FLIR

I first heard about Flir Systems several years ago but at the time I wasn't interested in a defense play. I re-read about it last year but the person making the case for it started out with the company has missed estimates for 4 quarters in a row but we still like it. That's not a ringing endorsement. I re-read about it over the last several weeks but the story still didn't resonate with me -- I still thought of it as a defense play. Then I read a comment about it in an issue of Forbes from a year ago (their 200 best small caps) and everything changed -- I finally got it!

My goal is to find can't miss situations -- companies that have such strong secular trends that they almost have to increase in value over time. Think about my recent purchases that have worked out wonderfully -- NVT and ILMN. Both times I bought in at a time when most investors were questioning the future of the two companies. Yet they both are beneficiaries of powerful secular trends: GPS/location based services and DNA analysis (genotyping and sequencing to be precise). Able to buy without having to pay for the great secular growth because no one believed in it. A year ago last summer, Flir Systems was also a great opportunity -- 18X next 12 months estimates ($25) and a beneficiary of strong secular growth trends.

Now the stock is $50 and sells for 25X next 12 months estimates and no one questions their growth prospects anymore. Yet I am still thinking about buying a small position in the stock -- why? Because the growth trends and profitability levels are that good. I would buy more on a pullback.

FLIR sells infrared equipment -- both thermography (temperature) and vision systems -- night vision. 46% of sales are to governments, 37% is in thermography and the rest is commercial vision systems. Within dual use (military and commercial) and commercial markets FLIR's market share is 40% vs. only 5% in dedicated military markets. Their main competitors are defense companies like LLL -- who are used to low volume high priced equipment -- i.e. military orders not commercial business. Flir has 3X the market share of their nearest competitor in the commerical/dual use market -- that means Flir has scale advantages that are huge in terms of costs and distribution.

The key to the growth story is that the cost to manufacture infrared cameras is dropping quickly -- and with that the prices customers pay. As the price drops more applications or uses make economic sense and more customers become interested.

What are the uses of infrared cameras? Thermography is about detecting small changes in temperature so its ideal for preventive maintenance, home inspection and process control applications to name a few. Vision systems are basically night vision equipment, which can be used for search and rescue, transportation (see more clearly while driving, flying or shipping/boating) and security.

Think about GPS systems several years ago -- they were expensive; used mostly by the government and were primarily about determining location. Years later they are cheap, used mostly by individuals for not only determining where they are but also for navigation -- how to get somewhere. Right now the cheapest infrared camera is about $7000 but in a few years it will be under $1000 and volumes will soar. Now Flir's volumes are measured in thousands but in a few years they could be measured in hundreds of thousands or even millions. Costs are dropping on a predictable curve -- similar to Moore's Law in semiconductors.

According to Bear Stearns, the company has had 18% CAGR for organic revenues since 1995. That's so much better than any of the companies I have been looking at recently. I expect the rapid growth to continue as volumes jump thanks to the lower costs/prices.

Flir sells integrated solutions as well as technology cores -- meaning BMW has bought a night vision solution for their 7 series cars from a firm called Autoliv, which gets its infrared technology from Flir. Integrated solutions means they design the product for a particular use including features and specs that matter to customers that need a particular application. This is how markets get started -- through application specific products -- over time more generic products may work better for lots of uses. One other key aspect to Flir is their ability to partner (Autoliv for cars, others for security cameras) and to add distributors to get the products to customers -- its a key barrier to entry.

So just to spell it out again in a slightly different way.... I see this as a technology that many many people would like to have at the right price point for various industrial, commercial and personal uses. With costs dropping, the company can lower prices and maintain margins while reaching those prices at which more customers think its worth it to buy. It then becomes a matter of time and execution -- can they continue to lower costs and introduce compelling new products to take advantage of the lower costs/prices? This is a much easier problem to solve then trying to find sources of growth.

That's the intro -- I have written about several companies lately -- all wannabes for inclusion in the portfolio -- this one is now at the top of the list. pray for a pullback so that I can buy in at a lower risk point. I'll keep you posted.....