Hurco Companies, Inc (HURC) is a global industrial automation company that designs and produces interactive computer controls, software and computerized machine systems for the worldwide metal cutting and metal forming industries. The company is based in the United Sates but has extensive overseas manufacturing operations and customers. In Fiscal 2008, over 75% of revenues were from customers located abroad, with the bulk of the foreign customers in Europe. The company’s fiscal 2009 year began on October 1, 2008 and filed a 10K report in January. The company’s latest 10Q report was filed in March.
Current Price Near Net Current Asset Value
At current price levels just under $15, Hurco is valued at close to Net Current Asset Value (NCAV), which is calculated by taking Current Assets on the balance sheet and subtracting ALL liabilities. This metric assigns no value to assets such as land, plant and equipment, and intellectual property. Hurco is priced at levels close to what Benjamin Graham and Warren Buffett refer to as a “cigar butt”, meaning that the company might have a few more “puffs” before liquidation.
However, Hurco is clearly not a liquidation play and in fact the underlying characteristics of the company demonstrate significant intrinsic value as a going concern. The stock has the potential to advance substantially from current levels when normalized earnings return. Furthermore, I believe that Hurco has a business model designed to operate on a break even cash flow basis during the recession, assuming that the economy does not degenerate into a decade long “Great Depression”.
At my average cost basis of $13.28 on shares acquired on April 7, Hurco was available at 88.7% of Net Current Asset Value per share (Current Assets less All liabilities) as of January 31, 2009. At the 52 week low on March 9, Hurco traded at $8.30, or 55.4% of NCAV per share. Hurco has cash of $4.68/share, book value of $19.11/share, tangible book value of $17.13/share, and NCAV of 14.98/share. The company has no long term debt.
Hurco has a long track record of profitability and expansion over the past five fiscal years (through 10/31/2008). Gross margins averaged 35%, operating margins 13.9%, and net margins at 10.2% over the past five full fiscal years. Return on equity averaged 24% during this five year period. Earnings power averaged $2.56 per share over the five year period peaking at $3.49/share in fiscal 2008. Sales grew at a compound annual rate of 17.6% over the five year span while earnings grew at a compound rate of 29.1%.
The company does not have material long term lease obligations or other off balance sheet items that would impair the ability to liquidate the business, although I do not consider liquidation to be a likely scenario for Hurco.
Severe Downturn Began in Fiscal Q4 2008
In fiscal Q4 2008, Hurco began experiencing the impact of the severe economic downturn in the US, and this spread to the worldwide markets in fiscal Q1 2009. In fiscal Q1 2009 ending 1/31/2009, sales fell 53.6% from fiscal Q1 2008. Gross margin fell from 40.8% to 30.2%, operating margin fell from 20.4% to 1.8%, and net margin fell from 12.8% to 1.3%.
However, it is notable that despite a precipitous drop in sales, Hurco was able to cut operating expenses and achieve a small profit while also strengthening liquidity measures (current and quick ratio). During this time frame, the stock price entered sub-NCAV levels dropping to under 56% of NCAV in March and rising to 88.7% by the time of my purchase.
Hurco Appears to Have Staying Power to Survive the Recession
Hurco has demonstrated an ability to achieve roughly break-even results in a terrible quarter and exercised significant operational discipline in the process. The management team currently in place led the company through the 2001-2002 recession and appears competent and well equipped to navigate the current downturn. Assuming a return to a more normal economic climate, earnings power should recover to pre recession levels.
Assuming a return to the average earnings per share level of $2.56 over the past five fiscal years and a conservative 10x multiple, the stock price should advance significantly from current levels. If Hurco can restore profitability to fiscal 2008 levels of $3.49/share (which was hardly an ideal environment considering the downturn that started in fiscal Q4 2008) and applying a 10x to 12x multiple would lead to a share price between $35 and $42.
I cannot predict when the economy will recover, nor do I think it is productive to make security selections based on macroeconomic factors. However, I believe that the catalyst for recognition of the value in Hurco is most likely to come as soon as the market begins to anticipate a recovery, whenever that may be. At that time, at the very least, Hurco’s discount to NCAV should disappear once and for all and it is likely that the stock will trade at a conservative multiple of anticipated earnings.
The other catalyst could involve a takeover. Hurco is a small company, but is large enough to land on the radar of many larger enterprises. I believe that this is the type of company Berkshire Hathaway could be interested in, although the absolute level of earnings power falls short of Warren Buffett’s criteria and probably would not “move the needle” at Berkshire Hathaway.
The risk of taking a position in Hurco appears minimal. As I wrote previously, I believe in taking a “pessimistic” view of the situation when evaluating any company selling at what appears to be a significant discount to fair value. It is important to understand that the market has in fact placed a large discount on the company and there may be very good reasons for this. Although the markets are by no means “efficient” in terms of arriving at appropriate prices, price signals deserve respect and attention.
I do not define risk as the chance of a further near term decline in the price of Hurco stock, nor in the volatility of the stock price. Risk is the possibility of a permanent loss of capital. From an operational perspective, there could be a permanent loss of capital if we enter a “Great Depression” environment and management fails to adjust operating costs to operate without suffering significant negative cash flows. If such a scenario occurs, management could still liquidate the business and investors at current prices would be protected by the assets on the balance sheet. However, it is always difficult to determine whether management would in fact move to liquidation in a depression scenario or if a control shareholder would emerge to force the issue.
Disclosure: The Author owns shares of Hurco purchased at an average cost of $13.28 per share. The author has no plans to purchase more shares or to sell his holdings at the time of this writing. This article should not be considered a recommendation to buy or sell securities and readers should conduct their own due diligence prior to making any investment decisions.