RealMoney Silver - Unlocking Key Technology

Unlocking Key Technology
By Ephraim Fields
RealMoney Contributor
1/17/2008 10:00 AM EST

If you are looking for a growing, undiscovered, undervalued company with a healthy balance sheet, significant international exposure, strong visibility into its earnings and end markets that do well in economic downturns, check out Key Technology (KTEC) . Key Tech is a leading supplier of process and automated inspection systems for the food, tobacco and pharmaceutical end markets. The company's products are in high demand because companies throughout the world are seeking to increase the safety of their products and are also trying to reduce labor costs by increasing the use of automation.

As a result of these industry dynamics, Key Tech has experienced a meaningful increase in revenue and profitability. During the last 12 months, the company's organic revenue has increased 27%, and the company has swung to profitability. The company should continue to grow and over the next 12 months, with its sole analyst expecting revenue to increase 17% and EPS to ramp 20%.

Key Tech is also benefiting from its significant international exposure as it generates approximately 53% of its revenue from abroad. If you, like me, are worried about a global slowdown, you should take comfort knowing that Key Tech's end markets (food, tobacco and pharma) all do well in difficult economic times.

Furthermore, the company has a very healthy balance sheet, with 15% of its market cap in cash, although I expect it to begin returning some of that cash to shareholders via dividends and/or stock buybacks, as well as to do a stock split, which should improve the stock's liquidity.

Finally, given the long lead time required to make some of its products, Key Tech also has very good visibility into its earnings, which adds a high degree of comfort to the company's positive outlook.

Again, for the fiscal year ended September 2007, Key Tech's organic revenue grew 27%, and the company swung to profitability. This translated to earnings (adjusted for gain) of $1.22 per share vs. its analyst's estimate of $1.15 per share. The company also announced its backlog was at record high levels.

As I mentioned, for 2008, the analyst covering the stock expects revenue to increase 17% and EPS to ramp 20%, although we view those estimates as conservative and note that the company, which doesn't guide but recognizes the value of underpromising and overdelivering, has beaten his estimates for the past few quarters.

As noted, Key Tech has a very healthy balance sheet, with $5 per share of cash. The company has no immediate need for all this cash, and we believe that management is considering initiating a dividend and perhaps repurchasing additional shares as it has done in the past.

Key Tech's equipment is used to clean, grade, convey and inspect a wide variety of foods and non-food products for defects and automatically remove unwanted materials and/or damaged parts. The company offers dramatic improvement in yield, product quality and safety and net cost efficiency through reduced labor costs.

Key Tech's net revenue is derived from three high gross-margin lines:

Key Tech is projected to generate revenue of $125 million in 2008 and $144 million in 2009. During that time, EPS is projected to grow 30% from $1.47 in 2008 to $1.90 in 2009.

The stock currently trades at 22 times 2008 estimated EPS and 17 times 2009 estimated EPS, which isn't as cheap as most of the stocks I buy but is cheap when you consider that EPS will be growing significantly this year and next year and the company has good visibility into its earnings. Furthermore, if you strip out the company's $5 per share in cash and the associated interest income, the P/E drops to 20 times 2008 estimates and 15 times in 2009 estimates.

I see a number of catalysts that should drive the stock price higher:

strong earnings and backlog to be reported in early February -- I would not be surprised to see the company beat its analyst's estimates;

return of some capital to shareholders through the initiation of a dividend and/or increased stock buybacks;

stock split, which should help liquidity; and

increased investor awareness.

On that last point, Key Tech is not widely known in the investment community, and this year the company plans to increase its investor relations. If this company were based in New York City instead of Walla Walla, Wash., we suspect that more investors would have heard of it by now.

Please note that due to factors including low market capitalization and/or insufficient public float, we consider Key Technology to be a small-cap stock. You should be aware that such stocks are subject to more risk than stocks of larger companies, including greater volatility, lower liquidity and less publicly available information, and that postings such as this one can have an effect on their stock prices.