National Presto (NPK) Dividend Stock Analysis

Summary

National Presto Industries (NPK) is an oddly diversified producer of military arms, adult diapers, and small cooking appliances with a market capitalization of well under $1 billion.

-Revenue growth rate over the last three years: 4%
-Net Income growth rate over the last three years: 18%
-Dividend growth rate over the last three years: 25%
-Current dividend yield: 7.30%
-Balance Sheet: Extremely strong, with tons of cash and zero debt.
-NPK’s CEO, Maryjo Cohen, owns 30% of the company.
-All of this comes with a P/E of only a bit over 12 as of this writing.

My conclusion is that National Presto is very good long term stock pick based on the large dividend, diversification, extremely strong balance sheet, and reasonable growth prospects, but that it should be purchased with a large margin of safety due to unique risks.

Overview

National Presto Industries Inc. (NYSE: NPK) was founded in 1905 in Wisconsin. The company has long since produced a wide range of small cooking appliances, and in the past several years has made acquisitions to be a producer of small military products and adult absorbent products.

NPK has been in business for decades, and currently consists of three business segments:
-Housewares/Small Appliance Segment (33% of total sales and 28% of total operating profit)
-Defense Products Segment (50% of sales and 63% of total operating profit)
-Absorbent Products Segment (17% of sales and 9% of total operating profit)

That’s good diversification, ranging from pressure cookers to ammunition to adult diapers. Their appliances are numerous, ranging from products for pizza to popcorn, deep frying, tea kettles, grills, griddles, and more. The defense segment produces ammunition, fuses, cartridges, and precision mechanical and electro-mechanical assemblies. The company also has a portfolio of over $100 million in short-term investments.

Revenue, Income, Cash Flow, and Metrics

NPK has had impressive growth over the years, but growth in the future will be at a more realistic level.

Revenue Growth

Year Revenue
2010 $479 million
2009 $478 million
2008 $448 million
2007 $421 million
2006 $305 million
2005 $185 million

Over this period, the five-year revenue growth was 21%, and the three-year revenue growth was a bit over 4%. Largely this is due to a difference in acquisitions, with the past being strongly influenced by extremely successful acquisitions, and so the more recent period is more predictive of future results. The company does, however, expect to make future acquisitions.

2010 revenue saw a big bump from appliances and absorbent products (5% and 8.2%), but a reduction in sales of the defense segment due to timing differences between the comparable years.

Income Growth

Year Income
2010 $63.5 million
2009 $62.6 million
2008 $44.1 million
2007 $38.6 million
2006 $28.0 million
2005 $19.0 million

Net Income has grown by 27% annually over this five year period. It has grown by 18% over the current three-year period, and has had negligible growth in the past year.

The company faced increasing commodity and transportation costs in 2010, and expects the trend to continue in 2011. Increased state taxes also bit into their profits, and their short-term investment returns are being held down by the low Federal Reserve interest rates.

Operational Cash Flow Growth

Year Cash Flow
2010 $57.8 million
2009 $62.1 million
2008 $35.3 million
2007 $38.0 million
2006 $5.5 million
2005 $22.3 million

The cash flow pattern is similar to net income, although a bit more erratic. The defense segments routinely provide timing differences.

Metrics

Price to Earnings: 12.2
Price to FCF: 13.5
Price to Book: 2.25
Return on Equity: 18%

Dividends

Among the strongest aspects of NPK stock is the dividend, which is paid once annually after the previous year’s results have been stated. NPK pays a regular $1 dividend every year. This is the dividend that shows up on most stock screeners. With such a low yield, people barely take notice. But, NPK also pays a special dividend every year based on profits. All dividends paid are adequately covered by earnings, and they reserve dividend flexibility by calculating their annual dividend based on their annual earnings.

Dividend Growth

Year Regular Dividend Special Dividend Total Dividend Dividend Yield
2011 $1.00 $7.25 $8.25 6.60%
2010 $1.00 $7.15 $8.15 6.50%
2009 $1.00 $4.55 $5.55 9.00%
2008 $1.00 $3.25 $4.25 7.00%
2007 $0.95 $2.85 $3.80 6.00%
2006 $0.92 $1.20 $2.12 4.50%

Over this five-year period, NPK has grown its dividend by approximately 31% annually on average. The three-year dividend growth is a bit under 25%. The most recent increase, however, was only around 1%.

The most recent dividend, which was declared in 2011 based on 2010 performance, was $8.25, and EPS was $9.26. The company paid out approximately 90% of its earnings per share as dividends. Keep in mind that NPK holds to a flexible dividend policy, so the payout ratio is intentionally high. The company doesn’t perform share repurchases, and instead pays out excess cash in the form of special dividends.

The dividend yield as of this writing, based on the total dividend paid out earlier this year ($8.25) divided by the current stock price (which has since dipped to a bit over $112), is over 7.3%.

Balance Sheet

NPK has a current ratio of nearly 5, has zero long-term debt, and their goodwill is negligible compared to their equity. Their financial position is therefore essentially flawless.

