RELL - Richardson Electronics: Pivoting Into A Green Energy Solutions Company?

2023-09-12 10:48:08 ET

Summary

• Richardson Electronics' stock priced has dropped significantly, providing a potential buying opportunity.
• The company might be undervalued, as the market does not seem to recognize its fast growth in green energy solutions.
• There are some risks concerned with this stock though, especially a build-up in inventory.
• My valuation shows that the company might potentially be trading at a 5-year forward P/E of just under 4.
• All in all, I rate the company a 'Strong Buy' as the pros greatly outright cons.

Thesis

Richardson Electronics, Ltd. (RELL) is a pretty boring electrical components manufacturing from Illinois. However, recently management has focused more and more on green energy solutions, which seems to be a winning strategy. Especially, the company's solution for wind turbines looks promising. Currently, the stock is trading at a P/E of 7.6 and a PEG ratio of just 0.6. The company thus seems poised to benefit from strong growth in the green energy market. In this new article I lay out why the stock is severely undervalued, taking into account both potential catalysts and risks. I find that the pros greatly outweigh the cons for this company and think it definitely deserves a 'Strong Buy' rating.

Background

Richardson Electronics is an electrical component manufacturing company from Illinois, based in La Fox. As they put it themselves on their website:

Richardson Electronics, Ltd. (RELL) is a leading global provider of engineered solutions, power grid and microwave tubes and related consumables; power conversion and RF and microwave components; replacement parts, tubes, and service training for diagnostic imaging equipment; and customized display solutions.

The company has been around for over 75 years and has over 1,000 employees, operating in 20 different countries. Its current CEO is Edward J. Richardson, who has been with the company for multiple decades. My eyes fell on this stock after reading an excellent write-up on the company by Jeremy Blum, which can be found here . I highly recommend reading it as well, before potentially investing in the stock.

Stock performance

Richardson Electronics' stock has been down over 44% this year, greatly underperforming the S&P 500 and completely missing the general stock market rally of 2023. This all happened after rallying to an all-time high of over $27 a share, just about a year ago. At the time of writing of this article, the stock is trading around $11.6 a share, so the stock lost almost 60% when compared to its former peak. It is trading at a market cap of $166 million, a P/E ratio of 7.6 and a dividend yield of 2.1%. Furthermore, EV/EBIT is at 5.6. This is all a lot lower than the sector average, thus making it an interesting stock to investigate further.

Recent results show a pivot towards green energy solutions

Richardson Electronics posted Q4 results of fiscal year 2023 on the 27th of May. The company beat its EPS target of $0.19 by $0.08 (EPS of $0.27) and missed its revenue target of $61.5 million by $2.67 million (revenue of $58.83). YoY revenue was down by 4.5% when compared to Q4 of fiscal year 2022. This happened after beating revenue by 20%-30% for a consecutive 9 quarters. Gross profit (-18.7%) and EBITDA (-59.4%) were also down significantly when compared to the previous year. The firm was still profitable though. Free cash flow was at $0.81 a share (-66.4%), but has fluctuated greatly over the quarters. This is mostly due to a build-up in inventory. Inventories, namely, are up significantly, rising to over $100 million in Q4 2023, compared to just over $80 million in Q4 of 2022. When compared to total revenue, as shown in the figure below, the build-up in inventory does not seem out of the ordinary as revenue is growing fast and demand is even higher. However, large build-ups in inventory can be a major risk with this company, as they have a track record of inventory obsolescence and thus potential mismanagement.

Richardson Electronics has four main business segments, these being: Power and Microwave Technologies ("PMT"), Green Energy Solutions ("GES"), Canvys (Visual Technology) and Healthcare. Over half of Richardson Electronics' revenue comes from its Power and Microwave Technologies ("PMT") segment, which has grown by 5.7%, compared to last year. The vast majority of its growth, however, comes from its Green Energy Solutions segment which has grown by over 110% compared to last year. This is spectacular growth which does not seem to be priced into its stock price.

According to Richardson Electronics' this segment comprises of:

Today we offer patented solutions that replace lead acid batteries in multiple applications such as wind energy, locomotives, and other critical infrastructure environments. We sell components used in electric vehicle (EV) manufacturing and charging stations. We are working alongside companies that want to replace fossil fuel by developing hydrogen as a fuel source from methane and other refuse. We are also a leading manufacturer of magnetrons used to produce lab-grown diamonds, a growing trend among people who want to buy a product that is both ethically sourced and eco-friendly.

