Maxwell’s 54% Q2 Growth: An Outlier, Not A Trend

Tom Konrad CFA

When I wrote about Maxwell Technologies’(NASD:MXWL) earnings restatement earlier this month, I predicted that third quarter (Q3) earnings would be much worse than recent trends were leading investors to believe.  I expected the stock would decline as analysts revised their expectations to reflect Maxwell’s weak short term prospects, allowing me to exit my short position, which I still hold.

Sure enough, analysts have reduced their earnings expectations.  Analyst consensus earnings expectations for Q3 have reversed from 13 cents to a 10 cent loss, while expectations for 2013 have plunged from 46 cents to 6 cents.  Consensus estimates for next year have dropped from 59 cents to 31 cents.

What has not happened is the stock decline I expected; the stock first drifted as high as $9.70, before falling over the last couple weeks.  Since my first bearish article, the stock is only down 3%, in line with the decline of the S&P 500 over the same period, and a smaller decline than we would expect from a volatile stock such as Maxwell.

Valuation

Maxwel Technologies’ Product Portfolio

At the current price of $8.84, Maxwell is trading at a trailing price earnings ratio (P/E) of 35, a P/E of 147 against current year expected earnings, and a P/E of 28 against 2014 earnings, a very rich valuation for a company that’s expected to grow revenues at a 13.5% annual pace from 2012 to 2014.  For Maxwell to be fairly valued, investors would have to expect the 33% to 54% year over year growth in the first two quarters to continue for several years.

Such growth looks impossible to achieve even on an annual basis in 2013.  The main recent source of growth, ultracapacitors for Chinese hybrid buses, has almost completely dried up.  These customers are waiting on new subsidies from the Chinese central government.  The Chinese press currently has been predicting these subsidies will be released in late August or early September.  August is now over, and the continued delay of their release is eroding Maxwell’s earnings potential for 2013.  Without the hybrid bus subsidy, Chinese bus operators  will currently be buying more buses with conventional drive-trains rather than hybrids, so many of these sales will be lost forever, not merely delayed.

Insider Trading

I first started buying Maxwell over a year ago in part based on significant purchases by company insiders including the CEO, David Schramm, and what appeared to be an attractive valuation in the $6 to $8 range.  The valuation at the time turned out to be less attractive than it seemed, because, apparently unknown to those insiders, the company’s revenue and profits had been inflated by too-early revenue recognition.  Those insider purchases have turned out to be good ones anyway.

One insider with good timing was the CFO, Kevin Royal, who sold shares in February at $10.77, shortly before the stock declined and eventually fell to $5.  Royal does not seem to be unloading his holdings, just selling part of his stock awards for cash, but he seems to have an knack to timing those sales for when the stock is near a peak.

Royal and Schramm both sold shares on the open market In August at $9.27.  Like Royal, Schramm is not liquidating his holdings, but rather only selling enough to pay the taxes on a share grant in February, which is what he told me he usually does when he receives a share grant.  Nevertheless, this sale is a far cry from his purchases in 2012.

Conclusion

Although Maxwell stock has been advancing, my thesis that the rest of the year will be disappointing to investors is now backed by additional evidence:

• Analysts have been cutting earnings expectations for this year and next.
• Chinese hybrid bus subsidies have yet to be announced, eroding near term revenue and earnings potential.
• Knowledgeable company insiders have stopped buying, and resumed selling when they need the cash.

Although I like Maxwell’s business and long term prospects, those prospects are currently very overpriced.  Much better buying opportunities are likely to arise later this year and early next.

Disclosure: Short MXWL

An earlier version of this article was first published on the author’s Forbes.com blog, Green Stocks on August 21st.

DISCLAIMER: Past performance is not a guarantee or a reliable indicator of future results.  This article contains the current opinions of the author and such opinions are subject to change without notice.  This article has been distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product.  Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.