DHB's Growth Should Protect Investors

Editor's note: We're pleased to introduce Jonathan Falk as a contributor to the RealMoney team. We hope you enjoy the column; as always, let us know what you think.

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In my columns I will try to make the case for stocks I believe will outperform during a 12-month time period. I'll explain the qualitative case for the company's business and the quantitative case for the financials.

I am a portfolio manager for pension accounts and high-net-worth individuals. One stock my firm has owned for two years is DHB Industries (DHB - commentary - Cramer's Take). The company manufactures the Interceptor vest and other military-related protective gear under its DHB Armor Group unit, which brings in 97% of the parent company's annual revenue. In addition, many law enforcement services use a more compact version of DHB Armor's protective gear for their officers.

The Interceptor vest has become standard equipment for American soldiers in Iraq; however, many soldiers still do not have a vest to wear in combat situations. Therefore, new orders from the U.S. government will continue to increase during the course of the Iraq conflict. Currently, DHB Armor controls about 80% of the military market for protective vests. While other companies may receive new requests in order for the government to have multiple sources, DHB Armor should maintain its dominance. DHB has bent over backwards to maintain quality control and delivery time -- it has even shipped some vests to Iraq on two-day delivery at its own expense. Moreover, one of the competitors, Second Chance, has had product performance problems with its zylon vests.

DHB Armor opened a new plant last year and will open another this year. The company has a current backlog of $160 million and projects $250 million in revenue for 2004. It also expects gross margins will be 27.5% and SG&A to be under 14%. Interest and preferred dividends will cost $1.4 million. The tax rate should level off at 40%, and the company has 44 million shares. Based on that information, I calculate the company should earn about 44 cents a share in 2004.

Missing the Value

Even with a comparable sector multiple of 20, the stock should trade at about $9, up from about $7 now. One company gaining a lot of attention is ceramic plate manufacturer Ceradyne (CRDN - commentary - Cramer's Take). This company sells at a multiple of more than 30 times 2004 earnings projections, but has just slightly better projected gross margin and SG&A ratios than DHB. Even though Ceradyne has many markets outside of the military for its ceramic products, the armor group has been driving current sales trends.

In addition, a number of factors may come into play to make current projections for DHB look very conservative:

First, given the tailwind to the revenue stream, I believe sales can go as high as $300 million. With the new plants, capacity won't be a problem, as long as Kevlar and other raw materials stay available. Management also has mentioned that new products will be introduced this year. Among a number of possible products are the ceramic plates of the Interceptor vest that actually stop an AK-47 round. While a fully equipped Interceptor ranges in price from $550 to $700, the ceramic plates cost over $1,500. DHB sells these as a pass-through, with margins of only 7% to 8%. However, if the company should start to produce these plates, they could get the higher Ceradyne-like margins of 14% on the plates.

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Please note that due to factors including low market capitalization and/or insufficient public float, we consider DHB Industries 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.

At time of publication, Falk was long DHB, although holdings can change at any time.

Jonathan Falk is a portfolio manager at M.D. Falk & Co., managing more than $60 million in equities and fixed-income. His analysis focuses on bottoms-up valuation of a broad range of securities, using discounted free-cash flow, enterprise valuation, earnings models and balance-sheet strength. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. While Falk cannot provide investment advice or recommendations, he welcomes your feedback and invites you to send it to [e-mail].