VSE Corp ($VSEC) Stock – Cheap: Yes, Undervalued: Perhaps Not

by on April 25, 2012

in Public, Small Cap Value Stocks

VSE Corp (VSEC) provides engineering and consulting services to the Federal government in the USA, primarily to the Department of Defense and the US Postal Service. These include maintenance of defense equipment, naval ships, logistics support, field engineering, IT support and consulting, and foreign military sales support. The company was founded in 1959 and is located in Alexandria, VA.

Why the Stock May be Attractive

The company is currently valued at $125 million in the market and the stock changes hands are about $24/share. Last year, the company delivered $3.93/share in earnings with the revenues of $618.6 million. This gives the company a trailing PE ratio of 6.08. The current expectations also peg the forward PE ratio at 5.33.

In the recent years the company has seen its revenues decline but has managed to keep its eps declines in check by improving its margins. A number of strategic acquisitions have helped the company expand its margins, while the revenue declines reflect the uncertainty inherent in Federal government business that depends on appropriations for funding.

However, it should be kept in mind that over the long term the company has done a great job of growing its revenues.

Why You may Want to be Careful

The balance sheet is not the kind that attracts a value investor. On surface, the book value is $144 m which gives the stock a price/book of 0.87. However, you will see that out of this $144 m, Goodwill and Intangibles amount to $205 million, so its Tangible Book Value is a –62m. The company also has a negligible cash on the books. A current ratio of 1.66, while not too bad, can be a stretch if they need to raise cash in a hurry. The company also loaded up on debt to fund its acquisition of Wheeler Bros Inc in June 2011 and the long term debt, due 2016, currently stands at $145 m.

Cash Flow: Since the company has pretty much zero cash on hand, it is interesting to see how the company generates and manages cash. For this reason I went back 10 years to 2002 and found the following:

  • 2005 was the best year in terms of cash flow when the company added $12.6 m in cash
  • This was also the best year in terms of net cash balance at $12.7 m

The company is very efficient in using up all the cash it has and it is not necessarily for the cause of paying dividends to the shareholders (current yield, 1.2%) or buying back common stock (net purchase in last 10 years = zero).

It just does not look like that this company is being managed to grow shareholder value.

Bottomline

There is a difference in growing revenues and eps versus growing shareholder value. Any business can grow in size by acquisitions and other means. However, if these acquisitions do not create additional value for the shareholders, they are meaningless from an investor’s perspective.

If you do consider investing in VSEC, make sure you pay attention to its balance sheet and review if the Wheeler Bros acquisition will generate enough EBIT to pay back the debt incurred during the acquisition by 2016. A lot will of course depend on whether you believe that the margin growth is sustainable or just temporary.

There have been reports of substantial insider purchases recently. Insider purchases are a signal, but just one of the signal. Insiders can be delusional.

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