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| | Street Patrol
5 standouts in the risky security sector
Gains are huge and big swings follow every terror-related headline, but these small security-services companies aren't for the timid.
By Robert Walberg
Growing concern over the threat of terrorism, spawned by the Madrid attack last month, has triggered a rush into many small- and microcap security-services stocks. Viisage Technology (VISG, news, msgs), Magal Security Systems (MAGS, news, msgs), Napco Security Systems (NSSC, news, msgs), International Electronics (IEIB, news, msgs), ICTS International (ICTS, news, msgs) and Vicon Industries (VII, news, msgs) are among the industrys biggest winners, posting year-to-date gains ranging from 259% to 86%.
They aren't household names yet. But if these stocks continue to perform as they have during the first few months of the year, investors will want to become much more familiar with the group.
Of course, thats a big if. Before you throw your hard-earned money at these small, high-flying stocks, lets take a closer look at whats driving the gains and try to determine which of these companies, if any, are positioned to be the next Taser International (TASR, news, msgs).
As for whats behind the groups big move, look no further than the evening news or the headlines of any major newspaper. Whether its a story about the Madrid bombing, the assassination of Hamas leader Sheik Ahmed Yassin, the rising number of dead in an increasingly hostile Iraq or the political debate over the intelligence failure prior to Sept. 11, theres little question that the news is contributing to a climate of fear that has sparked investor interest in companies involved with security.
Why this run might last
Such news-related runs are both common and traditionally short-lived. Take for example all the stocks that surged -- and then fell back -- with the original outbreak of anthrax. Then there were the fuel cell, stem cell, Internet incubator and fiber-optic runs. All very powerful, and all very short.
Is this just another case of news driving prices, or is there something different about this group that investors should take note of? While the group is definitely overextended on a short term, technical basis, a look at the industry fundamentals suggests that the security-services stocks just might be different from the other flame-outs.
For one thing, the groups valuations -- even after the dramatic advance over the past year -- arent that out of line, at least on a price/sales basis. Of the 16 stocks that make up the group, only a few sport price-to-sale ratios above 3. Several have price/sales ratios below 1.0, practically unheard of in a group exhibiting this kind of momentum.
| Security-services industry stocks | | Stock | Market cap | YTD price chg | 52-wk hi-lo | Price/sales | | The Brink's Co. (BCO, news, msgs) | $1.54 billion | 24.5% | 29.07-12.39 | 0.39 | | Checkpoint Systems (CKP, news, msgs) | $644.7 million | -2.2% | 22.45-10.35 | 0.92 | | CompuDyne (CDCY, news, msgs) | $96.1 million | 6.1% | 17.46-6.75 | 0.49 | | Diversified Security Solutions (DVS, news, msgs) | $43.5 million | 52.0% | 9.0-5.26 | 2.45 | | ICTS International N.V. (ICTS, news, msgs) | $43 million | 34.9% | 10.43-2.40 | 0.59 | | International Electronics (IEIB, news, msgs) | $14.8 million | 117.3% | 15.4-2.15 | 1.94 | | InVision Technologies (INVN, news, msgs) | $857.5 million | 45.3% | 50.50-20.65 | 2.06 | | Irvine Sensors (IRSN, news, msgs) | $59.2 million | 15.3% | 4.77-1.06 | 4.69 | | Kroll (KROL, news, msgs) | $1.12 billion | 9.7% | 29.25-18.30 | 2.30 | | LoJack (LOJN, news, msgs) | $116.6 million | (3.5%) | 9.90-4.57 | 0.93 | | Magal Security (MAGS, news, msgs) | $220.1 million | 255.0% | 40.35-4.60 | 4.16 | | Napco Security (NSSC, news, msgs) | $71.5 million | 152.1% | 23.20-6.60 | 1.29 | | Synergx Systems (SYNX, news, msgs) | $33.3 million | 77.9% | 9.95-1.125 | 2.03 | | Verint Systems (VRNT, news, msgs) | $938.5 million | 38.8% | 34.09-17.2 | 5.20 | | Vicon Industries (VII, news, msgs) | $40.4 million | 85.9% | 11.49-2.44 | 0.88 | | Viisage Technology (VISG, news, msgs) | $457.4 million | 258.9% | 13.78-3.34 | 10.2 |
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There is also no denying that this is a growth industry with real demand both here and abroad. Unlike other groups, such as stem-cell or fuel-cell companies, the demand is immediate and the technology is here. Consequently, the companies involved in the security-services industry are more apt to see steady and, in some cases, spectacular revenue growth for quarters to come.
