I have enjoyed owning this company since the spin-off, but currently the valuations makes no sense any more. OFLX is trading at 16x expected 2006 EBITDA and a 2006 P/E of 26x. The implied cash yield is less than 4% (cash earnings/stock price) which is less than my checking account interest rate. The only way one can justify paying these prices is if the company continues and accelerates its growth. My concerns on further growth:
1. The flexible pipe product is not new - OFLX has had it for several years. They are gaining market share, but mostly have enjoyed strong tailwinds in the housing market. Over 50% of their revenues come from new construction - see latest 10Q elaborates on their exposure to the housing markets.
2. Because of the exposure to the housing markets, revenues and profitability are somewhat seasonal with the weakest quarters being ahead of us - there is an explicit reference to this in the spin-off filing From 10-12G/A.
For everyone following the developments in the housing market the risks above should be huge red flags. In conclusion, I believe that OFLX is a great business with an interesting product but at the current stock price OFLX is not a good investment due to the extremely rich valuation based on very vulnerable growth assumptions and much bigger downside exposure than upside potential. From a valuation perspective buying or holding OFLX at the current stock price levels is a speculation, not an investment. So I'm taking my profit and look for the next opportunity.
Hope you found my thoughts helpful. Good luck to everyone.
There was a comments that OFLX�s shares �have come back to earth�, �OFLX lost $80 million in market cap because $11 million liability�, etc. My view is different and entirely based on valuation. Currently OFLX is trading at over 20x 2006 P/E or 5% cash yield � when I wrote my first comment on Aug. 25 it was trading at 2006 P/E of 26x, or 4% cash yield. While valuation has come down, I think it is still rich! Many saving money market accounts and CDs pay this yield with zero risk. True, OFLX has a good growth potential, but I see three medium term risks - one secular, one seasonal, and one company specific, which increase significantly the downside exposure of the stock: a) the slowdown in the housing market will potentially have a negative impact on OFLX�s growth; b) housing is seasonally slow in the 4th quarter which this year could be more pronounced than in the past; and c) the $11 million legal liability is not provisioned for, which means that it will have to go through the income statement - as a result OFLX might end up reporting a negative, or marginally positive net income for 2006.
This is not a well covered stock, and given that IBD 100 � type investors don�t seem to work thoroughly through the numbers, eliminating one-time events, and looking at normalized earnings, OFLX might get penalized when the name drops from this or that stock list because GAAP net income drops dramatically in 2006, or any of the other factors mentioned above impact the performance of the company. In a nutshell, even if I ignore the $11 million charge, at 5% cash yield there�s too much risk and not enough upside in my view.
Two additional points. There was a comment that OFLX could be bought � this is theoretically possible, but highly unlikely given the history of shopping this company before the spin-off, the minimal potential synergies, and last but not least the rich valuation which will play a role in any acquirer�s decision-making. This has been discussed at length on this post, so I am not going to be repetitive. Of course anything is possible, but I am not inclined to make an investment on something which in my view is such a remote possibility.
There was also a comment that insiders were buying. While this is true, the amounts in my mind are symbolic at best. A director bought 250 shares, an officer bought 100 shares and the CEO bought 1,000 shares. I will leave without comment the fact that a CEO whose cash compensation for 2005 was over $900,000 chose to show a vote of confidence by buying a total of 1,000 shares since OFLX was spun-off for a total of $19,620.
Regarding the latest OFLX stock price drop, it is easy to take credit when the market moves in the expected direction. However, as one of the all-time best investors has said �in investing one is right not because many people happen to agree with him or because important people agree with him, but because his thesis is accurate, his facts are accurate and his logic is accurate�. So I want to thank everyone for their comments and welcome any valuation-based discussions.
There was a comment that OFLX is on the IBD 100 list. I would like to provide two comments on this: a) this is not new news - this occurred a couple of weeks ago; and b) this has no relationship to the valuation of the company.
The IBD 100 Index is a computer generated index which selects companies based on 2 criteria: operational performance and stock price performance over the past 12 months (for a complete explanation on the criteria see the paragraph below from IBD's website). The only criteria which brought OFLX to the IBD 100 list is the stock price performance over the past 12 months - profitability and industry position has been the same 12 months ago. The fallacy of the IBD 100 list is that it does not look into the future and doesn't look at the valuation at which companies trade at their current stock prices. The fact that OFLX made the list only after the stock price rallied with no fundamental business/operational changes says it all. In fact, as elaborated earlier, OFLX is facing headwinds from the housing market, but of course this is not a criteria applied by the IBD computer model.
In other words, there could be a complete disconnect between the operational performance of a company and the price at which it is currently trading. Such is the case with OFLX which is a good company but the stock price has gotten out of hand.
IBD's description of how they generate the top 100 list:
How are IBD 100 stocks selected?
The IBD 100 is a computer-generated ranking of leading companies trading in the U.S. Rankings are based on a combination of each company's recent record of profit growth; IBD's Composite Rating (which includes key measures such as return on equity, sales growth and profit margins); and relative price performance over the last 12 months.
