Wait for this Underfollowed, Undervalued Stock

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Jae Jun

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Welcome to Key Tronic

One of the things that Key Tronic Does

Key Tronic (KTCC) started out in 1969 as a company in Washington state making computer keyboards. From their humble beginnings, Key Tronic grew into an Electronic Contract Manufacturing company which is another way of saying they are an OEM. They now make a huge variety of products, manufacturing for the printer market, telecommunications, automotive, medical, aerospace, military and more.

To be an OEM, you must be able to do everything from A to Z. Everything from handling supply chain management to prototyping, molding, tooling, product assembly, quality testing, distribution and even repairs.

A Look at Their Business

For a small company with a market cap of 100m, they refer to themselves as “North America’s largest precision injection molding company, capable of molding parts in any size, any volume and any material including multi-material products.”

Currently Key Tronic is generating revenue from 183 separate programs from 56 customers. In 2012, it was 165 separate programs and 48 distinct customers. 2011 had 119 programs and 33 customers. These are some very good customer growth numbers.

Think of programs as “projects” from customers. A customer is unique, but a customer may have several different products it wants to get built. For every new customer acquisition, if the service, quality and reliability is good, they will likely award Key Tronic with more products.

Because Key Tronic is an all-in-one solution, once they get into a customers good books, more programs are awarded, and a switching cost is created to the customer. This is an important moat to have in the manufacturing industry.

Contract manufacturing has always been a razor thin margin business. OEM’s make money on volume since the customer will be marking up their prices to a suitable retail price, the OEM price is cut throat.

Net margin  for 2012 was 3.4% and in 2013, it’s 3.5%. This is on the high end when you compare with other contract manufacturers. Usually, you’ll see net margins between 0.5% to 3%. Anything above 3% is fantastic.

The other highlight for Key Tronic is their cost structure. By being able to manage everything in the manufacturing process and more, operations can be scaled to keep the cost structure flexible. When revenues are expected to decline, the costs will be lowered as well to maintain consistency.

Let’s get into the highlights and lowlights for Key Tronic based on the Fundamental Stock Analyzer.

Key Tronic Highlights

  • Good consistency with margins; gross, operating and net.
  • Net receivables have gone down throughout the year. Key Tronic is finally receiving payments from customers.
  • Aggressively paid off all debt.
  • Shareholders equity has increased for more than 10 years. From 2003 to 2013, the shareholders equity CAGR is 13.63%.
  • Working capital was taking a toll on FCF in 2011 and 2012. Collection of receivables is showing a nice increase in FCF.
  • Owner earnings however, has been impressive since 2006 except for 2009. Average owner earnings since 2006 is $15m.
  • 2013 Cash adjusted PE of 7.7. In 2008, the cash adjusted PE was 6.
  • EV/EBITDA of 4.8 compared to 6 in 2008.
  • Delivering ROIC at 15% which is the highest since 2007.
  • CROIC is above 30% which is excellent.
  • Excellent Piotroski score of 7 and strong Altman Z score.

Key Tronic Lowlights

  • Business operations is at the top of the range. What happens if the economy turns? Margins will compress and even though valuation is on the cheap side, it can easily get lower.
  • Keep an eye on receivables and how customer acquisition affects the cash conversion cycle. TTM shows awesome improvement but Key Tronic shows the tendency to be lenient in this area to increase future revenues. Could be trouble in difficult times.
  • Changes in working capital varies wildly because for every brand new program and customer relationship that is established, Key Tronic has to spend resources to set up the proper facilities. The ROI will take some time.
  • Doesn’t buy back its stock no matter how cheap it gets. 2008 and 2009 are prime examples.
  • Very low insider ownership.
  • Latest Q4 results shows 36% decline in earnings for the fourth quarter, revenues down 13% from last year.

Quick Valuation

DCF fair value range around $13

  • Quick DCF: 15% discount rate, 6% growth, $15m owner earnings gives a fair value of $13.50.
  • A reverse DCF shows the expected growth rate to be around -1%.
  • Graham Growth Formula has it at $22.
  • Absolute PE shows $11.
  • EPV is around $16.
  • Check out the link to get a better understanding of each stock valuation method, or get the details from the ebook.

Viewthe KTCC Dashboard Summary


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7 responses to “Wait for this Underfollowed, Undervalued Stock”

  1. Hilton Meyer says:

    Just popped this into the Spreadsheet but my values are way off from what you are showing here. I reckon this may be due to the use of FCF over Owners Earnings. Is there a reason you went for the later?

  2. I manually entered it. Selected a value of $15m and used owner earnings. FCF isn’t a good measure for KTCC because of the variance in changes in working capital. If you look at the owner earnings numbers, it better represents what the company has been able to achieve.

  3. Hilton Meyer says:

    OK. But what made you lean to the direction of using Owners Earnings. Did you first check the owners earnings? Apologies if I’m asking silly questions, just trying to understand the logic to be able to use the spreadsheet better.

  4. good question. When I look at a company, I look at the way working capital affects a business. If you look at KTCC, working capital is not consistent. Thus it is not a good idea to include it. You could take the average of WC over 5 years, but the problem with this is that there is too much variance to make it accurate. I’d prefer to get a rawer view of the fcf figure.

    Thus I used owner earnings because I believe it represents KTCC better.

    If WC is consistent, then FCF and owner earnings should be similar.

    Try out lots of different companies. If you look at a capex heavy company like oil refiners, they have negative FCF, but +ve owner earnings. In such a case, I wouldn’t use FCF because it doesn’t tell the story for the business.

  5. Hilton Meyer says:

    I’ll need to read up a bit more on working capital and how important it is to the business. I don’t quite understand how you can simply leave a piece of the valuation out if it is not working for the company. Surely working capital is important?

  6. It depends on the business. Working capital affects the business, but to get a sense of the business performance it is not always needed.

    Working capital has more to do with spending and collecting money and how money intensive a business is. What you’re looking for isn’t just that. It’s useful to know and especially important if the company is bleeding money, but for companies where they spend extra one year, just to prepare or they slow down operations and focus on collecting receivables, it isn’t going to provide an accurate picture.

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