beekeepx/iStock via Getty Images

beekeepx/iStock via Getty Images

Every time I find a profitable company with no analyst ratings, I start to feel like a kid in a candy shop. The stock market can be a fierce battleground, with individual investors always sitting at the lower end of the food chain. Of course, I wasn't the first one to discover this fact.

If you find a stock with little or no institutional ownership, you've found a potential winner. Find a company that no analyst has ever visited, or that no analyst would admit to knowing about, and you've got a double winner.

Smith-Midland (NASDAQ:SMID ) is one of those stocks. Granted, institutional holdings are quite large at above 30% for a company without analyst coverage - so according to Peter Lynch, we only have a normal winner here. Fair enough.

Because I strongly believe infrastructure and commodities will be the next big trend in the years ahead, I was screening for cement producers, and even though tiny family-run SMID was falsely put into that category by my screener, I quickly realized that this company might still be one of the profiteers from this trend. Unfortunately, when I first discovered SMID, it seemed that I was a bit too late to the party. After strong Q1 earnings, the stock nearly doubled in price within only a couple of months, additionally fired up by the inclusion in the Russell Microcap Index. As quickly as the stock ran up though, it declined again, followed by Q2 earnings that weren't as spectacular as the previous ones. Now, that the stock price seemed more reasonable to me again, I took another close look at the company, and as it turns out, I believe Smith-Midland might offer decent and for a micro-cap unusually safe returns in the years ahead.

Smith-Midland, based in Midland, Virginia, was co-founded by former CEO and chairman of the board, Rodney I. Smith. He served as the company's CEO until 2018, and since then, his son Ashley B. Smith took over. Barely a year ago, the company's stock was approved for uplisting to the Nasdaq Capital Market, where it trades since November 2020.

SMID offers a variety of precast concrete products, such as highway barriers, lightweight construction panels, and sound walls.

As you can see below, in the recent years, the company shifted its focus from sales away to rentals and royalty agreements, which deliver higher gross margins.

Smith-Midland licenses its products all over the world, and in June, it also signed a licensing agreement with privately-owned Jensen Precast to manufacture the company's patented "JJ-Hook" barrier system in California, the state with the 2nd largest highway market of the United States.

As per latest 10-Q, SMID has 5.2 million fully diluted shares outstanding, with a very modest share count CAGR of only 0.8% in the last 10 years, attributable to stock compensation.

The company's balance sheet looks strong, with $14.4 million of cash and a debt/equity ratio of only 0.27.

It is worth mentioning that until 2020 the company used to pay a special dividend on an annual basis, which it discontinued due to the pandemic.

Return on equity in the last years has been ranging between roughly 8% and 20%. For a small company, I consider this pretty stable. An increase in rental and royalty volumes should only help improving this metric.

Source: Created by Author using data from stockrover

Insider holdings, after ROIC my number 1 key metric, at least when it comes to small caps or below, stand at roughly 19%, which is exactly my sweet spot. Below 10%, and the company has too little incentive, above 40%, and the company has too much control.

There has been an open market buy recently by the company's CEO. Notice though, that Chairman and co-founder Rodney I. Smith has been selling shares, beginning in July this year. Mr. Smith is 82 years old, so it is only understandable he might dispose of some of his holdings. As per form 8-K, a significant amount of the proceeds will go to charity. The filing also states that Mr. Smith intends to keep the majority of the stock he currently owns.

The U.S. Precast Concrete Market was valued at USD 15.50 Billion in 2018 and is projected to reach USD 25.24 Billion by 2026, growing at a CAGR of 6.3% from 2019 to 2026. While Smith-Midland is only a niche-player in this industry, most of the projected growth comes from infrastructure projects like highway renovations, and these are exactly where SMID conducts most of its business.

Plain and simple, I believe Smith-Midland will profit from:

Whether or not the Infrastructure Investment and Jobs Act will have the blessing of the House of Representatives, one thing is for sure: There will be massive infrastructure spending in the upcoming years. With its "JJ-Hook" road barriers and "Slender Wall" sound barriers, SMID is perfectly positioned to benefit from these infrastructure projects. The recent move into California could also be a major driver for the company in the years ahead.

