Like any stock market loser, when I read the news I'm always looking for any potential ideas that can come from the story's theme. When I read a BusinessWeek article about Homeland Security Secretary Michael Chertoff "promising more cargo screening" my mind immediately thought about the ramifications this move would have on the defense sector. I'm happy that the Homeland Security Secretary is starting to do something after his bold predictions of terrorist activist just a few weeks ago.
In my research I've found a company that should directly benefit from this spending on increased screening -- American Science & Engineering (NASDAQ: ASEI). Surprisingly, the stock didn't move on this news, which makes the situation even better as it seems the connection between American Science & Engineering (AS&E) and the Chertoff announcement flew over most people's heads. I think the reason for this is that AS&E wasn't in any way tied to the article, meaning the article doesn't mention the stock, or any other stock for that matter.
American Science & Engineering isn't a one-trick pony or a poorly developed company. In fact, the company boasts a strong product line, and an undervaluation when compared to its sector.
The company's product line is quite diversified between a wide variety of innovative and useful security technologies. AS&E's SmartCheck screening system basically creates an electronic chalk outline of the person being screened -- any potential weapons, for example, stick out from the body. The TSA has begun pilot testing this technology. The company's Gemini X-ray system is also very interesting. When compared to standard x-ray scanners, the product has been shown to more easily detect metal objects and fine details. Like the SmartCheck, it is easy to see the applicability of the Gemini in today's world. Lastly, and my reason for writing this story, AS&E has a product that provides excellent cargo and vehicle inspection -- the OmniView.
The OmniView can scan cargo and vehicles with very precise multi-imaging power, even through 14 inches of steel or 8.5 feet of oil! The OmniView also includes a technology called "Z Backscatter." This addition allows the OmniView to quickly generate views of the cargo from three different sides without actually moving the scanner, thus radically decreasing the time needed to scan each piece of cargo. This product's incredible abilities to see into cargo without taking too much time or effort leads me to believe it will find a roll in the increased port defense budgets. In fact, the product has already been very successful -- according to the company during its last earnings release, growth in the cargo scanning business was attributable to much of the overall top-line growth.
As I said before, the stock isn't good just because of its port screening technology. Unlike many story stocks without earnings and struggling balance sheet, AS&E is quite the opposite. The company's balance sheet is loaded with about $135 million in cash and short-term investments, good for almost $15 per share. Some of this cash is already being used to reward shareholders through a $35 million buyback and a newly announced quarterly dividend . In fiscal year 2007, the company earned $2.38 per share. But this figure is misleading because AS&E was forced to take a charge of $.80 per share for stock compensation expense. After adding this one-time charge back to the earnings per share, I arrive at a figure of $3.18 per share in earnings. Therefore AS&E is trading for 13.5x enterprise value/adjusted net income. When the security and protection industry trades for 27x trailing twelve month earnings, I have to argue that this company is undervalued, especially considering its growth potential.
I think that today's news serves as a potential longer-term catalyst for the stock because I believe that some of the port security budget is most certainly going to be invested in the OmniView. Considering the company's trailing twelve month revenues are only $153 million, if the company receives any Chertoff's promise of $200 million over the next four years, organic growth would probably be stellar.
For about one-half the price of the sector, you are buying a cash-rich company that is already doing things to reward shareholders, mainly initiating a buyback and a quarterly dividend, and this story seems interesting. However, considering the fact that the company has arguably the best port screening product on the market, and port screening is due to increase, this stock quickly becomes wildly attractive.
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