In Greek mythology, the great hero Hercules performed amazing feats of strength even as an infant. For more proof that big accomplishments can come from tiny sources, look no further than Hurco (NASDAQ:HURC).
Just a week ago, the small-cap machine tool maker announced that it would be delaying its earnings release for the fiscal year. Investors were utterly horrified, even though management's press release hinted at a positive cause for the uncharacteristic delay:
[I]n light of positive operating results throughout fiscal 2005, [Hurco] is continuing, together with its independent accountants, to review its provision for income taxes for future years and, therefore, fiscal 2005.
Despite the positive tone, investors weren't buying it -- literally. The stock dropped almost 14% to $20 per share immediately after the release, before rebounding later in the day to close near $22.50. What, exactly, did this delay mean for investors? Cynical discussion board posters suggested that perhaps the company was saying that business had been so remarkable that Hurco had to delay its earnings release so its accountants could sit around counting huge piles of money.
As it turns out, that wasn't too far off the mark.
The results
The lone analyst covering Hurco estimated fourth-quarter earnings at a cheery $0.55 per share, which many posters on the Web's financial discussion boards considered questionably optimistic. Imagine the surprise, then, when the results released earlier this week showed a stunning $0.77-per-share gain in net income, trouncing that analyst's estimate.
What's more, it turns out that the earnings release delay happened because the accountants were reviewing the company's tax liabilities, and realized that Hurco would both qualify for certain tax credits and benefit from carrying forward certain European net operating losses. So in addition to stellar operating performance, Hurco also had a favorable $0.37-per-share non-cash adjustment. This added another $2.3 million to net income for the year, giving Hurco an unbelievable net income of $1.13 per share for the fourth quarter -- more than twice the analyst's "optimistic" estimate, and more than the $1.04 per share that Hurco earned in all of 2004. Not a bad way to bring in the holidays.
Sales and service fees increased 26% in total for the year to an impressive $126 million. This increase in sales accompanied increasing profit margins all around, with gross margin jumping from 30.4% to 33.9% this year thanks to economies of scale.
Because of Hurco's market cap (previously under $100 million), Motley Fool Hidden Gems subscribers used to lovingly call it the "baby" version of Hidden Gems pick FARO (NASDAQ:FARO). But with sales of $125 million and a market cap now approaching $200 million, Hurco is fast catching up to its bigger brother. Despite rising more than 60% in value over the past two months, Hurco's stock is up again on heavy trading volume, and with good reason. After reporting fiscal-year earnings of $2.60 per share just after closing for the day at $22.83, this fast-growing company is now trading at less than nine times earnings. Considering that it also holds $2.10 per share in net cash on the books, that drops the true price-to-earnings ratio (P/E) for the trailing 12 months to less than eight. That's cheap.
Not so fast
However, among all of the rosy news, there are some risks for Hurco going forward. The biggest risk facing the company is that machine tool demand is extremely cyclical. Pull back to a 20-year chart and you'll be able to tell with precision where the cycle has ebbed and flowed. In addition, with so many of its sales coming from overseas, Hurco has enjoyed the benefits of a weakening U.S. dollar. A strengthening dollar over the past few months should be a point of concern, and if the dollar continues to rebound from its all-time lows against the euro, foreign customers could find Hurco's pricing to be much less competitive than in the past.
To mitigate some of the risk associated with the dollar rising against the euro, Hurco has been expanding operations in other countries such as in Asia, along with growing its domestic operations at a blistering pace. This past quarter, the company opened its first sales center in Shenzhen, China.
To help offset the cyclical nature of its business, Hurco has developed an entirely new product line that has greatly boosted sales, and the company has begun to focus on gaining market share. In addition, management has been eyeing rapidly developing markets such as China and India, which together account for approximately one-third of the world's population. This could help sustain the company if American and European machine tool demand begins to decline.
The Foolish bottom line
With a plan for the future and stunning results over the past year, it is little wonder that investors appear poised to grab shares with both hands. Although Hurco is not a formal recommendation of the Motley Fool Hidden Gems newsletter, it was Fool co-founder Tom Gardner's first-ever "Tiny Gem," in the same issue that featured Rex Moore's official pick, Portfolio Recovery Associates (NASDAQ:PRAA). Ever since then, the two companies have been competing neck-and-neck for the best performance. With a 15% gain since Monday and a 75% return since it was picked in June 2004, Portfolio Recovery has been giving little Hurco a run for its money. But Hurco is already up 24% since Monday's close and has already doubled in value since it was highlighted in the same issue.
Has Hurco reached an Olympian peak with these latest results, or will it perform more mythically mighty deeds in the future? Stay tuned, Fools.
Motley Fool Hidden Gems can help you find more small caps with big potential. To try it free for 30 days, sign up today .
Fool contributor Rick Casterline goes by the misnomer WBuffettJr on The Motley Fool discussion boards, where he wonders whether most of his online pals are friendly because they think he is getting an inheritance. He is a longtime Fool fan and subscriber to Motley Fool Hidden Gems. Rick owns shares of Hurco and Portfolio Recovery Associates but no other stocks mentioned in this article.The Fool has adisclosure policy.
