National Presto Report

National Presto Analysis

Prepared by: John R. Pangere

October 2011

Copyright © 2011 by John Pangere. All rights reserved. Sources: National Presto Company filings and

presentations, ETrade, Personal Calculations, Google Finance, Yahoo Finance, imf.org, bea.gov

National Presto Industries (NYSE: NPK)

Date of Report: 10-15-2011 Shares Outstanding (Millions): 6.864 Current Price: $95.96 Institutional Holdings: 46% 52-week range: $83.00 - $137.00 Fiscal Year Ends: 31-Dec Average Daily Volume: 37,474 FY 2011 Net Income (Millions): $63.5 FY 2010 EPS (Reported): $9.26 Book Value, as reported (Millions): $344 FY 2010 P/E: 10.37 Market Cap. (Millions): $659 Dividend Yield: 8.49% Price/Book Value: 1.92x Index Membership: NYSE Industry: Diversified

Business Description: National Presto Industries, Inc. (National Presto) operates through its three segments: Housewares/Small Appliance Products, Defense, and Absorbent Products. The Housewares/Small Appliance segment designs, markets and distributes housewares and small electrical appliances, including pressure cookers and canners, kitchen electrics, and comfort appliances. The Defense Products segment manufactures 40 millimeter ammunition, precision mechanical and electro-mechanical assemblies, medium caliber cartridge cases, and performs Load, Assemble and Pack (LAP) operations on ordinance-related products primarily for the United States government and prime contractors. The Absorbent Products segment manufactures and sells primarily private label adult incontinence products and diapers. The company was founded in 1905 in Eau Claire, Wisconsin and known then as Northwestern Steel & Iron Works.

Investment Thesis With the stock currently selling at a price near its 52-week low, the company is priced at a compelling valuation. National Presto has a long history of positive earnings and cash flow, and in the past 10 years, has only recorded a negative free cash flow once due to an abnormally large amount of capital expenditures. Since it reached its high of $137/share, National Presto stock has fallen 30% to its current price of $95.96/share. This is partially due to increased commodity costs affecting the Housewares and Absorbent Products segments, as well as decreased shipments of products across all segments. Despite the current struggles, National Presto has proven it is capable of weathering economic downturns through its shrewd operating practices.



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Sales Gross Profit Gross Margin Operating Profit Operating Margin

2010 479,000 113,574 23.71% 97,082 20.27%

2009 478,468 110,092 23.01% 91,347 19.09%

2008 448,227 80,214 17.90% 63,281 14.12% *Numbers in thousands

As you can see, National Presto has been able to produce solid income and substantial profits through the last three years, all while operating with minimal Selling, General & Administrative (SG&A) expenses compared to overall sales. Since 2001, SG&A expenses as a percentage of net sales have declined from 9.65% in 2001 to 3.71% in 2010, meaning National Presto has become much more efficient in running its business, all while sales have grown 300% since 2001, from $119.75 million to $479 million. As it continues to grow, it may become increasingly difficult to increase sales and profits on a much larger scale, yet the company’s earnings power should remain intact, especially if the company is able to maintain the level of its SG&A expenses at its current percentage of sales. Currently, National Presto is selling at a trailing-twelve-month (TTM) price/earnings ratio of approximately 11.5x. The company typically sells between 14x and 19x earnings. A return to those P/E levels will result in a return of approximately 22% to 66% from its current valuation. The company has a strong balance sheet. National Presto has a pristine balance sheet with zero debt and approximately $151 million in cash and securities. This has been the norm at National Presto, with the company operating with zero debt over the past 10 years and carrying, on average, $171 million of cash and securities on hand. This practice allows National Presto to weather economic downturns with little exposure to the possibility of bankruptcy. Currently, National Presto is selling at a stated book value of 1.92x ($50.11/share). Taking into consideration my revised estimates of NPKs book value of $51.49/share, the company is selling at 1.86x book value. The company is capital efficient. Capital efficiency, in effect, allows a company to produce its wares or services with little capital expended to maintain and grow its business when compared with the returns it affords shareholders. In the case of National Presto, the company has returned the following amounts to shareholders as a percentage of gross profit:



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Year Dividends Paid % of Gross Profit

2011 56,628 49.86%

2010 55,889 50.77%

2009 38,008 47.38%

2008 29,067 38.07%

2007 25,958 46.07%

2006 14,476 37.82%

2005 11,394 28.44%

2004 7,977 17.51%

2003 6,284 16.87%

2002 6,290 24.79%

Average Payout 35.76% *Numbers in thousands. Dividends paid are based on the previous year’s results (i.e. 2011 dividends paid from 2010 results)

