Note: I completed this research report on January 9th to prepare for my investment management interviews, and of course MASI has managed to climb 17% since that time – the FDA approval of the Pronto-7 should now add materially to 2012 results.

While I normally don’t like publishing write-ups “after-the-fact,” I thought this was still worthwhile to share.

I think there remains substantial upside, with a target of $30 or higher not out of the question (especially for a possible acquirer).

Disclosure

Long MASI

©2012 Value Uncovered. All Rights Reserved.

 *Hat-tip to Greenbackd for originally posting the image

In light of this environment, I’m pleased with my portfolio’s performance:

On a relative basis, 2011 turned out to be my best year, although I’m much more concerned about absolute performance.

A significant portion of my portfolio consists of microcap securities, and intra-day swings can be severe – both in the positive and negative direction.

This time, volatility landed on the positive side, as a 20% jump in my largest holding on the last day of the year added 300 basis points to overall results.

It is important to remember that this jump could have easily been in the opposite direction. So while the year-end cutoff is a convenient date for measuring performance, the results over a longer time period will be more representative of my stock selection abilities.

Portfolio Composition

My portfolio currently consists of 25 stocks, with the top 3 positions making up 33% of the portfolio.

The goal is to build a core section of around 5 or 6 ‘permanent’ names, companies that are capable of compounding cash at high rates of return for the foreseeable future. I’ve broadened my research to include these high-quality candidates, and it’s been a welcome change from the Graham-style of investing.

However, a significant portion of my time remains focused on the ultra-cheap, and I continue to build a basket of net-nets and other undiscovered/unlisted securities. In these small companies, diversification is important, and these companies are often so simple that it only takes an hour each quarter to stay up-to-date.

In addition, I will continue to search out special situations – currently 5% of the portfolio is invested in work-outs of some kind – and I have several I’m watching carefully for 2012.

The portfolio remains in a state of flux, as I rebalance and reshuffle legacy positions to match my investment philosophy.

2011 Highlights

• I went back to school full-time to pursue a career in investment management. This was a huge step, and I’m excited to pursue my passion for investing. I’m actively looking for internship opportunities for this summer, so please contact me  if you have a lead in the industry or are open to networking.

• I was fortunate enough to win both UNC stock pitch competitions, and was selected to represent the school at both the Cornell MBA Stock Pitch Competition and the Alpha Challenge. We ended up as a finalist at Cornell, but disappointingly missed out at the Alpha Challenge (the industry was homebuilders, a tough one for me, but I learned a lot).

• I purchased my first international stocks, buying several net-nets in Japan. I decided to close out Dainichi after the stock saw a huge run-up past ¥1000 in October – I continue to hold Fuji Oozx. I’ve also invested in several European companies that I hope to blog about soon.

Good luck to everyone in 2012!

©2012 Value Uncovered. All Rights Reserved.

This odd conglomerate – with very different business models, growth stories, and margins – makes the stock’s financial performance much more difficult to analyze, a fact that is compounded by the lack of significant analyst coverage.

Yet at current price levels, investors are getting a company with a long-history of cash flow generation, at a price which basically throws in a business unit or two for free.

Why Is NACCO Cheap?

• Conglomerate discount – Mismatched group of mostly low-margin businesses

• Volatile stock – High beta (2.74) causes wild price swings – 5 year stock price range is $15-$170!

• Family ownership – Dual share structure keeps control in the hands of founding families, making it less likely for an activist to influence the company

• Little analyst coverage – BB&T is the only firm currently covering the stock

History

The original coal business has been around since 1913 (see timeline #1 and #2), and operated exclusively as a mining company for more than 60 years. In the 1980s, the business converted to a holding company operating structure and rapidly expanded:

• NMHG: Yale forklifts in 1986, followed by Hyster in 1989
• HBB: ProctorSilex in 1988, followed by Hamilton Beach in 1990
• KC: Kitchen Collection in 1988; Le Gourmet Chef in 2007

The businesses are run independently by their own management team and board of directors, with the holding company receiving cash proceeds and providing financial help if required.

