RealMoney Silver - Two Gurus Give Nacco the Nod

Two Gurus Give Nacco the Nod
By John Reese
RealMoney.com Contributor
9/6/2007 3:27 PM EDT

When one thinks of highly diversified holding companies, along the lines of conglomerates, one usually thinks in terms of large companies such as General Electric (GE) and 3M (MMM) .

Yet Nacco Industries (NC) , with 2006 revenue of $3.3 billion and a current market cap of just under $1 billion, is not really all that large, but it could be considered a conglomerate. It is, in fact, a holding company that operates in three business segments, showing you do not have to be a giant to be diversified.

First, the company makes lift trucks under the Hyster and Yale brands. Second, it operates six surface coal mines as the nation's seventh-largest coal producer. Third, it produces small household appliances under the Hamilton Beach and Procter Silex brand names. The appliances segment was to be spun off to shareholders, but because of the recent market turmoil, the company canceled the spinoff, and the business will continue to be part of Nacco for the foreseeable future.

This is quite a basket of diverse businesses and is one of the reasons I am recommending Nacco now. Because it has diverse business interests and is not dependent on one market, I believe it is in a better-than-average position to weather the current market turmoil.

The demand for coal appears strong, for example, due to energy demands. The housing downturn will likely not much affect the market for small household appliances (these are not refrigerators or stoves). Overall, Nacco is performing well, and its stock seems reasonably priced. This is a good time to load up on it.

The Peter Lynch Strategy

I use a number of strategies based on the writings of well-known investors to analyze stocks. According to the strategy I use based on Peter Lynch's writings, Nacco is a "true stalwart," with a growth rate of just under 20%. Nothing fancy here, just a company going about its business, earning good profits with a nice growth rate.

The Lynch strategy relies a lot on the P/E/G ratio, which is the P/E ratio related to the company's growth. Nacco has a strong yield-adjusted P/E/G of 0.49, based on the average of the three- and four-year historical EPS growth rates; a P/E/G of 1.0 or less is acceptable. Also in the company's favor is inventory management. Though inventories increased as a percentage of sales this year, the increase was small and the financial numbers suggest management has inventories under control.

The Joseph Piotroski Strategy

The Lynch strategy is not the only one thinking highly of Nacco; so is the one I base on Joseph Piotroski's approach to investing. This strategy requires a company be in the top 20% of the market based on the book-to-market ratio (which is the inverse of the better known price-to-book ratio).

Piotroski, an accounting professor at the University of Chicago, did a study which found that investors can earn excess returns by holding a portfolio of high book-to-market stocks. Nacco, which has a book-to-market ratio of 0.83, meets this criterion.

The next issue is to determine if the company is in trouble, as evidenced by a high book-to-market ratio, or if the stock is being treated unfairly and the ratio should be lower. Making this distinction is significant because in his study, Piotroski found that it is very important to separate companies that trade at a discount because they are financially distressed from companies that are unfairly trading at a discount.

The strategy uses several criteria to calculate which applies to a given stock. One is return on assets. To prove a company is not distressed, it must have a positive return on assets for the most recent fiscal year. This is true for Nacco, whose return on assets was 3.48% in the most recent year.

Also required is that the return on assets for the most recent fiscal year be greater than the return on assets for the previous fiscal year. Nacco's return on assets was 3.48% in the most recent year and 2.22% for the year before.

A third criterion is that cash flow from operations for the most recent fiscal year also be positive. This eliminates companies that are burning cash and, therefore, more likely to be financially distressed. Nacco's cash flow from operations was $173.5 million in the most recent year.

One more requirement is that cash from operations for the current fiscal year be greater than net income for the current fiscal year. The company's cash from operations was $173.5 million in the most recent year, while its net income was $75.12 million.

And there is still more in its favor. The long-term debt-to-assets ratio for the most recent fiscal year must be less than or equal to the previous fiscal year, which is true for Nacco.

As an additional test of solvency, the current ratio for the most recent fiscal year needs to be greater than the current ratio for the previous fiscal year, which also holds for Nacco.

As a sign a company is expanding its profitability, this strategy requires that gross margin for the most recent fiscal year be greater than gross margin for the previous fiscal year. Nacco's gross margin was 17.0% in the most recent year and 16.0% the previous year.

The final criterion is that asset turnover for the most recent fiscal year be greater than asset turnover for the previous fiscal year. Nacco's asset turnover was 1.55 in the most recent year and 1.51 in the previous year.

All of these criteria point to a financially strong company, even if its stock price is somewhat weak.

Nacco is a diversified company that should do well in many markets, including today's turbulent one. It gets strong support from two guru strategies, with both agreeing the stock price is reasonable if not cheap, while the company is performing well financially. This is a good time to buy Nacco.