What this means is that National Presto does not require much more capital expended as it continues to grow, and it is able to pay out to its owners a larger and larger percentage of what it earns as it grows. As shown above, National Presto has paid out, on average 36% of its gross profit to shareholders, all while growing its operations without the issuance of debt. In comparison, National Presto has, on average, spent approximately 17.5% of its gross profit on capital expenditures over the last 10 years. The company is run by owner/operators. Insiders of National Presto currently own 30% of outstanding stock, while institutions currently own 46% of outstanding stock. This helps to align the interests of insiders with those of shareholders. The roster of insiders and their percentage of outstanding stock owned is as follows: Beneficial Owner Number of Shares Owned Percent of Common

Maryjo Cohen (CEO) 2,063,406 30

Donald E. Hoeschen 550 -

Lawrence J. Tienor 1915 -

Randy F. Lieble 1247 -

Patrick J. Quinn 200 -

Douglas J. Frederick 465 -

Joseph G. Stienessen - -

Richard N. Cardozo - -

All Officers & Directors 2,067,783 30.1



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Beneficial ownership of 5% or more is reported as follows (excluding Maryjo Cohen): Beneficial Owner Number of Shares Owned Percent of Common

Royce & Associates 772,212 11.2

Royce Special Equity Fund 593,700 8.6

BlackRock, Inc. 356,923 5.2

The company is shareholder friendly, returning the majority of cash flow to investors every year. National Presto operates in such a way so as to return the bulk of its earnings to shareholders, while still maintaining approximately $171 million in cash and equivalents year after year, as well as operating with little-to-no leverage (debt). Over the past ten years, National Presto has returned $36.79/share to shareholders in the form of regular and special dividends. The payout of dividends per share to shareholders since 2002 has been as follows:

2011 8.25

2010 8.14

2009 5.55

2008 4.25

2007 3.80

2006 2.12

2005 1.67

2004 1.17

2003 0.92

2002 0.92

Total 36.79

Why is this significant? The price per share of National Presto 10 years ago in October of 2001 was approximately $27/share. At that price, the shareholder who has continued to hold over the same time period has earned back more than the capital expended to buy shares of the company, as well as been a part of the capital appreciation the stock has had over the same time period. In all, the total return over that ten year holding period has been approximately 392%, or approximately 17% compounded per year. National Presto’s dividend policy is to pay the dividend once per year, rather than quarterly, in order to assess the previous year’s performance and pay the regular $1/share dividend in conjunction with the special dividend obtained and paid from operating earnings. This policy



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allows the company the flexibility to continue paying the bulk of earnings to shareholders without compromising the company’s balance sheet. If the total amount of money paid for dividends was declared as a regular dividend, the company may face pressure in paying the stated dividend, and therefore seek other measures to do so. By declaring a special dividend after assessing the previous year’s performance, this potential risk turns into a conservative and prudent policy. In essence, the holder of National Presto has paid off the initial investment in less than 10 years just by collecting dividends and essentially owns the stock for free. Should this payout of earnings continue in the future, the holder of National Presto will be rewarded over the next ten years just as in the past ten years, provided the shares are purchased at a reasonable price. At its current price, National Presto is yielding approximately 8.5%. Over the last 10 years, National Presto has typically yielded between 5% and 7.25%. A return to a more typical yield would value the shares at a high of $165/share, which would result in a gain of 72%, and a low of approximately $114/share, which would result in a gain of 19%. (Please note: the yield figures represent the declared dividend of $1/share plus the special dividend that has been paid since 2004.) Investment Risks The company relies on three main customers. During FY 2010, National Presto relied on three customers for the bulk of its business. In the Housewares segment, WalMart accounted for 11% of consolidated net sales. In the Defense segment, the US Department of Defense accounted for approximately 50% of consolidated net sales. In the Absorbent Products segment, the company had one customer, Medline Industries, which accounted for 11% of consolidated net sales. In addition, Medline Industries, the sole customer of the Absorbent Products segment, is building its own factory to produce absorbent products. Medline Industries has stated that their relationship and purchase of products from National Presto will remain intact after the production facility is on-line in the third quarter, but that remains to be seen and may affect National Presto’s net sales. If any one of these customers is lost, sales and free cash flow may be severely impacted. While the Defense segment comprises 50% of consolidated sales, there is no reason to believe that