The company has a dual share structure, with the majority of the super-voting B shares controlled by the CEO and other members of the founding Rankin/Taplin families.

While this voting structure makes it less likely for an activist to gain board seats or force out the executive team, the company seems committed to an open and shareholder-friendly environment.

The company provides a detailed segment breakdown of each operating unit, going above and beyond what is typical of other conglomerates. This disclosure allows the business to be evaluated on a sum-of-parts basis (see section later in post).

First, some financial data on the consolidated business:

Financial Overview

Strong Dividend History

NACCO recently became a ‘Dividend Champion,’ after raising its dividend for 26 straight years. The stock now yields 2.4%, and dividends have grown at 6.2% per year for the past twenty years:

Recent Financial Results

Like all industrial businesses, NACCO struggled during the recession.

Due to NC’s acquisition spree, a significant portion of goodwill was built up on the balance sheet, and the sales drop forced the company to take a $434m non-cash goodwill impairment charge, as the stock price fell to a low of $15 during the first quarter of 2009.

However, 2010 and 2011 showed a sharp increase in revenues and operating profits across all of the business units – TTM sales of $3.2B are up almost $1B from the 2009 lows.

Financials in Context

Looking at the business holistically, consolidated net income margins are low (3%), and the long-run average ROE and ROIC of 6.25% and 7% are not impressive.

However, the management team underwent a number of initiatives during the latest downturn to reposition the business lines and cut costs – and these improvements have shown in the latest financial results.

Consider this table:

The stock is trading for less than ½ of the average multiple during the latest upswing in the cycle (2003-2006) despite significant improvements to the business.

In fact, the market is still valuing NC at a discount to 2008 (2008 EV/EBIT was 6.96) despite a better industry outlook, improved efficiency metrics and a stronger financial position.

While the valuation is compelling, the combined company probably deserves to trade at a low multiple (with the ‘conglomerate discount’ effect in mind), but the current discount is grossly overdone, presenting an attractive entry point.

Even better, NC is solid on another, more important factor: cash flow generation: 

This stable cash flow is a requirement for a stock with such a strong dividend history – as the chart shows, there are differences in each business segment’s ability to throw off cash.

Segment Overview

Kitchen Collections (KC)

• Specialty retailer under the Kitchen Retailer & Le Gourmet Chef Brands, primarily in outlet mall locales; 300+ locations
• Business unit continues to struggle, with little or no earnings and low FCF generation over past 10 years
• Store count continues to rise, although management has said they are aggressively closing underperforming stores

I’m assigning little or no value to this division.

Hamilton Beach Brands (HBB)

• Manufactures leading household appliances such as blenders, coffee makers, and toasters; Sells primarily through retail locations such as Wal*Mart & Target, along with online through Amazon
• #1 or #2 market share in over 30 product categories
• Highest operating margins in the group, with target of 10% going forward

Although consumer confidence and unemployment continue to hold back HBB’s target market, the division has shown remarkable ability to generate consistent free cash flow well in excess of earnings.

North American Coal (NACC)

• Largest miner of lignite coal, and 7th largest coal producer nationwide
• Over 2.1b in coal reserves, with 1.2b committed to customers under long-term contracts
• Cost-plus profit per ton contract with no coal market price risk (due to flammable nature, lignite is not exported and therefore is not subject to wide swings in coal prices); many contracts are renewable up to 2045;

NACC works very closely with the power plant to guarantee a consistent source of coal reserves – basically lending out their operational expertise and access to the reserves.

For unconsolidated mines, the customer funds most of the capex expense, with the debt non-recourse to NACC.

NACCO Material Handling Group (NMHG)

As the largest portion of revenue – and the most cyclical – NMHG really drives the company’s overall results.

NMHG markets both Hyster and Yale brands lift trucks and fork lifts, and is the 3rd or 4th largest brand globally (with approx. 9% market share) behind Toyota, Kion, and Jungheinrich. In the U.S., NMHG controls roughly 21% of the market.

Lift truck sales are dependent on the economy and are very cyclical – the industry has shown strong growth coming out of the recession.

