If a Motley Fool Hidden Gems selection conjures up the image of a small, out-of-the-way company making its first thrust into the limelight and not paying a dividend, your view is outdated. Take a look at this watch list stock -- tire retread specialist Bandag (NYSE:BDG).
Bandaq has 15 production facilities on five continents. The company's equipment, products, and services are distributed through a network of approximately 1,000 franchised, independent tire dealers in more than 100 countries.
Second quarter results were disappointing relative to what Bandag's (sole) Wall Street analyst was expecting. Sales increased 7% compared to the same quarter last year but earnings per share missed that one analyst's $.75 a share estimate by a dime, but still topped last year's second quarter by $.10 if you net out a one-time tax adjustment that added a nickel a share to 2004 earnings.
The business case for Bandag's core operation is easily explained. A new set of tires for an 18-wheeler can approach $8,000. Bandag, with almost half the U.S. retread market, takes bald truck tires and places new tread on them. The expected life and fuel efficiency is nearly the same as new tires, but at a fraction of the cost.
So, what's the picture on revenue and earnings?
Revenue is being hurt by falling new-tire prices as established manufacturers move manufacturing overseas, and overseas companies entering the U.S. market. That said, the cost benefit of retreads is still significant.
Ignoring the favorable tax treatments that boosted last year's second-quarter earnings, this year's second quarter's diluted EPS jumped 18%. Leaving those tax treatments in, diluted EPS rose 8.3%. Worth considering is that the company's earnings stream is tied to the cost of raw materials, particularly rubber (which is impacted by higher oil prices). Additionally, profitability is down at Speedco, which can likely be attributed to Bandag's modifying the stores and training staff to sell tire services.
Bandag is spending its ample cash flow to build new Speedco outlets and converting existing locations to offer tire services. It is a growth engine that will bear watching. Bandag can aggressively fund its Speedco expansion plans and make other investments because its rock-solid balance sheet has $189.1 million in cash and investments and a paltry $49.8 million in total debt.
As the Speedco expansion continues, the situation bears monitoring. Despite its captive position to rubber prices, the retread market (which Bandag essentially owns) most certainly has a very well-defined niche within the transportation industry. And if the Speedco expansion offers growth, with an already sweet 2.8% dividend, Bandag might be a Hidden Gem worth owning.
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Fool contributor W.D. Crotty does not own shares in any of the companies mentioned.