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the segment will lose its sole customer in the near future. This is due to the renewal of a 5-year contract to manage and produce 60% of the US Army’s 40mm Ammunition System. (The US Army contracted National Presto and one other company.) The current contract runs through 2015. Exposure to rising commodity prices. All of National Presto’s segments face increased costs due to rising commodity prices, more so for the Housewares and Absorbent Products segments than the Defense segment due to the nature of how sales are made across each segment, and how the company secures raw materials for production. Since the year 2000, commodities prices (including energy) have soared nearly 177%, and nearly 89% since 2009. Excluding sources of energy from this data, commodities prices have soared 131% since 2000, and 68% since 2009. (See appendix for charts regarding commodities prices.) Any continued increase in commodities prices may have a material effect on National Presto’s profitability, especially in the Housewares and Absorbent Products segments. Integration of acquired businesses may prove to weigh down potential profits. The company has stated that it will continue to monitor for potential investments to expand the business, either within its existing segments or by adding an additional operating segment. These potential acquisitions should be carefully scrutinized so as not to weigh down existing profits during integration. The case in point has been the acquisition and integration of the Absorbent Products segment. The segment was created with the acquisition of certain assets from RMED International, Inc. in 2001 for $7.3 million in cash. Since the acquisition, National Presto has committed an additional $66.8 million in capital expenditures, including the purchase of NCN Hygienic Products in 2003. During that same period, the segment has produced an operating cash flow loss of approximately $21.1 million. Below is the breakdown of the segment’s performance since its acquisition, including the first two quarters of FY 2011:

Sales Gross Profit

Operating Profit

Capital Expenditures Depreciation Cash Flow

2011 (First 6-months) 47,100 1,917 937 5,671 2,008 -2,726

2010 80,764 8,471 8,081 13,382 4,061 -1,240

2009 74,663 7,890 6,234 822 4,243 9,655

2008 72,661 -315 -1,165 979 4,791 2,647



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2007 65,065 -1,597 -2,671 487 4,966 1,808

2006 53,377 -5,228 -6,673 1,078 5,072 -2,679

2005 35,624 -2,258 -3,107 10,893 3,013 -10,987

2004 28,261 1,550 1,230 22,512 1,861 -19,421

2003 15,502 716 700 580 1,047 1,167

2002 8,407 431 -131 212 827 484

2001 815 39 -147 0 260 113

Total 482,239 11,616 3,288 56,616 32,149 -21,179 *Numbers in thousands. 2001 includes 2 months of operations following the acquisition of RMED International in November of that year.

As you can see, while sales have increased, the segment has failed to produce any value to shareholders due to its negative cash flow over the life of the segment’s operations. Including the purchase of businesses for the segment, National Presto has spent approximately $74 million on the Absorbent Products segment. The question remains: what further value does the segment have for shareholders and the company? It remains to be seen whether the segment will ever produce a substantial enough return on the total invested capital. The argument could be made that the segment is strategic to capturing a portion of the health care needed by the Baby Boomer generation in the coming years, but my contention is that there is no guarantee that any profits will be made simply from increased sales. This has proven to be the fact over the last 10 years. In my opinion, the Absorbent Products segment has turned out to be a failed venture that has drained capital from National Presto and its shareholders. In comparison, the Defense segment, purchased near the same time as the Absorbent Products segment, has performed substantially better. Since its acquisition, the Defense Segment has produced the following:

Sales Gross Profit

Operating Profit


2011 (First 6-months) 113,283 32,022 28,671 855 1,798 29,614

2010 240,762 68,071 61,443 3,473 3,650 61,620

2009 253,789 61,866 54,823 1,275 3,570 57,118

2008 238,752 50,232 43,550 2,603 3,211 44,158

2007 224,384 48,294 36,700 4,821 2,729 34,608

2006 126,849 28,762 20,262 18,627 2,007 3,642

2005 36,954 9,564 5,797 2,137 305 3,965

2004 24,535 7,867 4,710 1,756 216 3,170



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2003 9,996 3,126 1,595 1,389 142 348

2002 9,290 2,966 1,925 1,771 153 307

2001 6,999 1,767 1,247 70 280 1,457

Total 1,285,593 314,537 260,723 38,777 18,061 240,007 *Numbers in thousands. 2001 includes 10 months of operations following the acquisition of AMTEC Corporation in February of that year.

