Portfolio Spotlight: Bel Fuse
Stock up 5x from the bottom in 2020, but still good value.
Disclaimer: This content is for educational and entertainment purposes only and is not intended as financial advice. Perform your own research and consult a qualified financial advisor. The author may hold positions in the discussed stocks. This is not a recommendation to buy or sell securities.
As a value investor, when you see a stock chart like this, you’ll be suspicious. And you should be. How can a stock up 3-5x still be good value at the current price?
But what if I told you this was the EV/EBITDA multiple during this period:
In other words: the price increase is not driven by multiple expansion. That must mean EBITDA growth is the underlying force.
Revenue only grew < 4% CAGR since 2016, but margin expansion tell us the real story. Here is the evolution of gross and EBITDA margins:
And rolling LTM net income:
“Overearning! “
“COVID tailwind! “
“Unsustainable!”
Good. You still have the scepticism of a real value investor. And despite the run up in stock price, the market seems to agree with you. Bel Fuse’s multiple hasn’t expanded even though the underlying fundamentals have improved a ton.
And that’s where the opportunity lies. I think you get a chance here to buy into a proven turnaround story while the market remains doubtful.
Let’s dive in.
Intro
Bel Fuse ( BELFB 0.00%↑ ) is an electronic components manufacturer for end markets like network & cloud, military & aerospace and EVs, all of which have favorable long-term tailwinds. These products, while somewhat commoditized, are vital "low cost components with a high cost of failure". I won’t go deeper into the business itself here but will provide additional reading material at the end of this post.
These companies can be good businesses, and peers like TE Connectivity (TEL 0.00%↑) and Littelfuse ( LFUS 0.00%↑ ) have decent to good ROE (12%+), while usually trading between 12x and 14x LTM EBITDA. Although somewhat cyclical, they benefit from long-term trends.
At $63, Bel Fuse has an EV of $785m. LTM EBITDA is $108m, so that’s EV/EBITDA = 7.3
I’m not a fan of stock pitches like “My company trades at X, while peers trade at Y. if my company starts trading the multiple of peers, I make a lot of money”
But this time, it’s different. Hear me out.
Why the Valuation Gap?
Bel Fuse rightfully traded at a discount to peers. It simply was a worse company, with worse margins and ROE than peers. The company overly prioritized revenue growth while ignoring profitability.
Peer electronic components companies both private and public typically operate at circa ~30 - 35% gross margins and ~20%+ EBITDA margins…. Bel Fuse stands out like a sore thumb, with gross and EBITDA margins a minimum of 10-15% lower, and often more, depending on the year.
In 2021, they hired a new CFO, Farouq Tuweiq. He brought a fresh perspective to the company, emphasizing profitability over revenue growth for the first time. He used to be a sell-side analyst covering the industry. He had seen comparable situations in private equity, and saw an interesting opportunity in joining Bel Fuse to improve it.
The good thing for Farouq, and shareholders, is that Bel Fuse isn’t even in need of a “real turnaround”. The company simply wasn’t focused on profit before. Don’t believe me? Here are some actual quotes from recent earnings calls:
The revenue has been the primary focus over the years to build scale, and margins were just not a focus for a period of time.
We even got a pubic apology from the CEO, Daniel Bernstein:
I have to give Farouq a lot of credit… And it was my fault. We were too driven to be the $1 bilion company from a revenue point of view. And maybe we took business in that we shouldn’t have taken in… we really had to evaluate every part of the business and mostly from a margin standpoint… we had customers that really didn’t fit and we has SKUs that didn’t fit.
Since Farouq came to Bel, I think he’s done a tremendous job to really focus on the margin. It’s a nice goal to have $1 billion of sales, but without proper margins, it doesn’t make sense to us any longer.
If you look back 2 year ago, th erange of margins that we had across our SKU base was very large. We had negative margin SKUs.
Needles to say, this offers some easy levers for the new CFO to pull.
And so far, so good. In Q3 23, Bel Fuse had 35% gross margins and they confirmed this is the new normal:
We know there are more cost improvements to be done in the business. … We actually have yet to hit on all cylinders, right? So we do think 35% margins are sustainable. We think 35% is about were we should be.
Valuation
As mentioned earlier, Bel Fuse currently trades at an EV/EBITDA of 7.3x. Herb Greenberg recently briefly mentioned the stock and included the detailed table below:
Balance Sheet and Capital Allocation
Bel Fuse ended Q3 23 with a modest net cash position.
In terms of capital allocation, they highlighted their financial flexibility and openness to various options. Notably, in the Q3 2023 earnings call, the CEO unexpectedly mentioned a stock buyback as a potential method of capital allocation, which was a very pleasant surprise.
However, they also stressed the importance of internal investments:
We’re resetting our cost base and structure for the business while prudently investing… we’re not looking to cut our way to growth, that doesn’t happen. We need to invest in growth.
(Q2 23 Earnings Call)
while not ruling out any M&A:
Always on the hunt for M&A, but that market has been slow lately. We're always looking for ways to improve our capital allocation strategy.
(Q3 23 Earnings Call)
These titbits suggest that Bel Fuse might soon initiate a stock buyback, further reinforcing the new value creation strategy focused on profit (per share) over profitless revenue growth.
A-Shares & B-shares
There are 10.4m class B shares (non-voting) and 2.1m class A shares (voting). B shares are more liquid and get a 5% higher dividend. When buying shares, the easy way would be to just buy the most liquid shares (B), but you could always opt for A shares when they trade at a substantial discount.
Risks
Dual-class share structure and governance concerns: current CEO Daniel Bernstein is the son of the founder. He holds 20% of the voting power through his A shares. He has seen the error of his ways and hired Farouq to fix things. But he’s still in control. Maybe he’ll change his mind about the new strategy, but the public markets rewarding him with a stock that has gone up a ton, should be a good incentive to stay the course.
Key man risk in the new CFO: Dependence on CFO Farouq Tuweiq, whose leadership seems to be critical to the company's revamped focus.
China Risk: A portion of their manufacturing is based in China, making them vulnerable to deteriorating US-China relations. Although the company is actively seeking ways to mitigate this risk, it remains a significant concern.
Resources
Good Twitter accounts on the company:
This VIC write up from 2022 goes DEEP. Be sure to check out the comments for further discussion.
nice idea thanks