However, upside remains, as U.S. sales would need to increase 32% to reach the long-term average… 

…while worldwide sales are still 23% below the 2007 peak. 

The sharp jump in shipments has translated into strong results for NHMG in 2011, as revenues were $1.8b through the first nine months of the year, up 51% over the prior period.

While this torrid growth will slow, there still remains a significant backlog of orders (25.6k in Q3 ’11, up 4.5% over Q3 ’10), that will flow through the sales figures in the next several quarters.

While 2012 will be facing tough comps after such a good year in 2011, I think the market is misinterpreting the cycle, as there still seems to be room to run for this division.

NHMG has a powerful brand, which is helped by having the lowest cost of ownership in the business, and management has reiterated on conference calls that they have been able to pass along price increases to their customer base.

Sum-of-the-Parts Valuation

The SOTP analysis clearly shows NMHG’s driving effect on the total company valuation, as the difference between the bull and bear case for that division is ~$470m.

With a current enterprise value of ~900m, the market is basically throwing in KC (negligible impact) and NACC (a consistent cash-flow positive business with growth prospects) for free.

Catalysts

• Spinoff or sale of business units – management had explored the possibility of spinning off the HBB unit in 2007, before pulling the plug due to deteriorating market conditions. I’d prefer a divesture of the underperforming KC division, but recent spin-offs (ITT, Fortune Brands, etc) could serve as a blueprint to follow. I think it’s likely for management to revisit this strategy.

• Share Buyback – In the latest quarter, management announced a $50m share buyback, the first significant buyback in 15 years. The buyback would cover roughly 550-600k shares, or 6% of shares outstanding. If executed fully, that would be a significant number over the next 12 months.

• Further upswing in the NMHG cycle – Continued order flow in the forklift business as demand returns to the long-term average. Final closure of retail side helps remove distraction and drag on earnings.

• Upcoming coal projects – Several new coal projects will significantly boost capacity (Liberty Mine, 4.2m tons annually starting in 2013; Camino Real Fuels, 2.7m tons annually starting in mid-to-late 2012). Top-line growth should resume in 2012, and margins should pick-up after rough winter and plant shutdowns in impacted 2011 results.

Disclosure

Long NC

©2012 Value Uncovered. All Rights Reserved.

Each team develops two pitches for the event – both a long and short investment idea – out of the provided list of companies (40 names in total). The teams then give a fifteen minute presentation on both ideas, followed by a ten minute Q & A session with the judges. You can check out the event rules here.

Although we didn’t make the finals this time, it was a great experience.

A Few Notes

• The industry chosen for this year’s event was residential home construction, which was an extremely difficult industry for me. It is very cyclical, and I think everyone is aware of what happened in the real estate markets in the U.S. and around the world over the past several years…
• Macro trends have a huge impact: unemployment figures, mortgage lending rates, population growth, regulatory environment, etc. – all areas that are outside of my normal circle of competence.
• The industry is also complex: there are a ton of variables that separate the various homebuilders: country (big difference between the U.S. and Brazil real estate markets for example), size of their land bank, type of dwelling, location, inventory make-up, etc. It took a ton of research to even understand how these companies make money.
• Standard valuation methods are challenging: Homebuilders have enormous working capital requirements (see this data set for perspective), as they are constantly investing in new land for the next round of building. This means that homebuilders in growth mode report negative FCF numbers – but the companies can decide at basically any point to reduce this investment and swing to a huge positive figure (as existing inventory is converted into cash). Forecasting these trends is difficult.

Our Presentation

©2012 Value Uncovered. All Rights Reserved.

I’m happy to announce that our team was voted as a finalist in the competition (a great showing for UNC!), although we ended up losing out to NYU and Wharton in the finals. Some background on the event:

Cornell MBA Stock Pitch Competition

Teams from each school are provided a list of stocks at 11am on Thursday, and 3 powerpoint stock pitches are due by midnight – trust me when I say that it’s a wild 12 hours.