Including the acquisition of businesses, National Presto has spent approximately $71 million on the Defense segment, which in turn has produced $240 million in cash flow. In addition, the Defense segment has been very consistent, as the profit margins below can attest:

Average Rates of Return 3 year 5 year 10 year

Gross Margin 24.56% 23.58% 26.43%

Operating Margin 21.79% 19.54% 18.71%

With robust gross and operating margins over the life of the Defense segment compared to that of the Absorbent Products segment, the Defense segment has performed very well for shareholders and there is no reason to believe it will not in the coming years. Since the company has spent nearly the same amount of capital on both segments since their acquisitions in 2001, it is clear to see which segment has come out on top for shareholders. Simply put, the Absorbent Products segment has failed to produce a return on invested capital for shareholders and the company may have been better off foregoing the acquisition. (See appendix for details on the performance of the Housewares segment for comparison to the Defense and Absorbent Products segments.) Potential Catalysts:

1. Lower commodities prices and energy costs. As has been previously stated, certain commodities are essential for the production of the company’s products. If the key materials used in production become less-expensive to procure, the savings from lower costs may help boost the earnings of the company. Energy is also a key component in the company’s overall operations. This is mainly due to the necessity of shipping products to its customers. Should the cost of energy, and therefore freight, decline, this savings may also help boost the company’s earnings. In addition, Chair of the Board and President, Maryjo Cohen, wrote in her letter to shareholders in the latest annual report:



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Housewares/Small Appliance and Absorbent Products segments are particularly vulnerable to inflation, and the effects on their bottom lines in 2011 are expected to be even more profound than in 2010. Efforts are ongoing to reduce the impact through the introduction of new products and redesign of current products to reduce costs.

The realization that costs may continue to increase, regardless of the source, is not lost on the company’s directors and executives. Should inflation of the commodities essential for National Presto’s products be tempered, or even decline, shareholders will benefit from reduced costs and increased profits.

2. Increase in shipments of Housewares and Defense Products. With the Housewares and

Defense segments being the main contributors of profit and cash flow for National Presto, any increase in shipments made from either segment, due to an increase in demand for the company’s products, will likely result in an increase in profit.

3. Sale/disposition of unprofitable business segment. As has been previously shown, the Absorbent Products segment has been a drag on the company’s free cash flow. The question remains: When is it time to realize that, regardless of increasing sales, the segment has failed to produce any sort of return for the company and shareholders and should be disposed of before further losses accrue? When is it time to realize that, regardless of how much capital is spent, the segment may continue to take money out of the company’s and shareholders’ pockets?

Had National Presto decided not to purchase the Absorbent Products line, sales, income and cash flow over the last 10 years may have been as follows:

Sales Gross Profit

Operating Profit


2011 (First 6-months) 160,054 40,702 32,573 3,433 2,258 31,398

2010 398,236 105,103 89,001 4,590 4,576 88,987

2009 403,805 102,202 85,113 2,515 4,495 87,093

2008 375,592 80,555 64,446 3,391 4,003 65,058

2007 355,651 77,952 56,631 5,737 3,519 54,413



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*Numbers in thousands. Figures based on the Housewares and Defense segments as reported in company filings.

With the Absorbent Products segment included in the figures above, the company has reported the following:

Sales Gross Profit

Operating Profit


2011 (First 6-months) 207,154 42,619 33,510 9,104 4,266 28,672

2010 479,000 113,574 97,082 17,972 8,637 87,747

2009 478,468 110,092 91,347 3,337 8,738 96,748

2008 448,253 80,240 63,281 4,370 8,794 67,705

2007 420,716 76,355 53,960 6,224 8,485 56,221

2006 304,681 56,343 36,030 21,019 7,891 22,902

2005 184,565 38,281 23,829 13,832 4,245 14,242

2004 158,956 40,066 19,121 28,188 3,310 -5,757

2003 129,744 37,461 18,849 2,903 2,353 18,299

2002 133,729 37,241 6,395 3,408 1,934 4,921

2001 119,757 25,371 4,943 2,038 3,436 6,341

Total 3,065,023 657,643 448,347 112,395 62,089 398,041 *Numbers in thousands.

