Background: With its high correlation to the Purchasing Managers Index (PMI) and short lead times for shipments of orders, Sun Hydraulics (SNHY) (“Sun”) gives an early glimpse into demand in the industrial sector. Sun Hydraulics is headquartered in Florida. It makes products having the exciting sounding name of: “screw-in hydraulic valves.” Two thirds of its products are used in the mobile market, which includes off road construction, agriculture, utilities, oil and mining. The other one-third is sold to industrial markets such as power units, automation, machine tools and plastics tools.
So what is Sun saying about its markets now? On the November 8 conference call the company disappointed the Street by guiding to fourth quarter revenue of $44 million below the third quarter revenue of $53 million and expectations of $49 million. It blamed the shortfall on order weakness caused by a slowdown in the PMI readings. (Remember, demand for Sun’s products is highly correlated to the PMI.) After peaking in June, the PMI has hovered around the low 50s. Orders for Sun began to slow in July and August.
Valuation: The company expects to earn $1.50 in 2011. At the present price of $23 it has a P/E ratio of 15. For a company that could grow revenues at 10% and earnings at 15-20% over the long haul, a P/E of 15 is reasonable.
Technical Analysis: A look at the chart on BigCharts.com shows a flat 200 day moving average. This illustrates that the market view is balanced between bulls and bears and is waiting for a move up or down through the trading range. The MACD line is near zero and looks ready to have the red line cross the blue line which usually signals a buy point. There is major technical support at $22 and the panic bottom for the year was recorded at $20. (It was at $20 for only two days.) Because earnings were mildly disappointing there may be little buying pressure to move the stock up before the end of the year.
At its current price, the stock is down about 8% for 2011 so there will be little tax loss selling in November and December. I would buy it now at $23-22 if one believes the economic picture will improve, even if only modestly. The best and safest price to buy is $20, but I doubt it will reach that level before the end of the year. I do not foresee enough bad economic news to push it down to that level before the end of the year.
Balance Sheet: Sun has no debt and a very strong balance sheet. Its current ratio is 7.5 to 1. (2 to 1 is considered strong) It has a large amount of cash on its balance sheet as shown by its quick ratio of 6.5 to 1.
Recommendation: Sun is a solid company which is growing share in a niche industrial market. The company has been profitable for 38 years in a row. In a market where sales grow 4-5% a year it has grown revenues at 10-15% a year. This shows that it has been gaining market share steadily. The PMI is a strong leading indicator for the company. If you believe that global industrial production will pick up, then Sun is a buy. If your view is that economic growth will slow, I would only buy Sun at a price which discounts a slowdown such as $22-20.
Sun is a microcap stock that averages 50,000 in daily trading volume. Since it is a thinly traded stock, it is subject to wilder price swings than normal. This makes it good for short term trading if you are so inclined. Long term investors who can ignore the recent volatility in the stock market may also be interested since it has a sustainable path to market share gains and is growing its addressable market.
If you believe that the world economy is on the verge of stronger growth Sun would be a nice play—short term or long term.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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