RealMoney Silver - A Bet on TNB

A Bet on TNB
By Bill Trent
RealMoney.com Contributor
1/9/2008 10:30 AM EST

Looking through my screens recently, I came across Thomas & Betts (TNB) . Earnings have been consistently revised upward, to the point that its Zacks rank (a measure of earnings estimate revision) jumped from average to the best last week. The latest revision trend puts it among the top 5% of stocks in terms of earnings revision.

All the good news, however, has been falling on deaf ears. The stock is down nearly 30% from its July 2007 peak. As a result, it is now trading at 12 times estimated 2008 earnings per share, and offering a free cash flow yield of 7.8% based on trailing-12-months free cash flow.

Sensitive to the Economy?

It isn't hard to figure out why the stock is down. The company operates in three segments -- electrical, steel structures and HVAC (heating, ventilation and air conditioning) -- but more than 80% of total revenues comes from electrical.

According to the company's 10K, "Demand for electrical products follows general economic conditions and is sensitive to activity in construction markets, industrial production levels and spending by utilities for replacements, expansions and efficiency improvements." I'm not too worried about spending by utilities, but those first two revenue drivers certainly give one pause.

Starting with activity in construction markets, we all know that housing starts have cratered.

Housing Starts

Click here for larger image.

Source: Data360.org, U.S. Department of Commerce, Census Bureau

Turning to industrial production ... well, it ain't looking so hot either.

Year-Over-Year Change
in Industrial Production Index

Click here for larger image.

Source: St. Louis Federal Reserve; William A. Trent

So if Thomas & Betts' business is sensitive to construction activity and housing starts, one might infer that sales have taken a similar turn. But one would be wrong.

Sales for the electrical segment rose more than 12% in the first nine months of 2007, ahead of the overall company average. In the third quarter, the gain was 18.5%, though this was driven in large part by the acquisition of the Joslyn Hi-Voltage and Power Solutions businesses from Danaher (DHR) in July 2007. On a pro-forma basis, growth assuming continuous ownership of Joslyn would have been 10% for the third quarter and 7% for the first nine months.

Instead of falling off a cliff, growth accelerated in the third quarter, even after adjusting for the acquisition. So far, it is hardly looking like the company is "sensitive to activity in construction markets and industrial production levels."

More to Come

Apparently, management is finding lots of attractive acquisition opportunities out there. It increased its credit facility to $750 million in October, and in November it closed on the $450 million acquisition of Lamson & Sessions (LMS) . Between 2004 and 2006, the company made cash acquisitions totaling just $50 million, so the 2007 activity marks a significant change.

It is possible that the sudden surge in acquisition activity is at least part of the reason for the decline in share price. The management team has been in place for several years but is relatively inexperienced at integrating acquired operations. Investors may be concerned that a bad acquisition will lead to operational problems and write-offs.

That may be true. But another explanation is that management saw an opportunity when the private-equity market dried up in July and is using that opportunity to bulk up their business more cheaply than they would have been able to a short time ago.

At any rate, the decline in share price appears to have anticipated at least one of the two concerns. I think from current levels it would probably require both a decline in business fundamentals and a botched acquisition to justify further share declines. If neither occurs, things could look sweet indeed.

Based on trailing earnings, TNB has traded at an average multiple of 25. The current 15 times trailing multiple is its lowest in five years. If the company can earn the expected $4.03 in 2008 and maintain its current (five-year low) valuation multiple, it could reach $61 by year-end. At its average multiple, the $4.03 in earnings would be worth more than $100.