earnings? They have increased tremendously over the last 12 months. Also note that while many companies need acquisitions to sustain growth DHB's growth has been 100% organic! Management did mention the possibility of an acquisition going forward.

What seems to be bothering Wall Street is that in spite of the large backlog DHB was unwilling to provide specific guidance for 2005. Brooks repeated several times that its lawyers had advised against giving specific guidance due to new Sarbanes-Oxley laws that have complicated the life of small businesses across the US. Sarbanes Oxley laws also caused an additional cost of about $1 million due to the fact that three separate audit firms have been turning the company inside out to find any possible wrongdoing. Brooks expects the company to get a "clean" bill of financial health shortly.

Let's point out that a recent article in the Wall Street Journal noted that many companies are nowadays reluctant to provide guidance. Large companies like Coca Cola, Google, and Berkshire Hathaway aren't giving guidance either. Wall Street of course doesn't like this practice as it complicates the job of the analyst covering the story. Rather than management telling him what EPS will be 12 months from now (and adding or subtracting a few cents to come up with his "own" estimate) the analyst has to come up with his own calculation of how much earnings could increase or decrease in the coming 6-12 months.

Where does this leave us? DHB continues to be one of our largest holdings and as we focus on results we can only be satisfied in DHB's performance. Many companies that post 100% earnings increases trade at 30 or 40 times earnings but DHB only trades at 18 times trailing earnings and 15.5 times expected 2005 earnings. Over the last 24 months management has delivered on all the promises it has made during its previous conference calls. Going over the company's previous full year results (in 2003-2002-2001) we see that management has always been very vague about guidance so this is something that probably shouldn't worry us too much. However, we will have to keep a close eye on the business developments going forward.

In his closing remarks Brooks re-iterated the following two points (paraphrasing): "...It continuous to be our goal to maximize shareholder wealth" and "progress will speak for itself... regardless of the short term share price". We are delighted with this final statement, as we prefer management that is concerned with its business rather than its stock price. In the end of the day management has little control over its share price.

Comments are welcome (as always)


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