Bel Fuse Stock: A Mispriced Compounder (NASDAQ:BELFA)

The following segment was excerpted from this fund letter.

Bel Fuse Inc. (NASDAQ:BELFB)

Market drawdowns provide good opportunities to buy shares in growing, cash generative, well-managed businesses at cheap prices. Our newest investment in Bel Fuse is no exception. Bel Fuse is a 75-year-old manufacturer of electronic components that designs products fit for use in telecom, aerospace, transportation, and consumer electronics end markets. For those with a non-technical background like your portfolio manager, Bel Fuse makes a lot of little pieces that go into bigger electrical systems. These little pieces are often very necessary for Bel Fuse’s customers as they help electrical systems function or prevent them from malfunctioning. Bel Fuse operates through three segments, Power Solutions, Connectivity Solutions, and Magnetic Solutions where they provide a broad array of SKUs with a wide range of applications. The company sells its products directly through various brands as well as through distributors where they have favorable end market exposure among industrial, automotive, aerospace and network technology customers.

When thinking about electronic components, the word commoditized might come to mind. At first glance, Bel Fuse seemed to fit that description given their large SKU count, low organic growth, and margins below peers. However, a deeper look into the business and industry dynamics revealed that BELFB has positioned themselves nicely between product design, implementation, and distribution, garnering a strong reputation for quality, which has led to trust and repeat business among their customers. I haven’t discussed Bel Fuse products in depth, but Bel Fuse products need to work, often for safety reasons. Circuit protectors, cables that are needed to work in harsh environments, and fuel gauge monitors for military aircraft are all examples of products that may not cost much, but where there is a high cost of failure.

That last point is important because it means that during their long operating history, Bel Fuse has developed sticky relationships with their customers, leading to input on the actual design and product specificity of some of their SKUs, which in turn protects them from competition on pricing and distribution. This can also lead to annuitized relationships with customers giving BELFB the ability to take some price over time. Evidence of industry success can be gleaned from Bel Fuse’s peers such as TE Connectivity (TEL), Amphenol (APH) and Littelfuse (LFUS), all of whom can be considered compounders, earning significant shareholder returns during the past decade with organic growth, exposure to favorable end markets and being integrated with their customers.

Bel Fuse is in a similar spot today, and I believe it is mispriced. Typically, businesses with 75 years of history, especially ones that are still standing, offer elements of a moat and staying power. That applies here, although changes had to be made. Prior operating history would reveal that the company lost its way for a period of time under family ownership, failing to grow organically, lacking efficiency, and losing sight of margin goals and product management. During the past few years, this has changed dramatically, and evidence of the company’s strong competitive position has begun to shine through.

Although Bel Fuse is a family owned and controlled business, current operations are being spearheaded by new CFO Farouq Tuweiq, the first CFO in company history, and first non-internal hire in decades. Hired in 2021, Farouq has an industrial electronics background and has done a remarkable job of turning the business around by implementing operating efficiencies, overhauling the company’s pricing strategy, and re-tooling the sales force to better align incentives throughout the organization. As a result, financial performance has improved drastically with gross margins up 1000 bps since Farouq’s hiring, and EBITDA margins up more than 3x from when Farouq joined to today. Importantly, margins remain comfortably below peers, leaving room for additional upside over time with selective pricing, better fulfillment, and new product development.

What started as a self-help story has now evolved into a business acceleration story, with notable operating momentum in each of the company’s segments, and the ability to increase both margins and cash flow into the foreseeable future. Adding to my excitement is the fact that Bel Fuse has yet to reach a point where each of their business segments are firing together. There are several reasons for this including supply chain issues, lack of component availability and some cyclicality, but as BELFB continues to prioritize organic growth and margins, they will drive positive results over time. Furthermore, with operational improvements out of the way, Bel will have a clean net cash balance sheet very soon, where positive capital allocation can help drive additional upside.

We were able to purchase our shares at a mid-single digit multiple of EBITDA, a low absolute valuation, and below peers, indicating there is room for multiple expansion. Insiders agree, having been purchasing stock since 2021, with Farouq’s most recent buying spree taking place last month. This is one of those investment opportunities that I can’t help but get excited about and can’t wait to see what Farouq and the team can accomplish. I look forward to sharing more details about Bel Fuse in future letters.