Techprecision Corp (TPCS.OB) reported fiscal 2011 second quarter results last week, continuing a trend of rising backlog and consistent profits.

The new CEO seems extremely confident in the future prospects for the company but the stock remains undervalued despite a recent run-up in price.

Financial Highlights

Second quarter revenues were $8.4m, compared to $15.1m in the prior year quarter. However, the 2009 quarter was affected by a non-recurring inventory transfer to the company’s largest customer, GT Solar.

I’ve written about TPCS’s dependence on GT Solar before – TPCS receives much lower margins on raw inventory transfers versus shipping finished goods.

Adjusting for this one-time cost, sales increased 25% over last year’s results, along with a sequential increase from the first quarter.

Although gross margins were around 30%, operating expenses increased $500k to 13% of total sales compared to only 4% of sales last year.

The increase is partially due to the hiring of new sales personnel to cover the mid-Atlantic market. The expense increase was also impacted by the CEO search (recently completed in July with the hiring of James Molinaro).

Net income was $855k or $0.04 per share fully diluted compared to $0.06 per share last year – YoY comparables are difficult due to the materials transfer last year.

Through the first six months of fiscal 2011, the company has generated a net profit of $1.6m, up 40% from the same time last year.

TPCS generated $1.1m in free cash flow despite a significant increase in capex costs associated with the purchase of a new gantry mill to upgrade and modernize the company’s manufacturing equipment. The mill’s total cost is $2.3m and will be spread out over the remaining quarters of 2011.

The balance sheet remains solid with a cash balance of $9.24m compared to total liabilities of $8.1m. The stock’s current ratio is 6.1.

Future Growth Opportunities

Total order backlog increased from $21.5m at March 31, 2010 to $26.4m as of the September 30, 2010 filing. It further increased to $31m as of November 1, 2010.

The sales efforts for the company have paid off with several large orders from existing customers:

• Sept 8 – $2.9 Purchase Order from Existing Tier-1 Clean Technology Customer
• Sept 29 – $3.9m Purchase Order from Solar Customer
• Oct 13 – $6.7m Purchase Order from Solar Customer

Even better, TPCS announced an exciting expansion opportunity in the fast growing Chinese market by creating a company subsidiary to meet the growing demand for local manufacturing and machining from its customers.

This new local arrangement resulted in a $2.9m purchase order, and the company expects a significant increase in business with multiple customers as a result of this arrangement.

According to Mr. Molinaro, TPCS’s CEO,

“Demand for solar, nuclear and industrial components is growing globally, but this demand is increasing most in Asia and especially China…Already, 80% of poly silicon panels and many nuclear reactors are scheduled to be built in China, and our customers indicated interest in expanding business with TechPrecision if we could support them locally in Asia”

Reverse Stock Split

The latest proxy statement shows a new amendment giving the Board of Directors the power to affect a 1-for-2 reverse stock split. According to the filing,

“The Board believes that the Reverse Stock Split is an effective means of increasing the per share market price of our Common Stock in order to achieve the minimum per share stock price necessary to qualify for listing on well-recognized stock exchanges, such as the American Stock Exchange or the Nasdaq Capital Market. “

Currently trading on the OTCBB, the uplift of TPCS to a major exchange will significantly increase its exposure to individual and institutional investors, likely resulting in a big boost to the stock price.

The shareholder meeting for this proposal was on November 22, and the amendment was subsequently approved.

Conference Call

Management held its second quarter conference call, and seemed extremely bullish on the company’s prospects going forward.