The pitches are then presented on Friday morning in front of portfolio managers at buy-side institutions like Fidelity (the lead sponsor), American Century, and Putnam Investments.

Each pitch is 10 minutes long, with a 5 min Q/A afterwards, and teams can recommend a long, short, or hold on each individual stock.

Our choices:

Every team was required to pitch the same stock in the first round, and then could pick one stock out of the lists for each of the two subsequent rounds.

Round 1: Required – GMCR

Round 2: Advertising – LAMR, CCO, IPG

Round 3: Asset Managers – FII, TROW, LM, WDR

Can anyone guess the stock I ended up pitching?

Although my investment philosophy has been refined over time, my process has always centered on finding businesses that are mispriced in some capacity.

I’ve had the most success among the deep value stocks found in the microcap realm, but I can also appreciate buying great businesses at fair prices – even if those businesses are outside of the normal ‘value investing’ metrics.

Even with this open mindset, I find that some businesses are trading at such high prices that I couldn’t even imagine the possibility of investing there…

Enter Green Mountain Coffee Roasters (GMCR)

GMCR is probably the ultimate anti-value investing stock – the company is selling at a P/E of 70x, has negative free cash flow, heavy insider selling – the list goes on.

At the same time, it is expected to grow 100% in the next year and has been one of the fastest growing companies over the past five. Due to these and many other factors, it is probably one of the most controversial stocks anywhere (outside of maybe NFLX).

To make it even harder, David Einhorn of Greenlight Capital fame just unveiled a scathing 110-page powerpoint presentation on the stock at the recent Value Investing Congress, causing a 40% sell-off in the last month or so.

As a team we decided that we wouldn’t be able to add anything unique or original to Einhorn’s presentation in such a short period of time, and therefore decided to go long GMCR  (I know, I know).

We ended up splitting up the responsibilities so each team member worked on an individual stock, and the GMCR assignment fell to me – which is ironic since the stock is pretty much on the complete opposite end of my normal investment universe.

Anyways, here is what I was able to put together in 12 hours:

Lessons Learned

Although it was very difficult to put myself in the mindset of someone who could be long GMCR, I think it was a great exercise that will improve my overall investing approach. A few lessons from the experience:

• Buying behavior – how does it apply to a company’s products?
• Growth dynamics – what combination of factors leads to such explosive growth?
• Acquisition strategy – can buying up competitors ever be strategic enough to ignore fundamentals?
• Identifying the opposing rationale – are all alternative viewpoints explained by the investment thesis?
• Valuation – how to value high-growth companies with little or no cash flow?
• Investment Thesis – how to synthesize vast amounts of information into the key points within a tight time window?

The greatest investors not only have the fortitude to follow a strategy during difficult times, but the ability to incorporate divergent viewpoints. I want to make sure that I stay open to other investing styles as I develop in my investing career.

Analyzing a stock – especially an extreme case like GMCR – from such an uncomfortable viewpoint provided a great deal of perspective. I hope to carry these lessons into future investment decisions.

Even so, I won’t be buying GMCR anytime soon.

Disclosure

No positions.

©2012 Value Uncovered. All Rights Reserved.

My goal for the presentation was to provide a clean look-and-feel, and not clutter the slides with tons of bullet points (the finer details would come out during the discussion).

Here are some talking points which loosely translate to my actual presentation. Hope it provides some further explanation/clarification.

Company Overview

• AIT provides distribution, repair, and value-added services for industrial customers
• Distribution network provides a competitive advantage (if machinery goes down, customers need to get it up and running ASAP. more distribution centers – > faster response time)
• Growing part of business is fluid power (~20% of sales). Higher margins than traditional industrial distribution

Investment Thesis

©2012 Value Uncovered. All Rights Reserved.

I joined the Investment Management Club, and just finished participating in the internal stock pitch competition – and I ended up winning 1st place!

The goal of the competition is to introduce students to the mechanics of delivering an effective stock pitch – developing a thesis, performing a full valuation, presenting in front of judges, etc. – and was designed to be a “low-pressure” way to practice for the more high-profile competitions.