As you can see, and as has been stated before, the Absorbent Products segment has been a drag on the company’s ability to produce ever larger sums of cash flow. Is the expense of $56.6 million in capital expenditures, in addition to the acquisition cost of the Absorbent Products segment’s operations, justified? The point is, the Absorbent Products segment has failed to produce the returns that management may have thought at the time of acquisition and is, in my opinion, siphoning cash from the company that would be better used for either an expansion of

2006 251,304 61,571 42,703 19,941 2,819 25,581

2005 148,941 40,539 26,936 2,939 1,232 25,229

2004 130,695 38,516 17,891 5,676 1,449 13,664

2003 114,242 36,745 18,149 2,323 1,306 17,132

2002 125,322 36,810 6,526 3,196 1,107 4,437

2001 118,942 25,332 5,090 2,038 3,176 6,228

Total 2,582,784 646,027 445,059 55,779 29,940 419,220



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the Housewares or Defense segments, or returned to shareholders. And with National Presto potentially losing its only customer in the Absorbent Products segment during the 3rd Quarter of 2011, the segment may even further depress the consolidated operations of the company. Should the company dispose of the Absorbent Products segment, sales will be impacted by the loss of revenues from the segment, but, as has been shown, income and cash flows may not be impacted, and may in fact, improve.

Recommendation: Upon my review of information relating to National Presto, I believe at its current price, the company’s stock is undervalued. It is true that sales and profits have declined in recent quarters as compared to the prior year’s results, but given the company’s ability to generate sizable sums of free cash flow even while operating in a depressed economy, all while maintaining a pristine balance sheet, there is no reason to believe National Presto will not continue to operate as it has in the past. National Presto has transformed itself from a small appliance company into mainly a Defense contractor over the past 10 years, and with Defense spending in the US continuing to rise, this should bode well for the company in the coming years (see appendix for more details). My main concern is the integration of newly acquired business segments and their ability to produce a return for shareholders. In the future, National Presto’s management should scrutinize any potential acquisitions more carefully so as not to repeat the current results of the Absorbent Products segment. In addition, while the company’s high dividend payout ratio is attractive to investors, at today’s price, I believe the company should utilize its authorized stock buyback program to repurchase its own shares. After careful review, I believe National Presto is worth $150/share. I believe it is safe to acquire shares up to a price of $105/share. This allows a margin of safety of no less than 30% to what I believe is its intrinsic value, and at its current price, a discount of 36%. Normally, I would look for a larger margin of safety, but given National Presto’s history of returning the bulk of earnings to shareholders, I feel the current margin is more than sufficient.



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Appendix: Housewares Segment Performance:

Sales Gross Profit

Operating Profit


2011 (First 6-months) 46,771 8,680 3,902 2,578 460 1,784

2010 157,474 37,032 27,558 1,117 926 27,367

2009 150,016 40,336 30,290 1,240 925 29,975

2008 136,840 30,323 20,896 788 792 20,900

2007 131,267 29,658 19,931 916 790 19,805

2006 124,455 32,809 22,441 1,314 812 21,939

2005 111,987 30,975 21,139 802 927 21,264

2004 106,160 30,649 13,181 3,920 1,233 10,494

2003 104,246 33,619 16,554 934 1,164 16,784

2002 116,032 33,844 4,601 1,425 954 4,130

2001 111,264 23,153 -3,342 1,968 2,896 -2,414

Total 1,296,512 331,078 177,151 17,002 11,879 172,028 *Numbers in thousands. 2001 includes plant closing costs of $7.653 million in the operating profit figure.

Cash Flow:

2010 2009 2008 2007 2006

Cash Flow 105,719 100,085 72,075 62,445 44,421

Capital Expenditures 17,972 3,337 4,370 6,224 7,271

Income Taxes 35,824 31,821 23,368 19,584 12,419

Free Cash Flow 51,923 64,927 44,337 36,637 24,731 *Numbers in thousands

Profitability:

Profitability Averages 3-year 5-year 10-year

Gross Margin 21.54% 20.25% 23.03%

Operating Margin 17.83% 15.66% 13.38%

Net Margin 12.07% 10.91% 9.65%

ROA 14.59% 12.61% 8.62%

ROE 17.55% 15.26% 10.41%

5 Oct 11

CHART 1INDICES OF PRIMARY COMMODITY PRICES

(2005 = 100) 1/

1/ Combines indices of non-fuel primary commodity prices and petroleum prices.

2/ Deflated by U.S. CPI.

INDICES OF NON-FUEL PRIMARY COMMODITY PRICES(2005 = 100) 1/

1/ Indices comprise 60 price series for 44 non-fuel primary commodities. Weights are based on the 2002-2004 average of world export earnings.2/ Deflated by US CPI.

CHART 2

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National Presto Report