AVX Corporation (NYSE: AVX) manufactures and sells products that allow for the storage, filtration or regulation of electric energy (used in a wide range of products from vehicles to solar equipment to tablet touchscreens). The company has a close relationship with Kyocera Corporation, which manufactures many of its products. AVX was a wholly owned subsidiary of Kyocera until 1995, at which point it was spun off into a separate entity. Kyocera retained 22.9%. Currently, Kyocera owns 71.6% of AVX’s shares. This is what AVX has to say about its ongoing relationship with Kyocera:
One principal strategic advantage for AVX is our ability to produce a broad product offering to our customers. The inclusion of products manufactured by Kyocera in that product offering is a significant component of this advantage. In addition, the exchange of information with Kyocera relating to the development and manufacture of multi-layer ceramic capacitors and various other ceramic products benefits AVX.
Some may worry that, with such a strong relationship and control of the company, Kyocera could take advantage of AVX minority shareholders. The potential for this to occur has been mitigated to an extent by having the relationship between the parties subject to various contracts, all of which must be approved by the independent directors of AVX. The upshot of the relationship for minority shareholders is that AVX has paid a (small) dividend in all but two years since it separated from Kyocera, likely out of an unspoken obligation as part of the spin-off to ensure that Kyocera’s remaining investment in the company would not lie fallow forever.
That said, it is quite a small dividend, and AVX could very easily afford to increase this. Let’s take a closer look at the company.
First, the company’s returns since 1995:
The company hit a rough patch from 2002 – 2004, undergoing restructuring in response to a downturn in their industry. Here’s a timeline that the company provided at the time (emphasis added):
The electronic component industry in which we operate is cyclical. Fiscal years 2000 and 2001 experienced significant growth and sales price strength as a result of an information technology expansion. Beginning in late fiscal 2001, our customers began to experience declines in demand for their products and determined that they had accumulated excessive passive component inventory. The utilization of the accumulated inventory and the decline in the worldwide economy led to significant declines in demand for our products throughout fiscal 2002. During fiscal 2003, we experienced modest increases in unit demand in line with end market demands for our customers’ products, however, average selling prices for our products continued to decline. In fiscal 2004, we saw a substantial improvement in the markets that we serve when compared to fiscal 2002 and 2003. During fiscal 2004, we saw some pricing stabilization, increases in unit demand, improvement in manufacturing capacity utilization and a more normal balance in supply chain inventories. In reaction to the slow down in demand during the past several years, we significantly reduced our labor force and operating costs. During fiscal 2002, 2003 and 2004, we recorded $24.6 million, $3.0 million and $27.2 million, respectively, of restructuring and special charges as part of our cost reduction and realignment initiatives.
Knowing now that this company operates in a cyclical industry, it is important to focus on the company’s cost structure and capitalization. It is a big mistake to invest in highly cyclical companies that have high fixed costs; as soon as the cycle turns against them, they can quickly swing to losses and high debt levels can push them into insolvency (just look at the airline industry). Let’s look at the company’s margins and revenues:
Here we see the 2000 – 2001 spike and subsequent crash, the cyclical nature of the company’s operations and margins. When margins improve or fall dramatically, in line with revenues, this is indicative of a largely fixed cost structure (conversely, stable margins would be indicative a variable cost structure). Let’s turn to the company’s capital structure to get a sense of any problems related to debt servicing that might arise in another downturn:
This is one of my all time favourite charts. If you look really closely, prior to 2002, the company held some debt, but such a small amount that you have to look really closely to see it otherwise you could very well miss it. And then the chart gets better. Look at all that cash and securities. Loads and loads of it, increasing at a nice even rate. In fact, today the company’s cash and securities (both long and short-term) amounts to $1.02 billion. This is an astonishingly high figure when you consider that the company’s market cap is just $2.0 billion (This figure is accurate at the time of writing, 8/9, but given the market volatility may very well be different by the time of publication).
