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 Stock
of the Day
Nov 11, 1999
Aeroflex: Expert Market Timers
Senior Analyst: Glenn S. Curtis 11/11/1999
Talk about deft market timing.
Insiders at Aeroflex (NYSE:ARX
- news) , a maker of
circuits and testing solutions for the commercial and defense markets,
sold a grand total of over 374,000 shares in the open market this past
year when the stock was in the mid to high teens.
Their timing was on the money.
After that selling, the stock slid to a low of $5.31, and has pretty
much been in the doghouse since. Wednesday, the shares closed at $7.50,
down $0.38. Under normal circumstances, we might have written this company
off for the rest of the year, except we think that the stock is oversold.
Why?
First off, Aeroflex is not performing as badly as the stock performance
suggests. During the first quarter of fiscal 2000, ended September 30,
sales increased a healthy 33% over the same period last year. Earnings
were $0.15 per share in the quarter, up 25% from the same period a year
ago.
Of course the stock had some good reasons for the sell off. Management
has said that the company's satellite business, which constitutes about
10% of its overall sales, is taking it on the chin.
The bad news in the satellite unit led several analysts to pull back
their revenue forecasts by $8 million to $10 million for 2000.
Why the weakness in satellites?
Clients like Iridium (NASDAQ:IRIQE
- news) , which recently
filed for bankruptcy protection, are having a hard time getting funding.
In turn, Aeroflex, which makes the gadgets which help run those systems,
is seeing its order flow slow. Backlog, according to Aeroflex chief
financial officer Michael Gorin is "at about $94 million which is
flat sequentially from June."
But Gorin said that he thought that what we are seeing is a one-to-two
quarter "hiccup, which will subside once funding returns." In
the second quarter ending December 31, the Street is expecting Aeroflex to
earn just $0.07 per share. This is down from the first quarter and lower
than the initial expectations that called for the company to earn $0.20
per share.
Another factor that caused some analysts to scale back their fiscal
2000 models was the fact that Lucent (NYSE:LU
- news) is cutting its
orders for thin film instruments for a switch that had previously been
outsourced from the company.
Is the Lucent business going away altogether? No. There is merely a
product transition underway says Gorin.
"Lucent will be moving to a second generation product line and
it's a matter of ramping up that business," he says. "We are
merely in a lull that will affect the next two quarters."
We think that has been more than factored into the current share price.
Consider that the stock is down almost 65% from its 12-month high of
$22.38.
Also, remember how we said that insiders were selling this stock
earlier in the year and that the timing of these sales, near the highs,
was very much to their benefit? Well officers and directors, sensing the
stock had been beaten down excessively, bought shares in late October.
This wasn't a token action either. Officers and directors bought a
total of 154,000 shares in the open market at an average price of $6.02
per share.
We think that these purchases were a way for insiders to tell investors
that Aeroflex is a bargain and that holders of the common shares stand to
benefit from purchasing the stock at current levels.
As an added kicker, the board of directors has authorized the
repurchase of up to 1.6 million shares.
We would expect the company to be in the market until just before the
release of the second quarter earnings and again when the window for
buybacks reopens.
A rebound is not the only thing shareholders are hoping for. Another
catalyst going forward is the expected ramp up of the company's FS1000
synthesizer. This synthesizer is currently being produced for Teradyne (NYSE:TER
- news) for use in that
company's mixed signal chip testing system for cell phones.
Gorin says: "Aeroflex generated only a couple of million from this
product. In 2000, expectations are that we make about $14 million or $15
million from this product alone. Our initial production has gone solely to
Terdayne. Going forward, that business will expand to other
customers."
As a result, the stock seems awfully cheap.
From speaking with management, we think that earnings in the June 2000
fiscal year will more than likely be in the lower end of Street estimates,
or $0.60 per share.
In fiscal 2001, when the satellite business pops back, we think the
company will earn $1 per share, although this figure is still lower than
the Street consensus.
But the Street consensus probably doesn't fully reflect the company's
current outlook. Some analysts did lower their estimates in the wake of
the Iridium bankruptcy and Lucent cutting its orders. But some have yet to
revise their old estimates, and so the consensus is likely skewed with
some out-of-date forecasts.
Once the company makes its way through a couple of rough quarters, the
picture should brighten considerably.
On the revenue side, Aeroflex is expected to generate $190 million in
sales in fiscal 2000. In 2001 management is comfortable with growth of
about 20%, which would imply approximately $230 million on the top line.
The result is that Aeroflex trades at just 7.8 times fiscal 2001
estimates. Earnings are expected to grow at 66.6%. This supports our view
that the stock is oversold and that insider buying at these levels could
prove to be a smart idea.
For one thing, the company's book value is $5.33 per share, giving the
stock a price-to-book of less than two.
Tax loss selling might depress the shares further, but once the news
flow regarding FS1000 orders starts coming in we don't think the stock
will stay under $10 for long. Of course, we expect more analysts to pick
up coverage of the company, and that will drive the stock even higher.
All of this leads us to our recommendation: Buy now.
Bottom Line:
By March, as Lucent picks up its order flow and as volume picks up on
the FS1000 synthesizer, we think that Aeroflex could be trading in the mid
teens.
For more in-house professional stock analysis and commentary, visit
us at Individual
Investor Online.
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