Investment Thesis

Sometimes dividend portfolios can be too concentrated in large-cap stocks. What I truly love to see is a small or medium sized company with reasonable growth prospects paying a dividend. To me it’s the best of both worlds. National Presto Industries, Inc. is just that sort of company.

In addition, the long-tenured chairperson and CEO Maryjo Cohen currently owns an impressive 30% of NPK. With hundreds of millions invested into this company, her interests are aligned with shareholders. That explains why this has been such a shareholder friendly company over the last several years.

The company has:
-An attractive valuation
-An extremely strong balance sheet
-Impressive backward growth with reasonable forward growth prospects
-A large and sustainable dividend
-Large insider ownership (mainly by the CEO)
-Simple and practical products in diversified segments
-Fairly strong free cash flow, because they pay very little in capital expenditure.

When it comes to catalysts for future growth, the defense segment looks to increase vertical integration to increase profitability, and the absorbent products segment has ordered a new machine, expected to be in operation in Q2 of 2011, that will produce gender-specific disposable underwear, ease capacity restraints, and expand the customer base. The segment expects to enter the retail market while continuing to compete in the institutional market. The defense segment’s backlog has grown from $274 million in 2009 to $329 million in 2010.

Although NPK is currently facing pricing pressure, the sales growth of their appliance and absorbent segments is promising. The company has shown enormous resiliency in this difficult economy, and performed exceptionally well in the period before when the economy was strong. I expect that as the economy improves, and interest rates eventually increase, NPK will rebound and continue reasonable growth.

The strong balance sheet and huge dividend mean that very little growth is even necessary to get reasonable returns, but growth is expected to be icing on the cake to increase overall returns. Current management has shown strong ability to grow the company organically and through acquisitions, so there is substantial potential upside in the future.

Risks

NPK has an odd risk profile. On one hand, their diversification into completely different markets provides risk reduction, and their products across all categories are very practical and needed. Combined with a beautiful balance sheet and conservative and frugal management with large insider ownership, NPK has a lot of stability.

On the other hand, NPK does have a fair number of significant risks. Their appliance and absorbent products segments face commodity cost issues, and rely on Wal-Mart and Medline Industries for significant percentages of appliance and absorbent products sales. (And Medline is currently building its own absorbent products segment that will likely eventually result in a reduction of business with NPK.) Neither of these two segments has an economic moat worth speaking of, so their pricing power is limited. In addition, NPK has contracts with the United States Department of Defense which add a lot of risk because NPK could potentially lose these contracts. Their defense segments rely on this very large customer. In 2005, they formed a five-year contract for 40mm ammunition systems with the Department of Defense, and in 2010 this contract was awarded for another five years. The amount of sales under the contract can vary from year to year, as funding and requirements change.

A potentially lucrative risk is the stock price volatility. Last year when I analyzed NPK, its stock price was a bit higher than it is now, and had recently had a large price increase, and I warned that it could potentially have a large price setback. In doing so, I mentioned that such a setback would be a good buying opportunity as long as the fundamentals remained intact. Sure enough, months afterward, the stock price dropped over 25% to under $90/share, and has since climbed back up to around $110+ (and for a while, significantly higher at nearly $140). I used this reduction in stock price as an opportunity to increase my position size and reduce my cost basis. The same thing may or may not happen in the coming year. With this stock, I find it a good idea to really focus on dollar-cost-averaging. Due to the volatility, it’s best to enter one’s position over time, so that one can spread the risk out and potentially decrease the cost basis of the purchased shares.

Conclusion and Valuation

If you want a small to medium sized, diversified, high-yielding company with decent growth prospects, zero debt, shareholder-friendly management and an earnings multiple in the low double digits, and you can stomach some volatility and an unclear political future, NPK might be a good pick. Based on the small size, even with the high payout ratio there is substantial growth potential, and the company pays a very large dividend.

Based on earnings of $9.26/share for 2010 and a reasonable P/E considering the growth and the dividend to be 15 in my opinion, I think shares are reasonably valued as long as they remain under $140, but it would be prudent to seek a significant margin of safety due to the varying risks.

Full Disclosure: I own shares of NPK.
You can see my individual holdings here.

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The Usefulness of Asset Allocation

Asset allocation, the practice of deliberately using several distinct forms of investments to accumulate or preserve wealth, has both obvious and subtle advantages. Various forms of investment include, but are not limited to, stocks, bonds, real estate, options, commodities, insurance, and currencies.

The Obvious Advantage

Most people readily grasp the obvious advantages of asset allocation. By spreading one’s wealth among a variety of investment types, one avoids “putting all of their eggs in one basket” and therefore reduces risk by reducing concentration. Sometimes stocks have bull runs and sometimes they have bear runs, sometimes bonds have solid returns, and other times they have low returns, and so diversifying between asset classes can reduce volatility and exposure to any particular risk. Fixed income investments have inflation risk, while equities are fairly resistant to inflation over the long-term. Equities are more volatile and have a more complex risk/reward profile.