Again I have to disagree with your comments on Omegaflex making the IBD 100 list. It gives crediablity to the stock. If you noticed in the comments it said that 70% of the stock is owned by officers of the company. So they have a great interest in seeing good returns.
Replying to your statement on the housing market slowing down. Yes, new starts are off by 7 to 10% depending on what part of the country your looking at, but they could be off by 50% and this product would still grow. Builders now more than ever are looking at their cost and labor cost are at the top of their list. This product saves 70 to 90% of the labor required to install gas piping. Also there are not enough people to do the work. Growth of this product will continue.
Boy have you missed the boat. CSST has only penatrated 55% of new housing starts. Growth will continue until it reaches 75%. Also there is a large commercial market that is only 2% oppened.
Thanks for sharing your thoughts.
With regards to the note that the market thinks this stock is not overvalued I'll only say that small cap stock are not well followed and understood (especially when there's no research like in the OFLX case), so in the short-run the stock price reflects nothing but the current sentiment not the underlying value of the company. Based on my calculations, outlined in detail in this post, this stock is way overvalued at the current stock price.
To the second comment of 55% penetration going to 75% penetration, etc. I welcome the discussion and would ask for the following clarifications: a) what is the source of this data; b) how does that translate into specific growth assumptions over the next few quarters for OFLX; and c) how does that get factored into the current valuation of OFLX.
I welcome a discussion based statements supported with specific facts and numerical calculations of expected returns. One-line statements might sound good but are hardly sufficient in my mind to substantiate an investment conclusion. For now, I remain convinced in the overvaluation of OFLX based on no new growth or profitability indications - compared to one year ago when the company was valued at 1/2 its current price, but the opposite - expected slowdown in the housing space. I welcome an exchange of views and look forward to feedback on the above.
There was a question on OFLX�s exposure to the housing market. My assessment is that the exposure to the new housing space is about 50% of revenues with the remainder being replacements of existing pipes. This is based on comparable company analysis and conversations I've had with people in the industry. While OFLX does not openly disclose this exposure they do make sure it appears both as a risk factor, as well as an integral part of their business description in their 10K, which confirms that it is a significant and material factor in their business model. Enclosed below are the relevant references.
From 10K filed on March 31, 2006
"Overview of Current Business / Business Seasonality
The demand for our TracPipe� flexible gas piping product may be affected by the construction industry�s demand, which generally may slacken in the winter months of each year due to cold and inclement weather. Accordingly, sales growth is usually higher in the spring, summer and fall, while sales in the winter may be static or rise only modestly. However, the effect of the winter weather may be offset by the increase in demand for flexible gas piping products in general as more contractors and installers choose to use flexible gas piping rather than black iron pipe."
From 10-12G/A filed with the SEC on July 22. 2005:
"Our business may be subject to seasonal or weather related factors.
The demand for our products may be affected by factors relating to seasonal demand for the product, or a decline in demand due to inclement weather. Some of our corrugated stainless steel tubing used in fuel gas applications is installed in new or remodeled buildings, including homes, apartment buildings, office buildings, warehouses, and other commercial or industrial buildings. Generally, the rate of new or remodeled buildings in the United States and in the other geographic markets in which we are present decline in the winter months due to the inability to dig foundations, problems at the job site relating to snow, or generally due to low temperatures and stormy weather. As the rate of construction activity declines during the winter, the demand for our corrugated stainless steel tubing may also decrease or remain static. The decreases that may be inflicted due to seasonality and poor weather may be offset somewhat by the increase in the use of corrugated stainless steel tubing from contractors who previously used only the traditional black iron pipe. However, the market share for corrugated stainless steel tubing in the fuel gas application within the construction industry may reach a finite point, and there can be no assurance that the decline in demand for our products or a decline in the growth of our products will not occur."
I agree that there was no auction run at the time of the spin-off, but I am sure the right potential buyers have been approached. I also agree that a year ago OFLX had $48 million in sales and if it reaches $100 in 4 years it might be a more attractive target. But that's in 4 years and the acquirer�s decision will factor in the valuation at that time along with all other considerations. I don't think that a strategic buyer will acquire the company today at a 2x to 3x higher valuation from what they intended to pay a year ago simply because the current stock price suggests that. BTW, all short listed strategic buyers supply to the same end markets, so they are all very aware of the current housing market dynamics.
On cost savings, clearly if an acquiror chooses to fire the top management they can save some money. However, they will be paying significant change-in-control buyout packages which will offset the savings for a couple of years and will be losing some pretty good talent which has been the reason for OFLX's business success to date.
To be clear, I am not saying that someone cannot come and buy the company at a much higher valuation - anything is possible. But it is highly unlikely based on all the history and the current valuation. This is why I cannot base my investment thesis on a potential but unlikely buyout. I continue to believe that the problem is not in the business, which is very good, but in the current price per share which makes this an unattractive investment.