At risk at the bottom line
Are there risks? Sure. Any time you have opportunities such as these in which companies are growing revenues by 20% or more, bigger, more financially established companies take notice. With deep pockets, the big boys have the ability to put the squeeze on the little guys when it comes to margins. In fact, one of the other things that stand out in a review of the group is that several firms have reported lower bottom-line results due to diminished profit margins.
At small companies, an earnings miss can wreak havoc on the stock. The industry experienced an example of this last week when CompuDyne (CDCY, news, msgs) warned of an earnings shortfall. The stock has dropped 38% from its April 9 high of $17.46.
A relatively small number of outstanding shares -- also known as a lack of liquidity -- makes these stocks very volatile and vulnerable to any bad news. Though still posting big gains for the year, Magal, ICTS International, International Electronics, Synergx Systems and Vicon have seen their stocks give back anywhere from 24% to 35% in just the past few days.
Industry could pace the market
But there are advantages to being small. Smaller companies can react more quickly to change, they traditionally experience greater percentage changes in sales and earnings, and they often attract highly skilled and motivated employees. In addition, a successful company in a fast-growing business can be an acquisition target of a bigger company. Again, the security-services industry experienced just such an occurrence last month when General Electric (GE, news, msgs) agreed to pay $900 million for InVision Technologies (INVN, news, msgs).
Though the competitive climate in the sector will only increase from here, the security-services industry remains well positioned to pace the market in the months to come given its favorable demand dynamics, relatively tame valuations and consolidation prospects. There are several stocks in the group that stand out because of their strong sales prospects and solid financials.
5 that stand out
Lets begin with Kroll (KROL, news, msgs). This little-known company provides clients with the information and analysis necessary to make informed decisions about potential risks and suspected wrongdoing. Krolls investigative and fact-finding services are used by businesses, governments, law firms and nonprofit institutions to address issues as diverse as threats to a company's reputation, money laundering, organized crime and management malfeasance.
Though not in the homeland security business, Krolls stock has definitely benefited from recent headlines surrounding corporate corruption. The company is projected to post double-digit sales and earnings growth over the next couple of years, it is cash flow positive and it has relatively high and defensible margins. Meanwhile, the stock trades at little more than two times trailing 12-month sales and only 19 times estimated earnings. Finally, the stock is still actively shorted. Consequently, theres plenty of room for short-covering to propel the stock higher from here.
Another well-established player in the security-services industry sporting a favorable mix of valuations and long-term growth is LoJack (LOJN, news, msgs). The company develops and markets the LoJack System, a patented system designed to help law enforcement personnel locate, track and recover stolen vehicles. LoJacks growth is a bit more pedestrian, about 10% to 15%. But at 12.7-times this years projected earnings and 0.93 times trailing sales, the stock trades at very reasonable prices. Assuming it merely lives up to Wall Street expectations, LoJack should experience material multiple expansion.
Now its time to add some spice to the mix. Magal Security Systems, Napco Security Systems and Verint Systems (VRNT, news, msgs) are three small, profitable companies with good momentum, strong growth prospects and still-reasonable valuations. Each is also more directly involved in homeland security.
Considering that the security-services industry is still in its early stages and that the group is subject to wild price swings, investment in one stock alone is probably an unwise strategy. However, a diverse basket of these stocks could well add considerable growth to your portfolio over the next six to 18 months. Ill be checking back on the progress of these shares in the weeks and months to come.
At the time of publication, Robert Walberg did not own or control shares of any of the equities mentioned in this column.
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