Ah, timing. It can make a great company a terrible stock pick, if you don't get it right. And many would argue that my pick for Stocks 2005, technical ceramic maker Ceradyne (NASDAQ:CRDN), was pretty ill-timed. After rising modestly early in the year, it cratered on news of no real, lasting problems. I thought it made for a great buying opportunity -- as I later explained. And after last week's Q2 earnings release, I'm even more confident that loading up on a second pile of shares at $18 -- and still another around $22 -- was the right thing to do.
What drove the stock back into the $30s? To take a phrase from a well-known cable guy, Ceradyne "got 'er done."
Revenues were up nearly 130% over last year, to $89.9 million. Keep in mind that last year's ESK acquisition juiced this top-line result. But even backing out ESK's $28.1 million, the former Ceradyne alone would have put up a 57.6% sales increase.
Record order bookings of $118.5 million contributed to a backlog of $215.6 million as of June 30, more than double last year's.
The major engine for this growth remains the armor plates Ceradyne supplies for our soldiers, and those of you who follow the industry know how volatile the firm, along with peers like DHB Industries (AMEX:DHB) and Armor Holdings (NYSE:AH), can be.
Recall that last quarter, Ceradyne missed its expected numbers because it upgraded its entire plate offering to a newer, higher-specification (and more profitable) plate. The government is still buying these as fast as Ceradyne can deliver them, and will, by all indications, be purchasing large amounts of them for the foreseeable future -- 32,000 plates a month for about four years -- regardless of the number of troops we field in Iraq.
To turn to margins, the story's not as scary as my colleague Rich Smith might have thought at first blush. The 36.2% gross margins were a 2% improvement over the prior year's quarter, and well beyond the firm's targets.
The nearly 4% drop in net margins resulted from a few factors. First, there were big interest payments owing to that ESK acquisition. Next, SG&A expenses tripled, rising to 13.8% of revenues (as opposed to 10.5% the year before.) Again, I'm not overly concerned about this. Having watched it swallow a German company nearly as big as itself, I fully expected Ceradyne's administrative costs to rise. Ceradyne has also been expanding its management team and sales efforts in order to set the pace for its aggressive push toward becoming one of the world's leading technical ceramics providers. Consistent with these efforts, R&D also tripled, and that's something I don't mind at all.
Finally, although it pains me to say this, I'm also not wondering about free cash flow for now. The slug of inventory that put a drag on cash from operations largely comprises raw materials and works in progress -- the kind of positive inventory divergence we like to see. The heavy capital spending is actually lower than last year's, and I believe it's being allocated wisely toward lower-cost production facilities and future-oriented efforts for vehicle armor.
By my reckoning, Ceradyne seems to have shrugged off most of the remaining questions about whether it's losing its touch. (And the analysts, many of whom wouldn't touch this with a 10-foot stick when it was at $18, are coming around too.) While the shares are no longer "stupid cheap," and body armor orders still comprise the bulk of the business, future opportunities in engines, coatings, the oil industry, and vehicle armor may someday make the current share price look like a very big bargain indeed.
For related Foolishness:
- Remember the lessons from the fall.
- Don't sweat stories about sectors. Watch the company.
- Learn more about the inventory story.
- Watch for the ugly side of growth.
Seth Jayson is probably a bit too enthusiastic about Ceradyne, but then, he owns shares. Go team. At the time of publication, he had no position in any other firm mentioned. View his stock holdings and Fool profile here. Fool rules are here.
