Investment Opportunity

Taylor Devices designs, manufactures, and sells shock absorbers all around the world, their biggest market being the US. Taylor Devices specializes in various segments which include Industrials, Aerospace/Defense, and Structural. Structural is their biggest one accounting for 58% of sales, followed by Aerospace/Defense with 34% of sales, and then Industrial which is their smallest one.  

Taylor Devices have had contracts with NASA, where their business started. They were included in the NASA hall of fame for the impact they had on space exploration with their damper technology that has helped NASA’s spacecraft to function efficiently and minimize vibration and absorb shocks. They have had record-breaking contracts of $7.5m  to install dampers on the San Francisco Bay Bridge, which was outdated and had to replace previous dampers that were not as efficient as those of Taylor Devices. They also have had previous contracts with California hospitals of $3.2m to install dampers. Basically they are all over the country taking care of structures and saving lives with their technology. They also work internationally, in Japan, a place where seismic activity is prevalent. In Taiwan, China, all the places where seismic activities are prevalent that you can imagine, Taylor Devices will be there. “Mr. Schneider reported seismic sales in the United States are holding steady, while sales are increasing in other areas of the world such as Asia. He explained how new ordinances in California are emerging that could help overall seismic sales for the Company.” So as seismic sales remain slightly growing in the US, they are getting more and more opportunities in Asia and in California in regards to seismic activity. “Mr. Schneider elaborated on new and improved strategies for sales opportunities in the future. For example, Taylor Devices is actively pursuing the news that the Japanese government discovered a Japanese competitor was falsifying test data. This situation could possibly create more opportunities for Taylor Devices. Mr. Schneider then explained how Taylor Devices’ seismic damper design is more robust and consistent in design when compared to the competitor’s design. (2016)”  Taylor Devices will benefit from their brand recognition and trust that they provide to their customers + having a world class testing facility that facilitates the gain of trust from their customers all around the world.

The company has spent a lot of money on commission to outsourced sales representatives that helped them get business contracts, but they have cut their reliance with independent sales representatives by adding staff to their business development and sales team, hence cutting costs.  These types of cost improvements are what is going to shape the company’s future and increase profitability and generate excess free cash flow. Now something to keep in mind, they do spend a lot in research and development and they are increasing the spending to accommodate for future growth in multiple sectors. But on the bright side, usually in the aerospace segment, their customers fund their R&D needs, so we have that going for them.

Now this is not your typical soggy cigar butt. This is a company with history, great technology, and acceptable management. Your typical cigar butt is either burning cash like there is no tomorrow, generating negative free cash flow, unprofitable, CEO salary takes all the profits, or all of their assets are tied up in inventory. Taylor Devices is different. They have a decent business with a small moat, their technology and brand recognition. Most of the things I look up on google about seismic dampers or what not, I always see Taylor Devices involved. They are not burning cash, they are profitable, and generate positive free cash flow with an average of $3.3m over the past 5 years. 44% of their assets are in cash, and during a downturn or a recession, that is what you want in a business. I believe this company to have a pristaline balance sheet with no debt and lots of assets which provide a large margin of safety + it enlarges it with the positive free cash flow it creates.  

The business is not great due to its dependence on the US economy, they have a positive relationship. If the US economic activity is up, the company is going to do great as infrastructure spending is likely to go up and defense spending will always be happening and contracts can be gained during these periods of time. “Mr. Metzger stated that the current administration indicates an increase in defense spending and that Taylor Devices is likely to benefit from the 2019 National Defense Authorization Act for $717 billion that was recently passed by Congress.” As evidence, defense spending was bound to increase in 2019 and management said they would benefit from the $700B being spent.  So as we go to a downturn in the economy, the same can be said. Economic activity will go down which will reduce the spending and ultimately hurt Taylor Devices top line and bottom line. To put it in perspective, the housing crisis that caused a US recession made Taylor Devices decrease sales and lower profits, same with the 1991 recession. The year following the recessions, they have grown revenues and profits subsequently. 

In 2019, the company made a change in management as the CEO, Douglas Taylor, was retiring. Alan R. Klembczyk, President, reported that the change in Management has been smooth and announced some new Company initiatives. These include new research & development efforts, hosting an International Sales Meeting for our representatives around the world, increasing our Lean Manufacturing efforts, initiating cost-savings efforts, establishing a marketing department, and hiring a new Western US Sales Manager.

Taylor Devices is financially sound with a pristaline balance sheet, positive cash flow generation, and profitable. The company has been profitable since inception, it has never lost money except for one year. The company holds 44% of its assets in cash, and only $4.5m in liabilities. The company for the majority of the time has been generating positive free cash flow even when they are very capital intensive, they invest a lot into new technologies and into their facilities.That has certainly paid off. One of my discomforts is that it is very capital intensive. But at least they generate positive FCF. Another thing that discomforts me is that shares outstanding are slowly increasing. That is value destructive and if they do not slow down or create a buy back program, the value will go down with time as they keep issuing.

The company has $21m in cash, $6.6m in receivables, and $6m in inventories. It is worth noting the working capital improvements that they’ve made. In 2019, accounts receivables were at $12m, it is now $6.6m. In 2020 the company had $11m in inventory, they cut that down in more than half. This all contributed to the vast amount of free cash flow they generated in 2021. They run a lean inventory as they don’t have much inventory ready for sale as soon as the customer orders. The company operates on an order to manufacturing basis, meaning that when the customer makes an order and signs a contract, that is when the company starts to manufacture the goods that it is going to provide to cut the risk of the inventory never selling. Taylor Devices only have $4.5m in liabilities. This brings the book value of the company to $41.6m or $10.6/share. The company currently trades at $34m or $8.76/share at the current time of writing. This represents a gap in value of 21%. The company also trades at a 5yr Avg 10x FCF. The company is very well financially and I expect them to keep their financials as they are or improve them over time.

Taylor Devices has a couple of catalysts. One of them being, like any cheap, small cap stock, a buyback program or dividend distribution. This will enhance shareholder value and increase the value of the business. The other one is an acquisition but it’s quite a long shot. An acquisition is unlikely but it is still possible by an engineering firm or some construction company or someone in the defense sector. Another catalyst is to see increasing seismic activity which will shift engineers to demand Taylor Device’s products to protect buildings and what not. We know seismic activity is prevalent in Japan, Taiwan, California, etc. If these locations experience more seismic activity, demand for Taylor’s products will increase and will cause a positive reaction into the top line and bottom line. Going hand in hand, a more strict building code will increase the demand for Taylor’s product as buildings will have to be retrofitted and everyone will be going to Taylor Devices for new and restructured buildings and bridges and what not. As we said earlier, if the economy enters a bull period and starts spending on infrastructure and defense and Taylor Devices is able to attract new contracts for new bridges and buildings, that will drive the price up. And ultimately, which is not really a catalyst but can attribute to price appreciation, is people realizing they are worth much more than what they are worth right now.

This investment is basically a bet on the US economy with the optimistic assumption that the US economy will be able to recover and thrive as it always does and that Taylor Devices will continue to seek opportunities as the US economy regains traction. On the other hand, the stock is cheap. Simple as that. They have no debt, they have tons of cash, selling below tangible book value and are cash flow positive. A large margin of safety is present in this company and if you lose, you won’t lose much. I will wait for the price to go down further as I don’t find the current price as attractive as it would be if it gets lower. I want to expand my margin of safety as much as possible. Don’t get me wrong, it is an attractive investment opportunity, but I want a larger margin of safety.