Put aside the rhetoric from your next-door neighbour and mainstream media reports of individual horror stories, airport security is a real problem – and for investors possibly a gold mine.
Thomas Carlyle, the 19th century English writer, said: He who could foresee affairs three days in advance would be rich for thousands of years.
I am not suggesting that investing in companies that provide airport security solutions will make you the next Bill Gates. But let’s look at what is happening in the market.
After protracted negotiations, London-listed Smiths Group and General Electric are merging their detection businesses, subject to approval by Smiths’ shareholders. Both companies make scanners and X-ray equipment, in demand at airports throughout the world. GE makes few mistakes. Of the 12 companies chosen to comprise the Dow Jones industrial average in 1896, GE is the only company still on the index.
From the London side, bullish demand for X-ray equipment has helped Smiths increase its half-year pre-tax profits by seven per cent to £134 million.
Over the past six months, Smiths has installed X-ray and bomb-detection equipment at airports in Dubai, Shanghai and Singapore. The newly-formed venture will also profit by replacing existing airport security technology with more sophisticated equipment.
Smiths will hold a 64 per cent stake in the merged entity with GE owning the remaining stake. Smiths must believe the deal has great potential as the company has agreed to pay a US$35 million breakup fee if the deal craters.
GE is still on target to acquire Smiths’ aerospace business for US$4.8 billion later this year.
Consulting firm Frost & Sullivan reports that the vision inspection equipment market earned revenues of US$2.32 billion in 2006 and estimates this to reach US$3.70 billion in 2013. Additionally, the analysis reveals that the X-ray inspection equipment market attained revenues of US$1.56 billion in 2006 and estimates this to reach US$2.66 billion in 2013.
Let’s look at one of the smaller companies in the sector.
Nasdaq-traded American Science and Engineering (ASE), which supplies X-ray inspection and screening systems, reported on 9 February the second-highest revenue in company history for the third quarter of fiscal year 2007, ending 31 December 2006.
AS&E customers include governmental agencies, border authorities, military bases, airports and corporations, including the US Department of Homeland Security, US Department of Defense, US Customs and Border Protection, NATO, Royal Thai Police, HM Revenue & Customs (UK) and Hong Kong Customs.
The Company reported revenues of US$47.8 million, net income of USD8.1 million, and net income per share of US$0.86. This represents a 24 per cent increase in revenues and a US$0.09 decrease in net income per share versus the third quarter of the prior fiscal year.
Earnings per share were impacted by the adoption of SFAS 123(R), "Accounting for Stock-Based Compensation," on 1 April 1 2006. As a result, the company recorded a pre-tax charge of US$2.3 million (US$2.0 million after income taxes, or US$0.21 per share).
The Company has posted operating profits over the last 12 consecutive quarters. On 3 March, ASE traded at US$53.24 per share, about half-way between its 52-week high of US$93.86 and US$36.03. Much of the blame for the low end movement involved tax issues rather than performance.
ASE has a number of things going for it. The Company’s P/E ratio is 19 and there is no corporate debt. ASE also has about US$13 per share of free cash.
On top of the financials, ASE has developed a patented technology called Backscatter, which detects organic materials – such as explosives – hidden in containers that X-rays cannot penetrate.
While the stock is a good solid bet, its price fluctuates with geopolitical developments so it may not be for investors who are faint of heart.
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