A few notes from the call:

• Management’s goal is 4 new Tier-1 customers before the end of fiscal 2011
• First Tier-1 gas generation client will have prototype done in mid-2011 with full production in 2012; expect a significant increase in business from this market
• Stillwater is finishing up the medical beam prototype and expects to complete clinical trials in mid-2011. The university has hired a prominent specialist to head up the new unit, showing a commitment to the proton beam therapy
• New China operation will provide slightly higher margins and some tax advantages. Will also better serve the solar market in China (GT Solar has more orders than capacity through at least 2012!)
• China operation will also give them access to the nuclear market. U.S. has 104 old reactors but China is building rapidly with 10 new nuclear plants planned

Valuation

Trailing TTM diluted EPS is $0.12, giving the stock a current P/E ratio of 10.42. Based on management’s bullish prospects and the increasing order backlog, 2011 fiscal results should come in higher.

Assigning a more reasonable multiple of 12 to conservatively estimated 2011 EPS of $0.16 would equal a share price of $1.92.

An even better valuation metric is EV/EBITDA. TPCS’s EV/EBITDA ratio is only 3.77, very cheap for a growing, profitable company riding the clean energy wave.

Risks

An investment in TPCS does have risks around customer concentration and common stockholder dilution.

Although the company has focused hard on expanding its operations outside of the solar market, 54% of quarterly revenues were from GT Solar. The loss of this customer, or even a pullback in demand similar to 2009, would have significant consequences.

In addition, the share count has been increasing each year through a combination of stock warrants, options, and convertible shares. The company has seen some turnover in its executive ranks, which leads to the corresponding options grants.

Hiring a new CEO is expensive for a small company from an ownership perspective. However, the new CEO has a great deal of experience in the solar space, and seemed extremely confident on the conference call on the future direction of TPCS.

Conclusion

Despite the solid report, a company insider has sold a significant chunk of stock in the past month, a possible warning sign.

I’ll be keeping a close eye on TPCS and evaluating my exposure, but I like the direction the company is headed.

The downside is limited due to the strong balance sheet so the investment thesis depends on management’s ability to capitalize on the company’s growth opportunities.

Disclosure

Long TPCS

China Agri-Business Inc (CHBU.OB) reported another outstanding quarter, driven by the rapid expansion of the company’s direct store sales program.

While the new distribution strategy seems to be working, the stock has appreciated significantly and now trades well above NNWC and book value – CHBU has now transitioned from a pure value stock into a growth story.

Financial Highlights

CHBU’s third quarter revenues were $3.5m, a 471% increase from the same period last year. This follows the 391% increase in second quarter revenues, as the company continues to add new direct stores at a blistering pace.

As of September 30, 2010, CHBU owned 400 direct sales stores, up from 346 direct sales stores in July. Management has set a goal of 500 stores by the end of October so growth should continue into the fourth quarter numbers.

While much of the sales revenue is due to direct store expansion, the company’s traditional network also saw a 120% increase in quarterly revenues, and are now up 22% on the year.

The company’s increased visibility and exposure seems to be helping across all business segments.

This growth is not without cost, as gross margins fell from 70.11% to 42.57% – the direct sales method has much lower margins than the company’s traditional sales network.

Operating margins took a hit as well, falling to 25.3% compared to 40% in the prior year period.

Since sales are increasing at a much higher rate, both operating and net incomes were up despite lower margins. Overall, net income increased 260% to $895k, or $0.07 per share, up from $0.02 per share in the third quarter last year.

Through the first nine months of 2010, CHBU has generated $2.1m in operating income and EPS of $0.15.

The company’s balance sheet remains strong, with almost $0.81 per share in net cash and a book value of $0.88.

Management has also taken steps to improve the stock’s capital structure. During the quarter, the company paid back a $500k convertible note, reducing the risk of share dilution for common shareholders.

The company still has 1.3m warrants outstanding as of September 30 at $1.00, $1.50, and $2.00 per share. However, 758k warrants expired in October.

The last significant chunk (500k) expires in Sept 2011, with a current exercise price of $1.50 per share.

Other Events

As I mentioned in my previous posts on CHBU, management had received approval from the local government for 66-acre land-use purchase costing $4.4m. If completed, this would take a significant chunk out of the company’s cash reserves and the original margin of safety for the investment.