2. Margin expansion due to the company's shift from barrier sales to rentals.

Source: created by Author using Seeking Alpha

As you can see below, while revenues declined slightly from 2019 to 2020, mostly caused by the company's shift from barrier sales to rentals, both EBIT and cash flow improved significantly during this period. As per latest 10-Q, while barrier rentals for the 6-month period of 2021 more than quadrupled to $6.9 million from $1.65 million in 2020, SMID still has a significant amount of barrier sales, specifically $2.25 million for the 6 months ended June 30 (32.6% of rental revenues). While it was not possible to deduct the exact margins for rentals versus sales, there still exists the potential of a strong margin increase for 32.6% of the company's barrier revenues. In my opinion, it is, therefore, safe to assume that the impressive $1.81 TTM of free cash flow and $8.3 million of EBIT might hold up for the full year 2021 at the very least.

Source: table created by Author using company financials

Let's establish a base case scenario for a current fair value of the stock. Assuming, SMID will make $1.81 in free cash flow for the year 2021, multiplied by the company's average 5-year EV/FCF of 9.43 and the sector median of 8.72, respectively, would result in a fair value of $15.78-$17.07.

Applied with an assumed EBIT of $1.60, the fair value would be even higher.

Source: created by Author using Seeking Alpha

As you can see above, the company currently trades at its lowest EV/EBIT multiple in more than 3 years. Its 5-year average multiple has always been pretty stable at roughly 14, close to the sector median at 13. This would result in a fair value of $20.8-$22.4.

Summing it up, I believe it is very safe to assume that SMID's current fair value lies between $15.78 and $22.4.

Considering the facts that there are no company guidance and analysts' estimates, I want to refrain from engaging in detailed 5-year models. But taking in account the recent tailwind of the company entering the Californian market, together with the big amount of infrastructure spending the United States will pursue, I think it is safe to assume that the company's current 10% revenue CAGR might spike to an average of somewhere between 15% and 20% in the coming years. This would either result in a current multiple expansion or simply a higher terminal value.

Product innovation: Rodney I. Smith, chairman of the board, co-founder and former CEO, is solely accountable for inventing all of Smith-Midland's products. Due to his high age, with him stepping aside, there is indeed a risk going forward. For now, the company should be doing just fine, as it has a broad and well-respected range of products. But future product innovation poses a bit of a question mark in my opinion. On the other hand, since his son had been taking over the role as CEO, the company greatly improved its bottom line, so management per se should not be considered a risk factor.

At a current share price of $15.71 at the time of writing this article, SMID does not seem like the deal of a lifetime. Usually, especially with small caps, I like to have a margin of safety of at least 50% to a company's lowest fair value target ($15.78 in this case). This would mean a maximum entry price of roughly $11. But since I believe the company currently is in a sweet spot, with it entering the huge Californian market and the secular tailwinds of increased infrastructure spending, I built a small position in the mid $13-range and, so far, regret not having bought more. I believe the selloff in July, just after the former CEO filed for a sale of part of his holdings, was unjustified. And if growth takes off, a quick retest of SMID's 2021 high of just below $26 seems more than reasonable.

I want to emphasize that due to the lack of visibility regarding the company's ability for product innovation, I currently do not think this is a classic buy and hold investment. But the company is well managed and perfectly positioned to benefit from the factors mentioned above in the coming years. I also like the fact that, because most of Smith-Midland's customers are government entities, its business should be quite resilient to inflation and economic downturns.

Summing up, I believe that SMID offers a decent bet on increased infrastructure spending, with limited downside and plenty of optional upside. Judging by the lack of coverage by analysts and on Seeking Alpha, I also think an investment in this stock might bring with it a first-mover advantage, resulting in a potential multiple expansion. At current levels, it is a (cautious) buy to me, though close to the lower end of its current fair value. If the stock were to retrace to the $11-$12 region, I would even rate it a very strong buy and load up the boat personally.

This article was written by

Disclosure: I/we have a beneficial long position in the shares of SMID either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.