The most important product that the company is selling through its GES unit is its ULTRA3000 Pitch Energy Model , which is 'is an ultracapacitor-based plug and play replacement for batteries within GE wind turbine pitch systems'. This is very much a lucrative market, since wind turbines play a large role in becoming carbon-neutral in the future. Even more so since a lot of countries committed to short-term goals of CO2 reduction, especially in Europe where Richardson Electronics has a foothold.

Fundamentals

Richardson Electronics is basically a family-owned company which is trading publicly. As stated in its most recent 10-K file, Edward J. Richardson owns 98% of its Class B common stock, giving him 62% of voting power of the outstanding common stock. I usually like it when the CEO has a big stake in the company as it gives him skin in the game, however the majority voting rights in this case make him basically untouchable. This can lead to a misalignment of interest with other shareholders, as he is not dependent on them for making decisions about the future of the company.

As briefly discussed above, Richardson Electronics is trading at a P/E ratio of 7.6 and has an EV/EBIT of 5.8. This is all very favorable, especially taking into account the accelerated growth the company has seen in recent years. Richardson Electronics' PEG ratio is also below 1, which could signify a lucrative buying opportunity. Taking a look at the balance sheet, one can see that the balance sheet looks strong, with an almost $25 million cash position and no long-term debt. The company looks very healthy, but might be a bit underleveraged. The stock is basically trading at book value, with current book value at approximately $11.23 a share, yielding a P/B ratio of just above 1. A lot of the company's assets are locked up in inventory though, as shown above. One thing is clear, however, this company is going nowhere during a recession.

Green Energy Solutions as a catalyst

There are some clear catalysts for Richardson Electronics with its expanding GES unit being the main one I will focus on:

• Its rapidly expanding GES segment is clearly a catalyst for future growth and potential stock price appreciation. With 'only' 50 million in sales and rapidly growing, there is a lot of room for expansion, particularly into the market for wind turbine capacitators. Besides the ultracapacitors; supplying parts to the rapidly growing market for hydrogen production and EV's can boost future profits greatly. The stock price does not seem to reflect the strong growth in this promising market, which will most likely grow to be an ever more important part of Richardson Electronics' business.
• Management has skin in the game and the company is basically still a family company. I like to see skin in the game from management as it aligns interests with its shareholders.
• The company has a strong backlog for most of its business units, especially for its semi equipment business (over $40 million in semi equipment backlog). Which they are expecting to ship in six months.

Risks

There are however also some clear risks when investing in Richardson Electronics:

• Management has a track record of building up too much inventory. Especially since inventory is building up rapidly in recent quarters, this is one to keep an eye out for.
• The CEO has majority voting rights and can therefore only partly be held accountable by its shareholders. This is something I do not like to see with companies I invest in, as this can lead to misaligned interests.
• Parts of its business are growing very slowly, even slower than general economic growth, which weighs heavily on its overall growth. Some parts of its business, like its tube business, were expected to be obsolete by now. However, their products seem to be more resilient than the market expects.

Valuation

As Richardson Electronics is investing heavily into inventory, performing a standard DCF valuation can be tricky, as one has to make more assumptions, which I am not a fan of. Therefore, I will resort to a 5-year EPS target for my valuation.

In the first figure below, I show the gross profits per unit for Richardson Electronics. As margins do not really vary much between the units, I will forecast the gross profit per unit 5-years into the future by using a 3% growth rate for all units except GES and a 40% growth rate for its GES unit (which grew 100% over last year). Then, I take the total growth rate YoY to estimate future EPS in the years 2024-2028. The results can be found in the second figure below. In 2028 the EPS are thus estimated to be around $3. With the current price, this means that the stock is trading at a 5-year forward P/E ratio of just under 4. According to Seeking Alpha's quant, the sector median is around 25. This means that the stock could potentially be worth 6 times the current stock price, if the company can keep growing its GES segment by a CAGR of 40% over the next 5 years. Even when relaxing the growth rate or using a lower industry P/E ratio, this company looks to be outperforming the market in the long run.

Takeaway

Richardson Electronics seems to be at an inflection point as the company could potentially shift from a small, slow growing, industrial firm to a fast-growing green energy solutions company. The company seems to still be valued like the former, its growth in its Green Energy Solutions unit not being fully recognized by the stock market. There are some clear risks concerned with the company though, but these are outweighed by the catalysts. Finally, my valuation shows that the company might be trading at a 5-year forward P/E ratio of under 4. I therefore rate Richards Electronics a 'Strong Buy'.

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