Wednesday, February 3, 2010

Expanding When It Should Be Contracting

American Metal & Technology (AMGY) is rather undervalued on an asset basis: the company trades for under $5 million, but has cash of $7 million and receivables and inventory of $3 million against total liabilities of just $2 million. Whether shareholders can realize value out of this situation is very much in the air, however, as a result of some questionable management decisions.

As sales dropped amidst the recession, the company began an aggressive capacity expansion program. During 2008 and 2009, the company added tens of thousands of square feet of manufacturing capacity along with several million dollars worth of equipment. However, whereas the company used to run three shifts a day, it is now down to one shift a day, as quarterly sales have dropped 80% year-over-year. The larger capacity means larger fixed overhead at a time when demand is suffering, which explains why the company's margins continue to fall despite layoffs.

If this were the only problem, and management was taking steps to remedy it, perhaps the company would still warrant consideration. Unfortunately, this seems like a company bent on continuing to expand when there appears to be a lack of demand for its products. Furthermore, a slew of questionable smaller transactions appear to be taking place as well.

An account labeled "other receivables" has increased $500K in the last two quarters, without much of an explanation. For most companies, this would be a drop in the bucket; for a company this size, however, this jump is significant and particularly worrisome considering the huge drop in sales.

Additionally, two of the company's customers account for the majority of its sales, which adds risk as discussed here. Complicating this matter is the fact that the company's CEO and a director are shareholders in these two customers. Multi-ownership situations such as these make it difficult to determine management incentives. Further exacerbating this question is the fact that management loans were recently forgiven, and a payment due to another company in which the CEO has a significant stake was increased as a result of depreciation in the US dollar!

Companies that trade at discounts to their liquid assets can appreciate in price significantly. However, questionable decisions can also cause value to be lost, and therefore investors should research companies thoroughly before exercising investment decisions.

Disclosure: None

This article was written by Saj Karsan of Barel Karsan. If you enjoyed this article, please vote for it by clicking the Buzz Up! button below.

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