K-Tron (KTII) Business Valuation

Gone are the days where people wearing coats, gloves and nets in their hair, stood in a line counting/measuring and packaging nuts & bolts, grain, chemical, pills, food etc.

Nowadays, factories, companies, assembly lines all automate for precision and efficiency. How? With feeders,conveying systems and other related equipments handling bulk solids. I find the business boring don’t you? Yet, I am excited by this boredom.

Business Summary

K-Tron is engaged in one principal business segment, which is material handling equipment and systems, and their operations are conducted largely through subsidiary companies. They design, produce, market and service material handling equipment and systems.

Business is operated through two separate business lines;
– The Process Group which focuses primarily on feeding and pneumatic conveying equipment.
– The Size Reduction Group which concentrates on size reduction equipment, conveying systems and screening equipment.

The Process Group (excerpts from the 2007 annual report)
The feeding equipment, which is sold under the K-Tron Feeders brand, controls the flow of materials into a manufacturing process by weight (known as gravimetric feeding) or by volume (known as volumetric feeding) and is used in many different industries, including the plastics compounding, food, chemical and pharmaceutical industries.

The pneumatic conveying equipment, which is sold under the Premier Pneumatics brand, addresses a broad range of pneumatic conveying applications that involve the handling of bulk solids. K-Tron Premier Pneumatics equipment and systems transport bulk solids from one point to another point with negative pressure (known as vacuum conveying) or with positive pressure (known as pressure conveying) and are used in many industries, including those served by the K-Tron Feeders brand.

Servicing and Parts is also a part of the Process Group where a global service network responds to customer calls within 24 hours almost anywhere in the world. K-Tron also sell parts to customers, and their service and parts business associated with sales of the equipment is an important source of revenue.

The K-Tron Electronics division produces and tests electronic assemblies. The design and production of products sold by K-Tron is done in house.

Size Reduction Group (excerpts from the 2007 annual report)
The subsidiaries that make up the Size Reduction Group are Pennsylvania Crusher Corporation, Jeffrey Specialty Equipment Corporation, Gundlach Equipment Corporation, Rader Companies. All of these companies design, manufacture, market and sell size reduction equipment, such as hammermills, wood hogs and double roll crushers. This equipment is used to resize various materials to a given smaller size, and the principal industries served are the power generation, coal and minerals mining, pulp and paper and wood and forest products industries

Growth Strategy

I am confident in saying that K-Tron is as close to recession proof as they come. Although it isn’t a company that directly produces and sells necessities such as food, medicine, toilet paper etc, companies require feeders and conveyors to transport and control materials. People may shy away from Italian handbags and stallions, but food, pharmaceutical and chemicals are required by consumers. Due to this, look at the lack of correlation between K-Tron and the market. Additionally, for the past 6 years, the stock has been steadily moving on up without much notice. Well actually, the stock has been rocketing upwards and I don’t see any big firms or analysts covering K-Tron yet. With an average volume of 6000-8000, it is a very thinly traded and undiscovered company.

K-Tron generated 36%, 34% and 38% of their sales overseas in 2007, 2006, 2005, mainly in Europe, with operations and manufacturing facilities in the United States, Switzerland, the United Kingdom and China and sales and service offices and representatives in more than 60 countries. They have expanded into China by purchasing certain assets of Wuzi Chenghao Machinery Co, a privately owned Chinese company in March 2007 that is targeted at the domestic plastics compounding and injection molding markets in China. This shows that K-Tron acts on its goal of diversifying into complementary products and new markets.

Growth was partly organic and partly driven by acquistions but excluding acquisitions, in 2007, K-Tron was able to deliver a 25.6% increase in revenue and 70.6% in operating income from their Process Group but The Size Reduction Group increased slightly.

“Demand is strong and K-Tron entered 2008 with its biggest backlog in its operating history.”

Competitive Position

K-Tron has complete control over the design and manufacture of its own weighing, mechanical and control systems. Their intellectual property as well as the ability to completely custom make solutions is a great plus. Holding more than 98 patents for weighing, mechanical and control technologies and their application to bulk solids handling further helps the cause, but it is stated in the annual report that even though patents are expected to expire soon, it should not have any adverse affect on the business.

K-Tron is considered to be the leading producer of feeders and related equipment primarily because of the use of digital control technology and digital weighing technology, their development of mechanical design improvements to products and extensive knowledge of material handling applications.

