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This report on Flanders was originally sent to subscribers of Stocks Under $10 on March 7 at 1:56 p.m. EST and is being reprinted as a bonus to readers. The Stocks Under $10 team added Flanders to the Stocks Under $10 model portfolio on that same date, and they continue to believe shares look attractive at the current price of $11.49. For more information on Stocks Under $10 newsletter, click here.



, a Stealth Stock, hit our radar screen as a low-dollar way to play the steady demand for air conditioner filters. The company is one of the largest domestic sellers of air filters for use in heating, ventilation and air conditioning equipment, and users constantly replace filters, which leads to a steady stream of revenue and cash flow.

This stable market, along with some new-product launches, creates the potential for operating margin upside in the coming quarters. Plus, the stock is under the radar screen of most analysts, but growth opportunities abound that could generate investor interest in 2006 and beyond.

Customers of Flanders' products range from retailers to pharmaceutical companies to tech firms. For example,




Home Depot


sell Flanders' products that are labeled with its partners' brand names, such as Lysol and Arm & Hammer. Pharmaceutical companies like




Abbott Labs


use Flanders' products to control cross contamination of dangerous chemicals in their facilities. Technology manufacturers such as



use the air filters to help eliminate airborne contaminants to ensure strong production yields.

Flanders' revenue is generated mainly from low-margin filters, which are sold to consumers at about $1 each. However, the company is growing its branded revenue with product-development partnerships with household names such as Lysol and Arm & Hammer. These filters, such as its Lysol line, which includes an antimicrobial layer, sell for about $5 each, and Flanders captures a greater margin on the sale. In addition, the company offers higher-quality filters through its retail channel, which should provide the opportunity for incremental margin benefits.

On the new-product front, Flanders introduced a patented "nested" filter product in 2005, which it began selling at the beginning of this year. By stacking four filters in one package, the company is able to offer a more effective product, ship a greater volume of filters in one package and lower its overall freight costs as a percentage of sales. Specifically, management believes Flanders could see a 20% improvement in cost-of-goods sold as its nested products grow as a percentage of total shipped volumes.

While we believe the company can comfortably earn 80 cents a share in 2007, which implies an attractive forward P/E ratio of 13.5 times vs. an industry average of closer to 20, there is potential for upside to these estimates from a possible contract from a mixed oxide (MOX) energy facility. MOX is a combination of plutonium and uranium, and the plant is part of a plan to use the waste of decommissioned nuclear weapons as a fuel source.

The MOX plant, to be built in South Carolina on a site adjacent to a Flanders facility, could lead to approximately $500 million in total funding for Flanders from the U.S. Energy Department over a four-year period, according to Wall Street research reports based on conversations between analysts and management. Flanders is a potential beneficiary because of its nearby location as well as its highly rated product offerings that meet the standards required for working with nuclear materials. There are a total of seven MOX plants in the world, and production timetables for the South Carolina facility have not yet been laid out.

On Feb. 16, Flanders reported fourth-quarter revenue of $60.6 million and earnings of 10 cents a share. Both results were in line with analyst expectations. Revenue marked 15% year-over-year growth, although, as expected, earnings per share declined by 3 cents from the year-ago period because of slightly lower gross margins and a pickup in operating expenses as a percentage of sales.

However, we believe this disappointing margin will be short-lived, and will improve in 2006 with increased sales of higher-margin products. In addition, Flanders is adding automation to its factories, which could boost operating margins by as much as 100 basis points.

The dominant risk to our thesis is the company's execution. Should the complete rollout of nested filters take longer than expected or not have the intended higher-margin benefits, our 2007 earnings expectations could be on the high side. Also, delays in the construction of the MOX plant beyond 2007 could weigh on investor sentiment.

Even so, the stock's low valuation relative to its industry, coupled with the potential for earnings upside from margin improvements and the MOX project, provide upside to earnings estimates.

William Gabrielski is a research analyst at In keeping with TSC's editorial policy, he doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Gabrielski welcomes your feedback;

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