<< From a valuation perspective buying or holding OFLX at the current stock price levels is a speculation, not an investment. So I'm taking my profit and look for the next opportunity. >>
Ok, you are entitled to your own opinion. (but not your own facts) OFLX is an exceptional business, in a growth market (worldwide), with outstanding management, clearly the best in the industry, by far. That is my opinion.
More important, nothing in OFLX's history refutes my view. Maybe its growth will be temporarily slowed in the U.S. by the housing downturn, probably so. Maybe the stock price will decline somewhat. In a serious way, I hope so. I want to buy more. This company is not an everyday opportunity; it is a gem. And the valuation (while not low) is definitely not too high, unless you seek something for nothing. Do you seek a wonderful business growing rapidly at 10 times earnings? Good luck!
Treasury bills and debt intruments yield 5%-6% ok. Yet inflation erodes the principal, and taxes do too. OFLX grows and prospers, most likely, in the meantime. Somewhat more risk? Yes. But not that much, in my opinion. The cream generally rises to the top. 26 times current earnings is not scandalous, unless you just want to steal outstanding businesses at low prices. If you are able to, kudos, congratulations. Otherwise, selling OFLX is questionable at best. Please advise your wonderful alternatives; I'm eagerly awaiting. Thanks.
I also respect everyone's opinion and this is not a matter of misrepresenting the facts. My position has been and continuous to be that OFLX is a good business. However there's a difference between a good business and a good investment - the difference is the price which is paid.
OFLX business fundamentals were the same a year ago and the growth prospects were much stronger, but the stock price was 1/2 of what it is now. A year ago the housing market was projecting very strong growth - now the expectation is 180 degrees from where it was. So in a nutshell my thesis is that paying 2x more for a business whose prospects are far from where they were is not a sound investment - it's a speculation.
Timing is important in investing and I don't see how the timing can be right to own or continue to by OFLX at the current prices. Please note that insiders seem to agree as collectively they have bought only less than 4,000 shares at 25% to 50% discount to the current stock price.
I don�t think it�s appropriate to turn this post into a stock recommendation site as the purpose is to share views on OFLX, but holding on to a stock (OFLX or any other) at any price because one cannot find a better investment is something I don�t find reasonable. Sometimes owning cash or bonds is better than taking undue risk when the risk/return proposition is out of hand. If the stock price goes down to reflect the eroding housing market fundamentals and OFLX's significant exposure to it - sure I might consider entering again. At the current stock price the risk/return proposition simply doesn't work for me any more.
I think good companies/good managements find a way to contnue to sell their product, despite changing market conditiond.
With 50% gross margins, they can afford to drive a heavier R&D program if needed.
26X PE is NOT the richest valuation in this industry-- look at thw Yahoo recap of OFLX vs other companies in this industry.
I'm riding this horse up to at least 30...
OFLX is a great business which happens to trade at unreasonably high valuation for what it is. It has nothing to do with margins, which are great, or ability to spend on R&D - I am sure they can, as can other companies in the space.
The point is that at the current stock price an investor is looking at a cash return of less than 4% which is lower than an online checking account. The growth which is needed to justify this low cash yield is expected to come from the housing industry which is slowing down dramatically.
I also want to see the stock go to $30, $40 or why not even $50, but that only depends on the next speculator/trend follower who will buy hoping that someone else will buy after him/her. This is not investing, but pure speculation and at that point it doesn't really matter which company it is and what the fundamentals are because the connection between price and value is long gone. At that stage any fact will be interpreted to support the trend, not to evaluate the company objectively. I get the feeling that OFLX has entered the zone where the valuation makes no sense any more.
I think I am missing something in the message from the original post. While the thought about the housing market is dead on, the Company also benefits from housing upgrades and repairs. I beleive that the fourth quarter has been traditioanlly the strongest year over year with the third quarter being the second strongest. the largest reason for this is home heating season and repairs that occur in conjunction with that season. Most older homes do not have flexible gas hosing. When that water heater or furnace breaks, in comes the need for it even in older constuction. Otherwise, I think this is about the price it shouldd be at currently and I woudl expect to see a slow down in the price increases, but continued increase in revenues and EBITDA for the Company over the next several quarters. Additionally, one huge overlooked fact, this Company was the first to bring to market a lightening strike rsistent hose. based on recent industry law suits this will put them at a huge competitive advantage. As I have indicated in the past, this Company is an acquisition target and someone is goinng to be willing to pay a 20% premium on the then current trading price. Because I beleive the price is right now i woudl encourage others to jumop in, because seriously, who would not like a 20% increase on their investment. Lastly, you have to like contouned buying by management and employees.
I am in agreement with your post.
However, because all investors and speculators are not necessarily logical, it does not mean that OFLX can not go higher. Momentum investors don't care about fundamental factors. In the end, I think you will have made the right choice. You may get another chance to buy OFLX back at a lower price.