Both the feeding and conveying equipment industry have strong competition but because of the numerous types of applications and the requirement of specialized equipment to suit each need, these niche type applications provide plenty of business opportunities which K-Tron can capitalize.

For a company its size, it has a surprisingly wide moat. With its large distribution and operations base spanning 60 countries, K-Tron is able to gain traction to penetrate into different markets. Also, due to the nature of the business, once a system has been either sold or custom designed, there is a high switching cost and most probably lots of anguish by the customer should they try to switch their equipment to another company. This also leads to a high barrier of entry. I believe that companies that purchase feeder and conveyors would pay the extra money to stick with the knowledge that they are in good hands.

Risks

As boring as the business seems, there are still some risks involved but nothing overly worrisome such as a rapid industry, lack of moat or no cash. Competition is always a factor, but a specialized niche market won’t attract the big fish. K-Tron factors this in by acquiring companies both locally and overseas.

As an industrial capital goods supplier, cyclicity may be an issue. During economic contraction or recession, demand would decrease. However, as intelligent investors, we know that contractions come and go, and it is the long haul that is important.

The more important risk is the way K-Tron also tends to grow by acquiring businesses. The thing is, acquisitions don’t always work. Integrating two companies is a difficult process and if the two companies aren’t synergised, it could be a mess. Look at the mess Gary Forsee made at Sprint with the Nextel merger.

Management

Very high insider ownership. The CEO, Edward Cloues, owns 271k shares totalling 9.8% of the company. Total insider ownership comes out to 16.31%. It’s safe to assume that insiders definitely want to create shareholder wealth and their visions are aligned.

For 2007, the CEO was paid a total of $1.5 million, but compared to the revenue of $202 million he helped orchestrate, I believe that he is on the “value” side of CEO pay rates with his pay being at 0.7% of 2007 revenue. Also, Im glad to see the company isn’t paying out money for personal yachts etc. I just can’t stand to see companies use shareholder money for a private jet or cruiseliner.

(Due to the lack of information available for K-Tron, I was not able to find any transcripts or conference calls to get additional information)

Valuation

Financially, K-Tron has some very impressive numbers. For the past 10 years the average numbers were as follows; gross margins constantly above 40%, operating margins around 10%, ROA at 8% and ROE at 20% and CROIC at 11.6% which is higher than the current 6% interest on debt they are paying. Meaning, K-Tron was able to make around 11c cash for every dollar invested.

Refer to the image below to see the financial performance for KTII from my intrinsic value spreadsheet.

For KTII, Morningstar has the wrong values for the number of shares outstanding so I corrected the numbers from those in the annual report to get the correct historical shares outstanding.

10 years of data shows me that K-Tron has been able to generate FCF at 30% annually. Will it be able to continue? I don’t know, but considering that K-Tron is a boring business without too much “change” in the industry, I don’t see why it can’t grow at 23%. Revenues have been growing at 60% year over year and other growth aspects are excellent.

Price wise, it seems like it is currently trading at a 38% discount to its intrinsic value. Basically, selling at roughly 60c to the dollar. Not the 50c that I like, but a good, stable, long term business at 60c sounds pretty good to me. Refer to the Wrigley’s example to see why Wrigley’s would have been a good investment if you were long from the early stages.

(Ben Graham tells me that he thinks that K-Tron is worth $287. )

However, don’t let the share price of $138 throw you off, the market cap is only $375 million so there is plenty of growth available.

Opinion

The past 6 years have been incredible for K-Tron, yet there are no analysts following the stock. High stock price and low number of shares may be a reason why K-Tron doesn’t have the recognition it well deserves but I believe that K-Tron has the capacity and ability to hit the radars of the big boys.

With so little information available on K-Tron, I’ll be providing updates when I can but this is a company that bores me to sleep. At least when I wake up in 5 years, I’ll be very happy.

So far I have found 2 blogs who also posted something on K-Tron (broken links).

1. Everyday Finance; K-Tron: A Diamond in the Rough You’ve Never Heard of.
2. Mongaup Investing; K-Tron (KTII) (Price: $138, Intrinsic Value: $165).

This blog shows KTII to be 52% overpriced which I find hard to believe after looking at their other calculations.

Disclosure: I own shares of K-Tron