The Subtle Advantage

Asset allocation is a bit more powerful than simply the obvious advantage. It allows one to, either actively or passively, take advantage of upturns and downturns in various asset classes.

Consider the simplified example of a portfolio perpetually consisting of 60% stocks and 40% bonds. Stocks and bonds tend to have imperfect inverse periods of highs and lows. In other words, when stock indices are going up, bond indices are often going down, and vice versa.

If one keeps their portfolio consistently allocated according to the 60/40 distribution, then they will be buying and selling stocks and bonds as the markets go up and down. When stock indices go up, the stock part of the portfolio will increase, and that would lead to the portfolio no longer being balanced with a 60/40 distribution. So, to counter that, some stock would have to be sold, and bonds purchased, in order to bring the distribution back to 60/40. Then, at a later time, when stocks have a considerable drop, the stock part of the portfolio will decrease, and that again would lead to the portfolio no longer being balanced with the 60/40 distribution. So, to counter that, some bonds would have to be sold, and stock purchased, in order to bring the distribution back to 60/40. A similar effect can be done by choosing to put regular contributions into whichever side is under-balanced.

If one keeps this up, they are essentially forcing their self to buy low and sell high. When stock indices are high, they are selling stock and buying bonds in order to get back to the 60/40 distribution. When stock indices are low, they are selling bonds and buying stock in order to get back to the 60/40 distribution. This approach, almost robotic-like in nature, allows one to buy low and sell high without attempting to predict market movements or time the perfect highs and lows.

This example can be expanded to include multiple asset classes. For instance, the “stock” category can be divided between domestic large caps, domestic small caps, and foreign stocks, and as their various indices go up and down, the wealth will be continually distributed among them.

Asset Allocation Doesn’t Necessitate Passivity

Many forms of asset allocation involve passive investments, but asset allocation should not be understood to necessarily mean a strictly passive investment strategy, although that’s one possibility. In fact, while I do not argue with the usefulness of index funds, I promote individual active investing in addition to them.

Why? In this particular article, I’m not going to get into the debate about whether passive or active investment is more likely to produce better returns for a given individual investor. Passive investing is an excellent financial strategy in many cases, and active investing may or may not produce better returns than this low-maintenance, high-reward strategy. Instead, the reasons I encourage individual stock selection are:

-The ramifications of citizens not having control of their country’s corporations are unfortunate in my view. With so much index investing and mutual fund investing, where people are invested in the economy as a whole with little concern for individual investments or shareholder voting rights, corporations are in a position to operate in a way that does a disservice to society. When the masses give up their voting rights into the hands of a few, rather than take active interest in the economy of their society, I find the situation to be problematic. What more could a board ask for than for shareholders to indirectly provide capital while willingly giving up their voting rights and attention?

-Some people panic or get confused when their passive retirement accounts decrease. There’s a sense of lack of control when people don’t understand their investments. Some people view the stock market as a casino, and some people take money out during market bottoms out of fear. When you’ve thoroughly analyzed a company, and can observe the specific results of their operations, the strength of their balance sheet, and their continued ability to pay and increase their dividend, then one becomes virtually immune to worry about stock price movements. One begins to only care about company performance. Disciplined passive investors can, however, achieve similarly powerful mindsets.

-Many people are unfortunately financially illiterate. I encourage people to be well-rounded: literate in science, history, business, culture, and so forth. Although not everyone is suited for active investing, the excuse that people are too busy doesn’t hold much water in my opinion.

-Although some forms of passive investing allow one to be a dividend investor, many of them do not. I feel that acquiring robust streams of passive income from investments that one understands is an important aspect of wealth, and many forms of passive investment don’t focus on it.

Conclusion

Regardless of whether you’re a passive or active investor, realize the obvious and subtle advantages of asset allocation, and use them to your advantage by understanding that asset allocation is more than just the sum of the parts. Keep your wealth growing and safe, and utilize approaches to buy at good prices without trying to predict market highs and lows.

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Minimalist Challenge #5: Save/Invest Your Entire Tax Refund

Those of us that wish to build ever-growing passive cash flow and wealth would do well to take a minimalist approach to life once in a while. We all try to keep spending in check, but I think it would be useful to try some positive challenges on minimalism from time to time.

So, here’s a sporadic series of articles outlining some challenges that we can take to improve our financial situation and even more importantly to increase our appreciation of other aspects of life.

Minimalist Challenge #5

Minimalist challenge number five is, if you have a tax refund, to save your entire tax refund.

This one’s shorter than other minimalist challenges, because it’s self-explanatory. Rather than using a refund as an excuse to spend a bit more, save all or most of it.
-Use it to boost your emergency savings.
-Invest it.
-Use it to pay off debt.

Whichever of the above options is most appropriate for your situation, if you have a tax refund, consider saving all or most of it. It gives you a quick boost towards the beginning of the year in terms of saving money and building wealth and financial security.

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