One of my readers asked me to review small cap with a strong dividend profile: Exco Technologies. If you have any stock review suggestions, just add a comment at the end of the article!
What Makes Exco Technologies (XTC) a Good Business?
XTC is an industrial company working with the automotive industry. Exco is a global designer, developer, and manufacturer of dies, molds, equipment, components, and assemblies to the die-cast, extrusion, and automotive industries. What’s a “die” anyway? Here’s the complete definition from Wikipedia:
“A die is a specialized tool used in manufacturing industries to cut or shape material mostly using a press. Like molds, dies are generally customized to the item they are used to create. Products made with dies range from simple paper clips to complex pieces used in advanced technology.”
The company has 3 different segments: Automotive Solutions, Extrusion Tooling Solutions, and Die Cast Solutions. The automotive solutions segment is the most important segment for XTC.
Exco Q3 2017 presentation
Revenue
Revenue Graph from Ycharts
You can clearly see how XTC business depends on how the automobile industry goes. Management has made several acquisitions in the past few years to grow and diversify their business. Exco has in 2010, 2011, 2013, 2014, and 2016 made five acquisitions (Allper AG, Exco Colombia, Extrusion Texas, Automotive Leather Company, and AFX Industries) and may make others in the future.
Their latest quarter showed a drop in revenue mainly due to the permanent closure of the group’s loss-making Lesotho operations at the end of November 2016 and the run out of the BMW 5 Series seat cover program, which ended in February 2017. Management is also now focusing on higher margin activities to improve profits.
How XTC fares vs My 7 Principles of Investing
We all have our methods for analyzing a company. Over the years of trading, I’ve been through several stock research methodologies from various sources. This is how I came up with my 7 investing principles of dividend investing. Let’s take a closer look at them.
Source: Ycharts
Principle #1: High Dividend Yield Doesn’t Equal High Returns
My first investment principle goes against many income-seeking investors’ rules: I try to avoid most companies with a dividend yield over 5%. Very few investments like this will be made in my case (you can read my case against high dividend yield here). The reason is simple: when a company pays a high dividend, it’s because the market thinks it’s a risky investment… or that the company has nothing else but a constant cash flow to offer its investors. However, high yield hardly come with dividend growth and this is what I am seeking most.
For some reason, Ycharts can’t publish the dividend payment or the dividend yield. Therefore, I will not publish the usual graph in the following sub-section of my article.
After the most recent stock drop (-21% over the past 12 months as at September 8th), the company shows a yield of 3.36%. While further digging will be required to discover what is happening with the stock price, XTC currently shows a very interesting yield.
XTC meets my 1st investing principles.
Principle#2: Focus on Dividend Growth
Speaking of which, my second investing principle relates to dividend growth as being the most important metric of all. It proves the management’s trust in the company’s future and is also a good sign of a sound business model. Over time, a dividend payment cannot be increased if the company is unable to increase its earnings. Steady earnings can’t be derived from anything else but increasing revenue. Who doesn’t want to own a company that shows rising revenues and earnings?
Source: data Ycharts, graph by author
Exco has steadily increased its payout for the past decade. The company does show an impressive growth rate for the past 5 years with a dividend increase from $0.0375/share to $0.08. While the company is dependant on the automobile industry, management showed they were able to keep the growth alive during a tougher environment.
XTC meets my 2nd investing principle.
Principle #3: Find Sustainable Dividend Growth Stocks
Past dividend growth history is always interesting and tells you a lot about what happened with a company. As investors, we are more concerned about the future than the past. This is why it is important to find companies that will be able to sustain their dividend growth.
Source: data from Ycharts.
With both cash payout ratio and payout ratio under 30%, the company shows plenty of room to grow their dividend in the future. I must admit I’m quite surprised by the fundamental of this small cap.
XTC meets my 3rd investing principle.
Principle #4: The Business Model Ensure Future Growth
XTC is a leader in die-cast molds in North America. This positions XTC on the front line for aluminum molds. What’s the matter? New regulations push the automobile industry to reduce their car consumption. Aluminum parts are definitely an element of solution.
I also like XTC light balance sheet combined with an appetite for growth. The company generates enough cash flow to sustain its activities and eye for additional acquisitions in the future.
XTC still shows a strong business model and meets my 4th investing principle.
Principle #5: Buy When You Have Money in Hand – At The Right Valuation
I think the perfect timing to buy stocks is when you have money. Sleeping money is always a bad investment. However, it doesn’t mean that you should buy everything you see because you have some savings aside. There is valuation work to be done. In order to achieve this task, I will start by looking at how the stock market valued the stock over the past 10 years by looking at its PE ratio:
Source: data from Ycharts.
