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Ignore the voting machines; Diebolds a winner
Driven down by controversy over its electronic voting machines, the company's stock is cheap. Its ATM business remains powerful, while its security business is posting solid gains.
By Robert Walberg
Diversification aint all its cracked up to be. Just ask the folks at Diebold (DBD, news, msgs).
After the election fiasco in 2000, the company jumped on the opportunity to enter the electronic-voting business. It seemed like a natural extension for one of the biggest makers of automated teller machines (ATMs). And Diebold has succeeded in capturing market share in this fledgling business. But it has come with costs.
Legal expenses from Diebold's incursion into electronic voting cost it about $2.9 million, or 4 cents a share, in the third quarter and forced it to cut 2004 earnings expectations. California is suing North Canton, Ohio-based Diebold, saying the companys equipment left its elections open to hackers and software bugs.
The electronic-voting unit's revenue, meanwhile, fell 28% in the third quarter from a year earlier, and the business problems are partly responsible for a decline in the company's profit margin. The fact that the stock is down more than 14% on the year has only served to increase the focus on managements potential misstep.
But is this really a case of what legendary investor Peter Lynch likes to call diworsification? No.
A short-term pop
The election will provide key clues about the electronic-voting business. If the companys 75,000 electronic voting systems prove trouble-free while traditional paper-voting systems come under renewed scrutiny, the public outcry for more updated voting systems could compel more states and municipalities to turn to companies such as Diebold for help.
But if Diebolds products falter, management may simply decide to jettison the troubled business, which makes up a small portion of the company's more than $2 billion in revenue. Either course is likely to push up the stock, at least for the short term.
What about beyond the election?
In the quarterly conference call, management put estimated fourth-quarter sales growth at 11% to 14%, above the consensus estimate. One reason for the strong growth stems from the fact that an order expected to hit in the third quarter was pushed into the fourth. Diebold is expected to earn about $184 million this year, compared to $174.8 million last year.
Its ATM business remains a powerhouse. The banking sector is in the midst of a major ATM replacement cycle, expected to continue through 2005. It's being driven by new encryption standards, new software platforms, a new check-clearing standard and Americans with Disabilities Act mandates.
Diebold's Opteva ATM line should enable it to build market share, especially in Asia. As banks transition to the new product line, profit margins also will improve. Margins have been under pressure recently due to increased commodity costs, intense competition and the voting-systems business.
Seeking security
Diebold also will benefit from the continued growth in its security business, which sells bank vaults, among other products. Bolstered by a couple of small acquisitions, Diebold is better positioned to penetrate the fast-growing commercial and government marketplaces. Management placed fourth-quarter revenue growth for this unit at 23% to 26%. For 2004, its revenue is expected to climb 16% to 18%, with Asia a major source of growth.
Considering that the majority -- roughly 94% -- of the companys business is doing well, its difficult to understand why the market has treated the stock so harshly. The only reasonable explanation for the stocks sorry performance is that investors are troubled by the lackluster performance of the voting-systems unit.
But remember, the electronic-voting unit represents a relatively small percentage of overall sales -- 5.6% of third-quarter revenues. So if management decides to bail, Diebold is unlikely to have a tough time replacing the revenue. But if Diebold's equipment works, the unit will again be seen as a growth driver.
Either way, theres a good chance that the focus will begin to shift away from the electronic-voting unit after the election and toward the company's stronger business segments. That would be good news for investors.
A cheap stock
The stock is trading at about 15 times estimated 2005 earnings of $3.06 per share, well below next years projected earnings growth rate of 20%, as well as the stocks customary valuation range of 17 to 19 times forward earnings. Then there's the fact that Diebold expects to deliver double-digit sales and earnings growth in the fourth quarter and in 2005, and that margins should improve by at least 50 to 70 basis points. Add all this up, and the stock is relatively cheap, especially when you consider that it also offers a dividend yield of 1.6%.
Regardless of whom you vote for in next weeks presidential election, electing to buy Diebold when the stock is near its 52-week low because of what amounts to little more than noise could be the best decision you make. Assuming the company delivers on expectations for 2005, theres upside potential over the next six-to-12 months to the $58 to $60 range, a 27% to 32% return excluding the dividend. For a market-leading company with strong financials, decent management and a dependable history of sales and earnings growth, that kind of potential profit is hard to come by.
At the time of publication, Robert Walberg neither owned nor controlled shares in any equities mentioned in this column.
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