I am bullish on CompX International (NYSE:19) with a “Buy” rating:
- Sales of security products rebound
- There are signs of recovery in the marine components segment
- The valuation is not excessive
Security product sales bounce
After 5 consecutive quarters of sequential decline in security products (mainly various types of locks, especially for businesses), CompX saw a recovery in Q3 FY23. Management attributed this to increased sales of ‘a customer in the government security market and expects business growth from this source to continue.
I am optimistic about a broader recovery in this end market, which I believe would correlate with new real estate development or renovation activity, as this is often the time when new security systems are installed. Until December, prospects for such activity were muted, when talk of “higher for longer” rates was the standard. However, in December 2023, the message from the Fed and subsequent market sentiment passed to one in which rate cuts expected in 2024. These conditions would be more favorable for capital expenditure in the real estate sector, and therefore also for CompX’s lock business.
There are signs of recovery in the marine components segment
In the marine components segment, CompX mainly sells ski/ski components.wakeboard boats and performance boats. In the Q3 FY23 In the MD&A section of 10-Q, management indicated that it expects shipping demand to remain weak in a high interest rate environment, noting that:
Several original equipment boat builders, including some of our customers, have publicly announced reductions in production schedules for the remainder of 2023.
Due to the changing rhetoric around rates, I believe this is an outdated outlook for the company. Given that boats are a big-ticket item, often purchased using financing options, I expect the rate reductions to spur greater activity in the recreational boating industry. From a bottom-up fundamentals perspective, I also note broader trend increased consumer participation in outdoor activities:
In the range of outdoor activities, windsurfing/windsurfing is the relevant sport related to CompX’s marine component sales. This ranks as the fifth fastest growing outdoor activity:
Therefore, I believe the outlook for lower rates and the fast-growing trends of sailing, windsurfing and wakeboarding in the increased theme of outdoor recreation lay the foundation for some green shoots of recovery in the CompX Marine segment.
The valuation is not excessive
CompX currently trades at an LTM EV/EBITDA of 8.9x compared to the long-term median of 7.0x, implying a premium of 27.2%. I consider this acceptable since I believe CompX is at the beginning of a booming upgrade cycle. And in the chart above it is clear that we have not yet reached peak valuations (~12x at least).
Key risk assessment and monitoring
CompX is a small $307 million market capitalization company. But it has no debt and is cash rich with an excellent balance sheet. Current assets of $120.5 million offset total liabilities of $18.1, almost 7 times higher. The company’s cash and equivalent balances represent almost 21% of the market capitalization.
The Security Products business has already shown signs of rebound last quarter, coupled with an optimistic management outlook. I think the main risk of my thesis lies in a false start of recovery in the marine components segment, because there the company has yet to show a quarterly recovery in growth. A macroeconomic indicator to assess the likelihood of a rebound in discretionary consumer spending is to look at University of Michigan Consumer Confidence Index:
So far, the rebound in consumer sentiment and favorable news can be seen as support for the idea that discretionary spending will also see a rebound. I will continue to monitor this metric to have a more accurate real-time assessment of the validity of the thesis.
Another thing I’m monitoring is the margin profile of the two end market companies. In recent quarters, margins have experienced some volatility due to lower sales volumes offset by lower raw material costs (notably stainless steel and aluminum). However, on average, the margins are broadly around the same range, in the mid-teens.
This volatility will make it difficult to draw conclusions about margin movements over a single quarter. Still, it’s something I monitor to make sure it doesn’t fall sustainably below the mid-15% range for EBIT or below the upper 20% range for overall gross margin.
In my opinion, the optimistic arguments in favor of CompX are quite simple and clear. Security products (locks) – the largest segment which contributes 77% of its overall turnover – are already experiencing a growth rebound which is expected to continue. The likely possibility of rate reductions is expected to further support the resumption of growth in the marine components sector, bolstered by consumer trends that show greater participation in outdoor activities, aptly combined with the growing popularity of surfboarding. windsurfing/windsurfing/wakeboarding, because that’s what CompX plans. The marine segment is oriented towards.
While CompX is on the cusp of a potential upcycle, I believe current valuations are not excessive, as it is still possible to achieve historically high valuation multiples. On the risk side, the balance sheet is in excellent shape. Consumer sentiment data is measurable at high frequency and so far the signs are rosy in this department. Some QoQ volatility in margins would have to be accepted, as it varies with sales volumes and raw material costs, but I don’t think this is a major concern as long as margins do not deteriorate sustainably below the normal band.
I consider CompX a “Buy”.
How to interpret Hunting Alpha notes:
Strong Buy: Expect the company to outperform the S&P500 based on total shareholder return, with higher-than-usual confidence
Buy: Expect the company to outperform the S&P500 based on total shareholder return
Neutral/Hold: Expect the company to perform in line with the S&P500 based on total shareholder return.
Sell: Expect the company to underperform the S&P500 based on total shareholder return.
Strong Sell: Expect the company to underperform the S&P500 based on total shareholder return, with sentiment higher than usual