Deep Relative Value: SMTC Corp. (SMTX)

I know it's a boring, tight industry, but has anyone noticed that the EMS (Electronics Manufacturing Services) sector has been on fire lately?

Most of the majors have already released their 4Q07 results and they were surprisingly good for the usually bland sector.

For example, Singapore-based Flextronics nicely beat profit estimates and maintained its forecast , Canada's Celestica exceeded on revenue while profit was at the high end of consensus and Wisconsin's Plexus' net income increased 81% from 4Q06 and guided higher.

Meanwhile, smaller PCB maker Multi-Fineline absolutely crushed revenue and earnings estimates with large orders from Apple and the stock took an immediate 40% jump. That jump to the $18 level from $13 has held.

There are, however, a few even smaller and hence riskier players in the industry that haven't caught the attention of analysts or investors at large. This leaves a relative value gap as those companies with solid fundamentals play catch up. One small company, which is the subject of this research piece, is Toronto-based SMTC Corp. (Nasdaq: SMTX).

SMTC is not a small company by most measures, as it does about $250 million in revenue annually. But the market cap is an astonishingly low $19 million.

In reviewing the numbers you can't help but be puzzled as to why the market is valuing SMTX so badly - the stock is near an all-time low - as the company appears to be in better financial shape than ever before. The valuation is especially strange since the other EMS players have been reporting such great results.

Look these comparative valuation ratios for some color into the value gap:

Ticker	Market Cap	P/S	P/E	EV/EBITDA
FLEX	$9.2 billion	0.38	N/A	10.9
JBL	$2.9 billion	0.23	29.9	6.35
CLS	$1.4 billion	0.18	N/A	4.49
PLXS	$1.0 billion	0.63	13.37	6.51
MFLX	$457 million	0.90	153.14	15.17
TTMI	$445 million	0.64	15.93	5.90
DDIC	$98 million	0.53	N/A	4.57
MERX	$57 million	0.15	N/A	5.0
SIMC	$27 million	0.20	8.18	5.72
SMTX	$19 million	0.07	5.00	3.18

Notice on these valuation ratios that SMTX is lagging very far behind the group among all measures? Just to get to their nearest competitor valuation-wise, SIMC, the stock would have to double. And even then its valuation wouldn't be close to the average.

Meanwhile, on the fundamentals side, current/short-term plus long-term debt stands at $25 million at the end of the 3rd quarter, reported by the CFO as the company's lowest in eight years. Total debt at December 31, 2006 had been $43 million.

And importantly (also not surprising given the debt pay-down), cash flow from operations has been coming in at a strong clip, with the last 4 quarters seeing $24 million -- with $9.8 million the last quarter alone.

Note that $24 million in twelve months operating cash flow is greater than the current market cap!

Despite the revenue and earnings hiccup in the third quarter, the CEO stated the following in the last release:

"'For the fourth quarter, we expect to substantially increase sequential revenue, although we are unlikely to attain the record level in the fourth quarter of 2006. We also expect to return to satisfactory margin and profitability levels', stated John Caldwell."

The fourth quarter's numbers are due to be released on March 6.

But don't listen to him.

Listen instead to Ingenico, SMTC's largest customer, which reported record 4th quarter growth of almost 30% compared to the same period last year.

And to Harris Corp (NYSE: HRS), SMTC's second-largest customer, who also just reported something huge.

And finally to an institution who not only doubled its position at the end of December but has continued picking up shares lately through open market purchases while the stock remains under the radar.

In general, BDC believes that EMS companies should be relatively stable, at least in the early stages of a flagging economy, because more tech companies should move to outsourcing in order to lower their own cost structure.

SMTC in particular has been badly beaten up compared to its peers and thus represents an extreme relative value play within the group.

Of course, any investment has a degree of risk, so if you invest in this stock you may lose money.