We had 7 minutes to deliver the pitch, with a 3-5 minute Q/A session to follow. Stocks had to be in the Industrials sector, with a minimum market cap of $500m.

I ended up choosing Applied Industrial Technologies (AIT), a $1.2b industrial distributor. I’ve included my presentation below:

Next up: UNC will be hosting the Alpha Challenge in November, one of the premier MBA stock pitch competitions.

Needless to say, I’m looking forward to it!

Disclosure: No positions.

©2012 Value Uncovered. All Rights Reserved.

I originally picked up the stock back in October 2010, when the stock was trading below the lower bound of the director’s estimated liquidation range.

On August 15, the company distributed a press release announcing a final liquidation distribution of $0.103 per share payable on August 19, 2011.

This was a pleasant surprise, as TNFG’s March press release had estimated a final stub payment in the range of $0.04 – $0.07 per share.

Here are the final results of the workout:

Not stunning, but a nice result for my first attempt at this type of investment.

Joe Ponzio at F Wall Street summed up a good maxim for investing in workouts:

“The question is: Upon thorough analysis, do they offer safety of principal and a satisfactory return. To answer the first part, you must know the deal; to answer the last part, you must know the timeline.”

If you have followed the series of posts on TNFG, the one constant is my utter inability to predict the timing of the various payments – but I at least had a timeline and worst-case scenario in mind.

The lesson here is to always be extremely conservative when estimating the timing and return possibilities for these type of investments.

While the returns are certainly welcome, the best part about these types of opportunities is that they are largely uncorrelated with the rest of the market.

In these volatile times, I’d be very happy putting a much larger percentage of my portfolio into these types of scenarios, and will be actively searching for similar situations.

©2012 Value Uncovered. All Rights Reserved.

While my style of investing doesn’t have much to do with trying to time the markets, I haven’t been very active in the investing community since May due to some changing personal circumstances.

I certainly haven’t sold out however, and therefore have maintained most of my positions during this volatile time period, but I’m looking forward to getting back into the swing of things with investing and writing.

A New Career Path

Starting off on a more personal note, I’m excited to announce that I’m returning to school for my MBA.

After much planning, I started classes this past week at the University of North Carolina – Kenan-Flagler Business School in their full-time program, with the intention of pursuing a concentration in investment management.

I received admission to other top schools, but felt it was best to stay in North Carolina (and the combination of in-state tuition plus a substantial scholarship certainly helped sway the decision!).

UNC is a top-notch program with opportunities to participate in investment-related case competitions, manage a student-run investment portfolio, and access a specially designed Capital Markets Lab with Bloomberg terminals, Capital IQ, FactSet, etc.

I’m very excited about this new path, and am looking forward to turning my passion for investing into a full-time career.

I plan to explore the various career paths in investment management, but would like to stay focused within the value investing community, with the goal of landing a summer internship (and eventual equity analyst role) at a value-oriented firm.

I’d love to work for one of the well-known (and obviously highly selective) value funds like Greenlight or Baupost, but am also exploring other avenues like Vanguard, the Royce Funds, the large banks, etc.

It’s amazing, but company presentations for summer internships start in September (!!), so networking will be a key focus during the fall semester.

I’d love to branch out and discuss additional aspects of working in the equity research / hedge fund / investing field, so drop me a line if you’d like to talk about the industry.

YTD Results

A bit late to be commenting on results for Q2, especially since my portfolio has slid along with the rest of the market, but I think it’s still a useful exercise.

Two of my largest holdings, APNC and IBAL, have more than doubled from my initial buy price, contributing to a large portion of the gains through the end of the second quarter.

I have taken advantage of the market sell-off to add to existing positions that I have covered before – namely AMCON Distributing (DIT) and Sparton Corp (SPA).

For additional perspective, check out this nice write-up on DIT as it reaffirms much of my original investment thesis.

Looking Forward

I’ll be tweaking the portfolio in the near-term, as I’d like to free up some cash by selling out of some old positions.
In this type of market, having cash on the sidelines is a huge advantage.

