Tuesday, July 24, 2012

Sevcon ( Nasdaq - SEV ) -- On-Road Electric Vehicles Show Spark

( Note - Previous reports about Sevcon can be found in the International Stocks section. )

Sevcon (SEV $6.00) reported Q3 (June) results that were less than our expectation.  Fully taxed earnings declined 75% to $.01 a share.  The company is based in the United Kingdom, where the standard rate is 23%.  Sevcon operates around the world, though, so its official tax rate fluctuates depending on the specific locations where it conducts business.  It also claimed some R&D credits in the latest period.  After adding all the benefits back in Sevcon reported GAAP income of $.05 a share for the June quarter.  Sales rose 8% to $8.88 million. 

Sevcon is a leading provider of computerized controls that manage the engine performance of electric vehicles.  The company had a gangbuster business going prior to the 2008 Financial Crisis, focusing on industrial and off-road vehicles.  As gasoline prices blew past $100 a barrel mining companies, forklift operators, and a wide range of other work machine users switched to electricity to save on fuel costs.  In some cases they received government subsidies or other benefits because they were fighting the good fight against global warming.  That business fell of the cliff in 2008 (see financial table below).  Sevcon has a fantastic and hard working management team, which didn't panic.  The company diversified into the on-road (motorcycles, scooters, and city cars) and ATV markets.  Recently, it signed a deal with a Chinese truck manufacturer, as well. 

Those diversification efforts restored sales growth.  The legacy industrial segment returned to life over the past two years, as well, providing further impetus.  Sevcon's newer consumer oriented markets continued to gain momentum in the June quarter.  But the industrial segment experienced some backsliding as a result of the poor worldwide economy.  Sevcon added several engineers in the quarter, boosting expenses.  The shortfall in sales combined with the higher expense level crimped income.

Sevcon is dependent on the industry's performance.  It might be counter-intuitive but history suggests demand for electric vehicles is strongest when the economy thrives.  People have money to experiment with.  The tests are successful.  They expand.  Strong economies also make it easier for governments to support emerging technologies.  The deer in the headlights approach to economics now being pursued in Europe and the United States is likely to provide a significant headwind, until it changes.  On the plus side, electric vehicle price performance is continuing to improve at a fast pace.  So even under recessionary conditions the industry is likely to keep growing.

Sevcon is a high potential speculation.  The company's market capitalization is $20 million.  Sales are approximately double that.  Margins could improve substantially if volume improves.  The age old formula of rising sales and expanding margins could drive the value of these shares substantially higher over the next 2-3 years.  We projects sales could reach $75 million to provide earnings of $1.20 a share, after allowing for the sale of an additional 1.25 million shares to support growth.  If financial results reach that level, moreover, they're probably going to keep going higher, perhaps at an explosive pace.

( Click on Table to Enlarge )

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