Dynamic Materials ( BOOM) has been on a ferocious tear of late, up over 1,600% since November 2004. Yet only one analyst from a small firm covers this company, which dominates its somewhat unique space of explosion-clad metals. Dynamic Materials owns 60% of the clad-metal market share (excluding China). Earnings and sales are growing strongly. Due to the long-term planning process of the projects in which the company supplies materials, management has a fairly clear view of its business going forward. The stock is heavily shorted, and there's always the opportunity for a short squeeze on any good news. The shorts piled on as the shares began to rise in 2004 and grew to trade at high multiples, currently including a trailing P/E near 37 and a price-to-sales ratio of nearly 5. Late last year, over half of the float was sold short. The figure has come down since then, but is still at a sky-high 43%. This is the sort of bullish story I love for investors who are willing to take on some risk: a little-followed, heavily shorted stock with growing earnings and cash flow, a solid balance sheet and a near-term catalyst to get the stock going.
Blown Up Real GoodDynamic Materials make its living by blowing stuff up. The process known as metal cladding involves placing a thin layer of expensive, corrosive-resistant metal on top of a lower-cost metal. An explosion between the two sheets causes them to bond, creating a corrosion-resistant metal sheet that mostly consists of a cheaper metal, such as carbon steel. The company's products are used in oil refineries and ships, to name a few areas. The upgrading of oil refineries will be a strong catalyst for growth, says Michael Shonstrom, an analyst with Emerging Growth Equities -- the lone sell-side analyst with coverage of Dynamic Materials; he rates the stock a buy. (Emerging Growth Equities does not have an investment-banking relationship with Dynamic Materials but does make a market in the stock. Shonstrom does not own any shares.)
"There's a lot of expansion that will take place on the heels of the issues we ran into with Katrina and the shortage of refinery capacity," Shonstrom said. "Capacity is really below where it was in the 1980s in terms of total production volumes. It's nowhere near where it needs to be to match demand." Not only should capacity increase, the type of oil that is being used works in Dynamic's favor. Many of today's crudes have higher sulfuric acid content than in years past and require a more corrosive-resistant product. Roughly half of the company's revenue comes from North America, where it has virtually no competition. The barriers to entry are quite high because of technology costs and other logistics. Not surprisingly, when working with explosive materials, there is a lot of governmental red tape that needs to be addressed. For a new company, that could be quite burdensome. Dynamic Materials has salespeople all over the world. Its business unit in Europe, global sales force and market-leading position allow the company to compete for virtually any opportunity. "We feel confident that if there is a
metal cladding project out there, we know about it," CFO Rick Santa told The Denver Business Journal.
Rapid Growth, Rising ShortsSince 2004, earnings have been growing at a rapid pace. Last year the company earned 86 cents per share, up from 39 cents. Sales also spiked to $79 million from $54 million. Shonstrom estimates that 25% of that jump was due to an increase in metal prices. However, the remainder can be attributed to stronger sales. As a result, gross margins grew by nearly 450 basis points in 2005. Despite the 46% hike in sales, selling expenses only grew 8%, causing operating margins to rise by more than 700 basis points.
In 2006, Shonstrom forecasts EPS of $1.12 per share on sales of $96.5 million, with operating margins to increase by another 260 basis points. The balance sheet is rock solid, with $5.5 million in cash and just $2.2 million in long-term debt. Net cash flow increased to $3.4 million from $1.9 million the year before. Since Dynamic shares took off in November 2004, the shorts have taken it ... in the shorts. There have been some periods with drastic corrections in the stock, but the price is up 419% since the beginning of 2005. As of Feb. 10, nearly 2.4 million shares have been sold short -- a remarkable figure considering that the current float is only 5.5 million shares. The enormous short interest makes it likely that short-sellers can easily be squeezed on any good news or continued stock rise. When asked to respond to why the shorts are so attracted to its shares, Dynamic Materials declined to comment. I usually loathe those "no comments," but in the case of commenting on shorts, it's the prudent thing to do. Companies that fret over short-sellers tend to not have their eye on the ball, and underperform.
Au RevoirA significant change is brewing both for Dynamic Materials as well as for its stock. SNPE, the French government-owned defense contractor, currently holds 5.9 million shares, or 50.4% of the total outstanding. The company has filed a 13D with the Securities and Exchange Commission, informing investors of its intent to sell its entire position. No date has been set for the offering. This could more than double the float. However, it will not dilute earnings, as the outstanding shares will remain the same. Emerging Growth's Shonstrom believes the divestment by SNPE will be a win for everyone involved. "It removes the French government from the board of directors. I don't want to disparage their thought process, but the company is not a core business for SNPE, so it's probably better that they don't own it."
Four of the seven board members are SNPE people. A spokesman for Dynamic Materials said that after the stock sale, the company expects to elect four new board members, though no one has been nominated yet. The increased liquidity as a result of the SNPE sale could attract more coverage from the sell side, lifting the stock further. In sum, Dynamic Materials just might offer explosive growth for investors willing to take on the risk of owning a stock that has already had a huge rally. With solid fundamentals, the possibility of more attention from Wall Street and the rocket fuel that short-sellers may provide, Dynamic Materials may not be ignored for too much longer.