Disclosure

Long IBAL, APNC, DIT, SPA

©2012 Value Uncovered. All Rights Reserved.

Repro-Med Systems (REPR) is a great little company which is basically undiscovered by the market. The best part about this company is its high-margin recurring revenue stream. This is explained later in this report.

Investment highlights:

l  The sale of one of their subcutaneous infusion pumps guarantees at least a six year recurring revenue stream to the company.

l  The FREEDOM60(R) Syringe Infusion Pump is the only Medicare-funded pump for Subcutaneous Immune Globulin (SCIG).

l  Its product is the most technologically superior and the cheapest.

l  Revenue has grown from 1.7 million to 4.7 million over the last 4 years.

l  Net Income has steadily grown from ($254,000) to +$704,085 over the last 4 years.

l  Earnings are accelerating due to the rapid growth of the use of subcutaneously administered immune-deficiency drugs.

l  The company is expanding its manufacturing capacity to keep up with demand.

l  Growing medical companies are recession-proof.

What does this company do?

REPR has two main products. The main product, and the main driver of growth, is the Freedom-60. The Freedom-60 is a specialized infusion pump that administers various types of drugs to patients subcutaneously rather than intravenously. This means the drug is injected into the fat of the body just under the skin, rather than the vein.

Their second product is called the RES-Q-VAC. This is a portable suction pump. Sales of this product are trending up, but are lumpy and not really important to the valuation of this business. Thus, this entire report will concentrate on the Freedom-60.

The advantages of subcutaneous administration

Currently, the most widespread use of subcutaneous administration is for primary immunodeficiency disease using drugs called immunoglobulins. These help individuals with immune deficiencies to live a more normal life. The two main drugs in this area are Vivaglobin and Hizentra – both made by CSL Behring.

People are switching to subcutaneous immunoglobulin (SCIG) because:
- It is more convenient because treatment can be done at home rather than at a hospital.
- It costs less.
- There are less adverse reactions.
- Since treatment is generally done weekly instead of monthly,

the immunity level remains more constant, which should help keep the patient more healthy.

Further research on the superior efficacy of (SCIG) can be found here and here.

Therefore, the market for this kind of therapy is rapidly growing with an estimated 10 million people with this disorder.

Enter Repro-Med Systems and the Freedom-60 infusion pump.

Competitive advantages of the Freedom-60

1. 1. The company’s 10-K states – “In June 2007, Medicare issued a letter of clarification stating in part:

“The FREEDOM60(R) Syringe Infusion Pump is the only allowable pump to be billed with the Subcutaneous Immune Globulin (SCIG). …All other pumps or modifiers will result in a denial.”

This is important for several reasons.

First, the lack of funding for other devices creates a huge competitive advantage against other companies.

Second, application for funding takes a considerable amount of time, as bureaucracies tend to move at snail’s pace. Thus, if any company has noticed this niche market, it is going to take considerable time before they can possibly get a device approved. In that time, so many more Freedom-60s will have been sold and the recurring revenue stream can be secured.

Third, there is NO guarantee that potential competitors can actually receive Medicare funding approval. In my communications with the CEO, he described the approval process as something of a “black art”. He surmised the reason the Freedom-60 received funding was because of its superior performance and its extremely competitive price point. He also said, should a multi-national decide to compete in this niche market, it would make more sense to acquire his company than go through the process of

a) actually developing a product at such a low price-point

b) developing the years of know-how that have gone into the Freedom-60.

2. The Freedom-60 is technologically superior to more expensive (non-Medicare funded electronic infusion pumps). This is best summarized by the 10-K -

“Our proprietary technology employed in the FREEDOM60(R) uses constant pressure to administer drugs. FREEDOM60(R) avoids an important problem faced by electronic pumps currently on the market, which employ constant flow mechanisms that result in potentially dangerous, high pressure placed on indwelling catheters or under the skin. In order to protect the patients, these pumps must contain an overpressure sensor to shut the pump off when a potentially threatening pressure is detected. Some of these electronic pumps generate extremely high pressures exceeding 60psi before the over pressure system will activate. Also with these systems, the alarm can falsely trigger halting administration until a health professional can verify that the infusion is in fact safe and the pump may be reactivated. In either case, the patient is at risk from damaging pressures or not receiving the medication required.

