Over the weekend, news hit the wire that Russia would be pulling out of the 1987 Intermediate-Range Nuclear Forces (INF) treaty. This follows a similar announcement from the U.S. a day or so earlier. So, since this is a post about investing, I can hear many readers asking: What’s all that got to do with investments and penny stocks? Well, I’ll get to that in a second. But first, a table setter.
Treaties like the INF are good for world peace, but they crimp profitability of companies that are in the defense and security business. And when anything happens that could heighten world tensions, those companies are well positioned to benefit.
This week’s twin announcements, coupled with ongoing geo-political and trade tensions with China, make our pick a candidate worth considering for portfolios – either as a short-term trade opportunity, or as a longer-term addition.
Given the above geo-political and trade environment, we wanted to look at a penny stock that could most benefit from what’s happening. And we’ve believe found it in Arotech Corporation (ARTX) – a company in the defense/aerospace and diversified industrial sector.
Not only does ARTX trade under $5 – our classification of a penny stock, but it’s been on the move lately, returning yields of over 25% to portfolios that held it over the past 60 days or so.
Arotech Corporation (ARTX)
So, what exactly draws us to ARTX? Well, first let’s look at the neighborhood in which the company operates. Established in 1990, Ann Arbor, Michigan-based ARTX is a provider of security and defense related products and services worldwide. It operates several divisions, and provides a range of products, technologies and services to the U.S. forces, municipalities, law enforcement departments, government agencies and private clients globally.
Given our introductory comments about the current defense and security landscape, ARTX’s interactive, digital simulators for use-of-force training and weapons operation means that the company is in an ideal position to capitalize on the current environment. But it also provides training systems for air crew and combat vehicle operators and aerospace crew. Again – ARTX is at the right place at the right time!
But there’s more! In a prior incarnation, when it operated under the name Electric Fuel Corporation – (a name change occurred in 2003) – the company excelled in the manufacture and servicing of primary and rechargeable batteries and charging stations for military and commercial use. The growing trade tensions between the U.S. and China, and a global push to move to electric and renewal fuel sources, means ARTX is once again smartly positioned to leverage future opportunities.
An added note of optimism for the company is that some of its batteries are currently being evaluated for potential deployment in five NATO countries.
Over the past four quarters (Q4-2017 to Q3-2018), the company has consistently either met or beat earnings estimates – which is always a healthy sign. Financial results for Q4-2018 are expected in early May 2019, with the street expecting an EPS of $0.03. Last quarter (Q3 2018), the street was expecting $0.02 EPS, but the company handily beat those expectations by $0.04 (EPS came in at $0.06).
According to publicly available analysis data, ARTX has grown at a decent rate of roughly 8% over the past 5 years. Those same sources expect the company’s growth estimates for next quarter to be around 20%, with comparative growth estimated for the broader S&P 500 standing at just 0.04%. Next year, analysts expect ARTX to grow by 64.7% (8.08% for the S&P 500). These are impressive expectations from a stock one is looking to add to one’s portfolio.
Although cheap on a Price/Book valuation (1.24x) and Price/Sales (0.87x), the stock is trading at around 12X forward P/E, which does make it look slightly expensive. However, given its growth profile (as estimated above), the stock could easily grow into its valuation.
In terms of profitability, the company is reaping Profit Margins and Operating Margins of 5.72% and 4.63% respectively. These may look weak at first blush, but if (as is likely) demand for its Simulators and power systems picks up as a result of recent geo-political happenings, those margins could easily expand. What’s encouraging for investors is that management seem to be reasonably effective stewards of capital, posting a ROE of 8.38%. However, compared to industry ROE standards (around 14%), ARTX does have some work to do.
A word of caution: At 19.08, the company’s Debt/Equity ratio is a bit high
Over the past 5-days or so, the stock has been beaten up, moving down about 5%. Volume declines in the short-term may be positive though, since stock price moving in tandem with volume is generally considered a good thing. If we look at a graph of the 12-day EMA and 26-Day EMA for the stock, we see that the short-term average is above the long-term average.
This generally indicates a buy signal for a stock. On a YTD basis though, the stock has risen over 30%.
There are further technical indicators that could indicate ARTX is a buy now. Generally, a buy signal flashes when an upward-moving MACD (yellow) line cross the signal (red) line. At the moment, this is precisely the case for ARTX.
The Bottom Line
As if Russia-U.S. tensions with ballistic missiles weren’t enough, when you add to the mix China’s play for military dominance in the South China Sea, that makes for an interesting global security dynamic. Whether you believe that global tensions will ultimately subside, and a broader arms reduction deal will be reached between the superpowers in the long run; for the short-term the arms race has begun, and the starting pistol was likely fired this weekend.
If you believe in that thesis, then ARTX should be a name worth considering for your portfolio.
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Author does not have investment in stock discussed in this article.