A first look at the PE chart tells me two things. #1 this could be an amazing buy opportunity and #2 there is something wrong with the company. When a company loses half of its PE ratio within three years, there is usually a very good reason why.
Digging deeper into this stock valuation, I will use a double stage dividend discount model. As a dividend growth investor, I’d rather see companies like big money-making machines and assess their value as such.
| Input Descriptions for 15-Cell Matrix | INPUTS | |||
| Enter Recent Annual Dividend Payment: | $0.32 | |||
| Enter Expected Dividend Growth Rate Years 1-10: | 6.00% | |||
| Enter Expected Terminal Dividend Growth Rate: | 7.00% | |||
| Enter Discount Rate: | 10.00% | |||
| Discount Rate (Horizontal) | ||||
| Margin of Safety | 9.00% | 10.00% | 11.00% | |
| 20% Premium | $18.85 | $12.61 | $9.48 | |
| 10% Premium | $17.27 | $11.56 | $8.69 | |
| Intrinsic Value | $15.70 | $10.51 | $7.90 | |
| 10% Discount | $14.13 | $9.45 | $7.11 | |
| 20% Discount | $12.56 | $8.40 | $6.32 | |
Source: how to use the Dividend Discount Model
I had to consider a 10% discount rate due to the size and the nature of the company. However, with a low dividend growth rate (compared to the past 10 years), I’m still able to find value. In other words, while there are risks in this play, XTC shows an interesting margin of safety.
XTC meet my 5th investing principle with a potential upside of 11%
Principle #6: The Rationale Used to Buy is Also Used to Sell
I’ve found that one of the biggest investor struggles is to know when to buy and sell his holdings. I use a very simple, but very effective rule to overcome my emotions when it is the time to pull the trigger. My investment decisions are motivated by whether or not the company confirms my investment thesis. Once the reasons (my investment thesis) why I purchase shares of a company are not valid anymore, I sell and never look back.
Investment thesis
I like when management posts things like this in their presentation:
And then:
Exco Q3 2017 presentation
This alone is enough for me to initiate an investment thesis. XTC is a well-run company paying a steady and increasing dividend. It is a leader in its industry and shows growth vectors through potential acquisitions and additional demand for aluminum molds.
Potential Risks
The more I write about XTC, the more I start to think it’s a great investment. However, I still have this question in mind: why is the share price going down like there is no tomorrow?
And then I found the answer: XTC is evolving in a highly cyclical environment and everybody feels it’s about to take on the down side of the mountain:
Exco Q3 2017 presentation
The automotive segment seems to be on a slump already. AFX’s sales were down 16% during the quarter mainly reflecting fewer releases associated with established programs and a slower than anticipated ramp up of new programs. AFX was acquired on April 4, 2016.
Catching a falling knife is always a complicated task. Will the company bounce back and show strong numbers by the end of the year? This could push the stock higher. However, if sales and earnings are as deceiving as they were the rest of the year, I wouldn’t be surprised to see XTC around $8. This is the problem with smaller caps; they tend to be volatile!
XTC shows a solid investment thesis and meet my 6th investing principle.
Principle #7: Think Core, Think Growth
My investing strategy is divided into two segments: the core portfolio built with strong & stable stocks meeting all our requirements. The second part is called the “dividend growth stock addition” where I may ignore one of the metrics mentioned in principles #1 to #5 for a greater upside potential (e.g. riskier pick as well).
As previously mentioned, there are some risks around XTC. It seems the demand in the car industry is slowing down and this could affect XTC. On the other side, it appears that all the bad news has been factored in the price already. If the company can go back on the growth path, shares could explode rapidly.
XTC is a growth holding.
Final Thoughts on XTC – Buy, Hold or Sell?
In light of my analysis, I think XTC is a very interesting company with a strong dividend profile. I don’t know why though, there is still something that bugs me. I’m not sure what it is exactly, but I’m just not ready to invest in it. I guess I’m too concerned about the automobile industry going sideways. Nonetheless, it could be a very interesting play as a small position in any dividend growth portfolios.
Disclaimer: I do not hold XTC in my DividendStocksRock portfolios.
The opinions and the strategies of the author are not intended to ever be a recommendation to buy or sell a security. The strategy the author uses has worked for him and it is for you to decide if it could benefit your financial future. Please remember to do your own research and know your risk tolerance.