Other unsafe conditions of conventional equipment include runaway administrations; overdose due to programming errors or pump failure, and over-pressure resulting in burst blood vessels or failed internal access devices. We believe that the increasing sales of pumps and tubing sets for the FREEDOM60(R) demonstrate that the FREEDOM60(R) eliminates these potential outcomes and ensures a safe, constant, controlled infusion. Electronic devices will increase infusion pressure while attempting to continue an infusion at the programmed rate, while the FREEDOM60(R) design maintains a safe constant pressure and thereby automatically reduces the flow rate as required, a process we refer to as “dynamic equilibrium,” if any problems of administration occur.”

3. Cost-constrained Medicare funding heavily favors cost-efficient devices.

As can be seen on page 41 here, the Freedom-60 is the cheapest device available on the market. Debates over health-care spending continue, but there is no doubt over the long term cost-containment rules. This plays into Repro-Med’s hands.

Recurring Revenue

The best part, from the point of view of investors, is once the Freedom-60 is bought, the patient with immune-deficiency disorders must continuously purchase disposable tubing sets.

From the 10-K:

“We estimate that each FREEDOM60(R) pump, when used for immune globulin administration, uses an average of four to six tubing sets per month per patient. Antibiotics may be administered much more frequently, occasionally up to four times per day. In some cases, a tubing set may be used for as long as 72 hours. We estimate tubing set usage for antibiotics to be as much as 10 sets per month per patient. The tubing sets currently have an average price of $5.41.”

The list price of the Freedom-60 is $399

The revenue information that they put in the 10-K regarding disposable sales indicates that they are thinking big.

Pumps in the Market Annual Sales of Disposables

5,000                                $1,530,000

10,000                                $3,060,000

50,000                              $15,300,000

100,000                             $ 30,600,000

I think the above table speaks for itself

The tubing sets are patented and only Repro-Med’s tubing sets will work.

From the 10-K – “Our patented luer disc connector ensures that only the Company’s FREEDOM60(R) tubing sets will function with the pump. Non-conforming tubing sets, without the patented disc connector, are ejected from the pump to prevent the danger of an overdose or runaway pump from injuring the patient. We are achieving our objective of building a product franchise with FREEDOM60(R) and the sale of patented disposable tubing sets.”

The other key point about this type of recurring revenue is it allows for continuous improvements in operating margins because dollars are not having to be spent to incur new sales.

Valuation

Revenues are currently growing at more than 40% annually with earnings currently growing more than 100% sequentially.

Furthermore, the automatic recurring revenue through the tubing sets will certainly allow significant operating [not gross] margin improvements.

25% compounded revenue growth over 4 years is easily achievable

Operating Margins should rise from 25% to at least 30%.

Assume the shares outstanding are about 40 million in 4 years.

So, TTM Revenue compounded at 25% for 4 years = $12,800.997

30% operating margin = Operating Income of $3,840,299

Tax of 35% = Net Income of $2,496,194

Divided by share count of 40,000,000

= EPS in 4 years of 0.0624

Now choose various PE ratios to give a 4-year price target.

I chose a PE of 14. I believe this to be conservative given the quality of the company’s business model

Multiplying these two gives a price target of $0.87 vs the current price of $0.37

Over 4 years, growth in price from $0.87 from $0.37 is a return of 23.83% per year.

Further points of interest:

1. According to the immune deficiency organization (primaryimmune.org) there are more SGIG drugs that are going through trials right now. This should further increase demand for SCIG treatment and Freedom60 sales.

2. On May 20, 2011 REPR received their long anticipated FDA approval for the marketing of their new needle set. It is expected this approval will lead to a significant increase in sales and REPR is undergoing significant manufacturing expansion in anticipation of this.

Disclosure: The author of this guest post is long REPR.

©2012 Value Uncovered. All Rights Reserved.