Lots of cash and securities is a good thing, but it is important to look for clues as to how it plans to spend it. Sometimes management will squander it as part of an empire building endeavour, and shareholders never see their capital put to a good use (being returned).
I looked several of the company’s recent earnings call transcripts, and the subject was broached in Q4 2010 (evidently for the first time!):
Operator: Jim Suva, Citi.
Samuel – Citi: This is actually (Samuel) on behalf of Jim Suva. First, congratulations on the quarter and second, my question is, you have a very strong cash position and now that the economy is recovering, can you discuss plans to use of cash and potential M&A or organic expansion and in what areas and how much capacity?
John S. Gilbertson – CEO and President: Yes. Kurt is going to answer that.
Kurt Cummings – VP, CFO, Treasurer and Secretary: No one has ever asked that question before. I think the cash is going to serve a lot of different purposes. If the sales growth continues, there will be a need to increase working capital to support that. We talked about capital expenditures. We will continue to pay dividends assuming the Board chooses to that and we’ve talked before about growth organically, as well as growth through M&A and all those options are on the table.
Surprisingly, this is where the conversation ended. There was no push-back about how the company had (at the time) $913.8 million in cash and securities, as compared to net $1.3 billion in capital expenditures over the company’s history to date, meaning that it was highly unlikely that the company would need that amount of cash and securities for capital expenditures (likewise, this figure was more than twice the amount of working capital less cash and securities at the time). Simply put, the company could (and can) afford to pay a bigger dividend or do a share repurchase.
Speaking of a share repurchase, this topic was touched upon in the Q2 2011 earnings call, with the following exchange:
Joe Wittine – Longbow Research: Shawn was on another call, so I just want to throw one quick follow-up actually, real quick one, the share repurchase activity, pretty modest this quarter. Do you expect that to continue over the next couple of quarter, if so in the same range?
Kurt Cummings – VP, CFO, Treasurer and Secretary: Well, because of the amount of float that we have out there, we’re not trying to take on large amounts of repurchases in any quarter. We go in to try to support the price when it makes sense to benefit all the shareholders. So going forward, I don’t know what to tell you in terms of the amount we may buy, but the authorization from the Board still has a number of millions of shares that we can buy when it make sense to do that.
So the company has a lot of cash and securities, but has not articulated a very good reason for holding onto it. Even the potential for acquisitions would hardly make sense. Over the company’s history, its largest acquisition was $226m in 2008, or 1/4 of the company’s current cash and securities balance. Simply put, the company does not need to hoard that capital. It could fund a number of average sized acquisitions, increase its working capital and increase capital expenditures and still have plenty of cash (and as we’ll see below, the company is doing a good job producing free cash flow each year). Only if you expect incredible (and risky) increases in acquisitions or capital expenditures would the current amount not look disproportionate.
Remember, this cash and securities is the property of the shareholders. If it cannot be put to good use immediately (let alone over a decade), then it should be returned to the shareholders to invest elsewhere. Also, as mentioned, the company is generating healthy free cash flows on a consistent basis:
To provide some context, the company has, over the last five years, generated free cash flows of $621.1 million, or $124.2 million on average. If you strip out the company’s current cash and securities balance, this would be a 12% free cash flow yield. Through a recession. Over the same time, the company paid out just $140 million in dividends, or about 1/5 of its free cash flow.
With strong free cash flows and weak reasons provided for holding onto the cash and securities, it is a wonder that analysts and shareholders aren’t demanding answers. My guess is that Kyocera doesn’t want the cash and securities distributed, and so AVX will simply continue to build up this balance until Kyocera wants it released.
Though I would be unhappy as a shareholder to be subject to the whims of a majority shareholder, I could get past that if the price was right. While I did find a margin of safety for AVX under a variety of scenarios (and thanks to the large cash balance, a fairly limited downside), I would wait for a far more attractive entry price to compensate for the risk that the cash and securities will not be paid out for the foreseeable future and may very well be squandered in the meantime.
What do you think of AVX?
Author Disclosure: No position.