Likely due to these delays, CHBU announced on November 12 that it would be leasing a ~4 acre parcel of land to construct a warehouse and distribution center.

The lease term is for 21 years at $53,800 per year (subject to a 12% increase every three years), with a prepayment of the first ten years in an initial lump sum of $540k.

While I’m not an expert in the going price for Chinese land, this lease agreement seems to come at a high price, especially when compared to the original purchase option.

Valuation

Due to its large cash balance, CHBU trades at very low multiples i.e. EV/EBITDA sits at only 1.73 using an enterprise value of 3.46m.

Looking at it another way, the stock has generated $1.7m in adjusted free cash flow for the year and should produce over $2m for the year – even using this conservative estimate, the stock has a ridiculous FCF yield of 57.8%!

The business should generate EPS of $0.06-$0.07 in the fourth quarter for an annualized EPS number of $0.22, translate into a P/E ratio of only 5.

Both DCF and EPV valuations suggest an intrinsic value of around $1.60.

Conclusion

While the stock has turned in an impressive year, my original thesis was predicated on a discount to tangible asset value.

Now that the stock is trading higher, it has ventured beyond value investing territory and has become even harder to predict. Also, I’ve become even more leery of Chinese small-cap stocks due to major accounting scandals that have recently surfaced.

While I think the stock could run up near $1.50 in the next few months (especially on the back of fourth quarter numbers with easy YoY comparables), I’m going to take the cautious approach.

I’m going to sell CHBU out of the Value Uncovered portfolio based on yesterday’s closing price of $0.99.

The investment gained 80% in 5 months for an annualized return of 314%.

Disclosure

No positions.

Electronic Systems Technology, Inc. (ELST) reported third quarter results last week, with significant improvements in revenue, operating income, and EPS.

2008 and 2009 were rough years for ELST, but recent trends show a return to former operating levels.

Truthfully, the stock is boring, but the company continues to trade at a discount to its net asset or liquidation value, providing a solid margin of safety.

Financial Information

Total revenues for the third quarter improved to $588k compared to $379k in the same quarter last year, an increase of 55%. Surprisingly, most of this growth was generated on the domestic sales side (in the first quarter, growth was seen mostly in the foreign markets).

Domestic sales made up 91% of quarterly revenues. While this sales growth is positive for ELST’s core markets, domestic sales have much lower margins than the international business.

Year-to-date sales of $1.6m are 20% higher than the same time last year, with growth increasing quarter over quarter.

The company reported positive quarterly net income, bringing YTD profits up to $102k or $0.02 per share.

A good portion of this yearly increase can be attributed to mobile data computer systems (MDCS) to public and government entities. For the first time, the company disclosed a material customer, ACL Computers & Software, which is a government subcontractor.

ELST’s products have long been used in patrol cars for police forces, and it appears the company is expanding into the federal space, a positive development.

The balance sheet remains strong, with a current ratio of 23.9. A significant portion of the company’s assets are in cash or short-term certificates of deposits.

Valuation Scenarios

At the latest closing price of $0.54, the stock is still selling at a small discount to NCAV and only slightly above NNWC.

Enterprise value is actually negative, as the company’s cash balance is more than the current market cap.

As a going concern, the company should report full year EPS of approx $0.03, with owner earnings of $200k.

Assuming no growth going forward, this still yields a DCF value of approx. $0.62 per share.

Conclusion

Now that sales are picking up, I’d like to see management return some of the excess cash to shareholders.

The company paid a consistent dividend from 2005-2008 when the business was in similar financial shape, and the resumption of this practice would be a good start.

Although government sales are notoriously unpredictable, another possible catalyst could arise through this new federal government reseller. Even a small federal contract could significantly help a company like ELST.

Overall, this is a pretty boring stock where future gains are limited but with solid downside protection. I’ll be keeping a close eye on an opportunity to sell if the price jumps significantly above the current asset value.

Disclosure

Long ELST