I continue in my search for “hidden gems” in the stock market. However, most “undervalued” companies that show on my screener have issues once you dig a bit deeper. Taitron Components (TAIT) is one such company that looks decent on the surface, as it is has a dividend yield of 5.3% and a 2019 P/E ratio of 24x. However, there are certain factors that make this an investment to avoid.
Just a brief background on the company – Taitron Components is an ODM (original design manufacturer) supplier for custom-made small products for electronic equipment manufacturing companies. The company focuses on higher-margin ODM projects where its engineers work with its customers to design the parts they need. The company also has an electronic component distribution business, which is a legacy business it has slowly shifted focus from.
Based on disclosures from the 10-K, the company’s revenues are highly concentrated, which constitutes a significant risk. In 2019, two customers accounted for 59% (42% and 17%) of sales. Taitron does not disclose the name of its customers, so it is difficult to gauge the future demand of those end-products. Compounding this risk is the fact that most of the company’s sales are done on an order-by-order basis, meaning that are no binding long-term sales contracts between the company and its customers. However, since these are multi-year turnkey projects, switching suppliers isn’t as easy. It all ultimately depends on the complexity and importance of the specific parts that Taitron supplies. Compounding this issue is the fact that the company’s SEC filings are quite scant on details, so it’s hard to make a determination on this.
In terms of Q2 2020 results, like most manufacturing companies, Taitron’s operations were heavily disrupted by the coronavirus pandemic. Due to the disruption of supply chains worldwide, the company has experienced delays both from getting the necessary materials from suppliers as well as being able to export to customers. Net sales decreased by 26.5% in the quarter compared to the same time last year. Given that the company saw sales drop by 17% in 2019, it would seem that the company might have 2020 revenue even lower. Net income is down by 53% this quarter compared with the same time last year. Management blamed the “decrease of ODM project sales volume” for the abysmal YTD performance. As mentioned above, without the proper disclosures on what these ODM projects are, it is difficult to make a determination on the long-term trends.
Given the lack of multiple comparables we can use for Taitron given its limited product disclosure, I decided the best approach would be to build a discounted cash flow model. Note, in terms of valuation, I made the decision to ignore the short-term effects of the coronavirus in 2020 when forecasting the long-term financials of the company and assume that any decrease in revenue for this year will be made up in the following year or 2022.
To forecast the revenue growth rate, I used the company’s growth rate from 2015 to 2018 of 9.5%, as 2019 saw a huge drop in revenue. I believe that this is achievable given the low revenue base of the company. The fact that the majority of its income comes from two customers implies that winning another contract could easily increase revenue. Therefore, the assumption I am making is that eventually, revenue growth will return to this faster pace.
Author calculation using data from Seeking Alpha
Similar to my calculations for a previous article, to calculate the discount rate for the company, I used an equity risk premium of 6.5% from the June 2020 KPMG report and a risk-free rate of 4.43%. Taitron has a low beta of 0.5 that I don’t believe is reflective of the market risk. I decided to use a beta of 1 to reflect “market risk”. Given the business risk and lack of disclosure, I wanted to put an additional premium of 5% in the discount rate in order to account for the uncertainty in the investment. Putting this all together gives us a discount rate of 16%, which I used to calculate the unlevered discounted cash flows. Adding up the present value of cash flows and terminal value from the model ($3.9 million and $1.1 million respectively), we get an estimate of the value of the business operations of $5.1 million.
Taitron has a pretty solid balance sheet as well, with cash of $5.9 million against an immaterial debt of $163,000. The company also owns a 50,000 square foot property in California, which it uses as its headquarters/distribution facility, as well as some office space in Shanghai and Taipei. The company’s book value for these assets is $6.1 million; however, I think it’s safe to say that the market value of these assets may be higher. I valued these properties with a multiple of 1.25x, which I feel is a conservative estimate. I estimate the property value of the company to be $7.6 million.
Source: Company 10-K
Author calculation using data from Seeking Alpha
We calculate the enterprise value by adding the valuation of the firm’s operations and property value, while subtracting net debt, which gives us an EV of $18.7 million. Dividing this EV by 5.9 million shares outstanding, we get a share price target of $3.12, which implies a 32.3% upside. It may be tempting to invest in Taitron Corporation, however, there are two factors that make this a risky investment. First is the model makes the assumption that Taitron will once again enter into a growth phase. The lack of disclosures by the company makes it difficult to evaluate the business and its competitive advantage. Second, the bulk of the company’s value is not from its operations but from its real estate assets. This value will be difficult to unlock unless the company decides to liquidate. Given these factors, there is a potential that the stock is a “value trap”, and I don’t believe it is worth the risk. I rate the stock as an “Avoid”.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Caveat emptor! (Buyer beware.) Please do your own proper due diligence on any stock directly or indirectly mentioned in this article. You probably should seek advice from a broker or financial adviser before making any investment decisions. I don’t know you or your specific circumstances, therefore, your tolerance and suitability to take risk may differ. This article should be considered general information, and not relied on as a formal investment recommendation.