Commentary

Valuation: Graham Corporation (GHM)

Company Profile: Graham Corporation (GHM) (obtained via Yahoo Finance)

Graham Corporation designs, manufactures, and sells vacuum and heat transfer equipment worldwide. Its products include steam jet ejector vacuum systems; surface condensers for steam turbines; vacuum pumps and compressors; various types of heat exchangers, including helical coil heat exchangers marketed under the Heliflow name; and plate and frame exchangers. Graham Corporation’s products are used in a range of industrial process applications comprising petroleum refineries, chemical and petrochemical plants, fertilizer plants, pharmaceutical plants, plastics plants, liquefied natural gas production facilities, soap manufacturing plants, air conditioning systems, food processing plants, and other process industries, as well as power generation facilities, including fossil fuel, nuclear, cogeneration, and geothermal power plants. It sells its products through sales engineers and independent sales representatives. The company was founded in 1936 and is headquartered in Batavia, New York.

1) Is the business simple and understandable?

This is a simple business to understand as the company designs and manufactures custom-built vacuum and heat-transfer equipment. Due to the market flexibility of the product this company sells, we may expect this company to remain healthy thru the rest of the year.

2) Does the business have a consistent operating history?

This stock is in the machinery industry, which has generated market-like returns over the past 5- and 10-year periods. Note, however, that this company has been one of the strongest performers in its industry over the five-year period. Keep in mind when looking at a stock or industry’s record that historic returns are not necessarily a predictor of future performance. Most stocks in the machinery industry have seen steadily growing revenue and impressive earnings growth over the past three years. This stock has done even better than most of its peers as far as top-line growth is concerned, which means that its revenues have grown very rapidly over the past three years. In addition, just like its peers, this stock’s earnings per share have grown at a very high rate over the past three years. Note that this stock’s sustainable growth rate is quite a bit less than the rate at which its earnings per share have grown. That means that the company will probably have to raise additional capital from outside sources at some point if it continues to grow at its current rate.

3) Does the business have favorable long term prospects?

This stock’s forward earnings yield of 4.08% is the annual return it would generate if its profits remained fixed and it paid out all of its earnings as dividends. Not only is this much lower than the earnings yields of other stocks in its industry, it is also low in absolute terms. For this company to generate decent returns for investors, it will have to realize considerable growth in earnings or a higher valuation by the market. Over the long haul, this company has posted results that are about average for its industry, though its ROA over the most recent 12 months was very high. Note that the company’s net profit margins, another key profitability measure, have been similar to other companies in its industry.

4) Is management rational?

We find the management of this company to be rational in the way they are running the company. They have emphasized their efforts on creating a healthy and constant growth strategy that we had seen over the last three years company’s financial performance. We also came to notice a low dividend yield and constant capital expenditure which will make us believe that GHM’s management cares about their company’s growth.

5) Is management candid with its shareholders?

The GHM’s investor relation webpage contains information on the research analysts that cover this company, SEC filings, Financial news on GHM, investor factsheet, shareholder account question free toll line, and other features that builds investor confidence on the way management are treating them.

Financial and Value Review

Click here for a review of our method of screening companies.

Defensive:

1) Size of firm

This company’s market capitalization of $546 million is lower than $2 billion, which is what defensive investors require. “Fail”

2) Strong financial condition

The current ratio of 3 is greater than 2. “Pass”

3) Earnings stability

GHM has not had positive net income for the previous 10 years. “Fail”

4) Dividend record

The company has not paid dividend constantly for the prior 10 years. “Fail”

5) Earnings growth

Over the past 10 years there has been earning growth of at least 33%. “Pass”

6) Price to earnings analysis

Its PE is of 28.7 which is greater than 20 and the Metal Fabrication industry average of 18.7. “Fail”

7) Price to assets analysis

The PB ratio and PBxPE are both more than 2.5 and 50 respectively. “Fail”/”Fail”.

Overall

Having passed only 2 of the 7 required defensive investor’s tests, we believe that Graham Corporation will not be a suitable investment for the defensive investor following Benjamin Graham’s investment strategies.

Enterprising:

1) Strong financial condition

This company current ratio is higher than 1.5. “Pass”

2) Strong financial condition

GHM’s debt to net current asset is lower than 1.1. “Pass”

3) Earnings stability

Graham Corporation has not maintained a positive net income for the past 5 years. “Fail”

4) Dividend record

This company currently pays dividends. “Pass”

5) Earnings growth

The company’s earnings are currently higher than they were 5 years ago. “Pass”

Overall

Having passed only 4 of 5 of the enterprising tests, we feel that Graham Corporation may be suitable as an investment for the enterprising investor.

Valuation:

Our valuation model finds a fair value to be around $98.75.

Opinion:

Since the company is currently trading at about $104.38, we feel it is currently over priced and that it may only be a suitable company for enterprising investor. However, we recommend further research by the reader prior to making any investment decisions.

The author did not hold a position in GHM at the time of publication. Also, please read our disclaimer and Our Methods.

Andres Romero
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https://www.moderngraham.com
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