Fuel Systems Solutions, Inc. (FSYS)

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Fuel Systems Solutions: Extreme Punishment Unjustified

It is perplexing that Wall Street's reaction to Fuel System Solutions' (FSYS) third quarter report (one that actually met expectations, both on the top and bottom lines) was so hateful, that it mercilessly stripped 30% of market value away, in a blink of an eye.

Why was the carnage so brutal? Believe it or not, it was because the company narrowed its full year revenue guidance, to the bottom of its previously stated range of $400 to $420 million. So in effect, a potential reduction of $20 million in revenues, extracted $70 million of market value-pretty preposterous when considering those lost sales, would of generated just $5 million of gross profit. I guess the only explanation for the "sell now, ask questions later" reaction, is the market evidently assumed that the business it is slated to lose from both Volkswagen China and Honda Thailand by year's end, can not be replaced.

An ironic twist: Did the market even pay attention to the obscure fact that if it wasn't for an impairment charge of $1.7 million, the company's earnings would have essentially doubled? The charge was attributable to the purchase of the remaining 50% of its India based Rohan BRC joint venture. Evidently the company overpaid when it initially entered into the JV three years ago.

The conference call: the way it was run, didn't help matters either. The lack of enthusiasm, and robotic delivery, amplified the stock's sell-off. Further weakening the call were the participants very strong Italian accents, which were difficult to understand. The analysts compounded the problem by presenting questions that were off the mark, when it came to the priority of the stock price. Why not ask the obvious? "When are you going to begin a stock buyback"? Maybe that's why they are analysts, instead of traders. Those who can't, "analyze", while those who can, "trade" comes to mind.

Stellar balance sheet: The company holds $74 million in cash and another $13 million in long term German bonds. It has no debt and shareholder equity of $321 million (about $16 per share). If you pull at the company's entries for intangible assets and goodwill of $62 million, its adjusted book value of $13, is still quite respectable.

The quarter revisited: If you look at the third quarter numbers, they were not that bad. Sales rose 9% to $97.6 million, while earnings were 5 cents versus a .03 loss. Gross profit margin swelled 160 basis points to 22.60%. Research and Development Costs dropped from 7.50% to 7.0%,. In the negative column, the company did a poor job in controlling its Selling, General & Administrative costs, rising 5% from 13.2% to 13.8% of sales.

The case for a stock buyback: Just three years ago, FSYS raised $60 million in a secondary offering, by selling 2 million shares at $30 per share. Since then, the company's financial condition has improved substantially, through three years of additional retained earnings, yet shareholders are worst off. Why not initiate a stock buyback plan to buy back those same shares, at less than half the price? Sounds like a good use of corporate funds to me. The act would also send a very powerful message to the street, regarding the company's confidence in its operations and compelling value of its shares.

Others in the space: Westport Innovations (WPRT) and Clean Energy Solutions (CLNE) each have market caps five times greater than FSYS, yet they both produce less sales and earnings and possess inferior balance sheets. Why does the market give a pass to these alternative fuel players, but evaluates FSYS to a much higher standard? I have no idea, but I do look at both of these competitors as potential suitors.

Price to sales ratio: the rage the past few years, in order to justify momentum bubble stocks without earnings, is to judge them by their price to sales ratio. I am not sure how many stocks in the universe have a ratio as low FSYS's. For example, Amazon's (AMZN) price to sales ratio is just 2.10, but FSYS's ratio stands at a mere .66. That means in just 8 months, FSYS will produce more sales than its entire market value. If you compute the ratio based on enterprise value (market cap less cash, plus debt) it falls to just .45 to sales. I would be surprised if any listed company, has a metric lower.

Conclusion: Don't get me wrong, there are many negatives associated with this company that have contributed to its erratic track record. Changing Government incentives, the price of oil and currency exchange fluctuations, just to name a few. In addition, its management team has had a difficult time communicating its vision to the street, and has been less than stellar in learning the art of, "under promising in order to over deliver". The stock is simply unpopular, but that is a good thing, because contrarian investors realize that to make money in the market, it is imperative to buy stocks, when they are unpopular, and sell them when they become popular-how else are you supposed to buy low and sell high?

The good news is these negatives have driven a huge disconnect between the stock's intrinsic value and market value, creating a juicy opportunity for value players to exploit. This stock price is merely a inefficiency, in a efficient market, that will become efficiently priced either through a takeover, or another drastic event. Who knows, maybe activist shareholder Kevin Douglas (he owns 5%), will exert pressure on the Board to unlock shareholder value. In the interim, investors should consider its severely depressed stock price, as the ultimate buying opportunity.

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