One of the hallmarks of a high-quality company is meaningful inside ownership. If executives hold a sizable stake in their own firm, then their incentives are more likely to be aligned with shareholders.

That’s especially important when a company faces operational setbacks. Ideally, management should suffer alongside shareholders, thereby increasing the likelihood that they’ll find a way to right the ship.

To that end, it’s also important to have experienced executives at the helm who have demonstrated past success at delivering long-term shareholder value.

Happily, in the case of AirBoss of America Corp. (TSX: BOS, OTC: ABSSF), we’ve found an undervalued company whose CEO possesses both attributes in spades.

As co-founder of AirBoss, Chairman and CEO Gren Schoch is the company’s largest shareholder, with 19.7% of shares outstanding.

Schoch is a serial entrepreneur who’s launched several companies in the energy sector, the most successful of which perhaps was Petromet Resources, an oil and gas exploration company that was sold to Talisman Energy for more than $900 million in 2001.

His entrepreneurship and business achievement give us confidence that AirBoss will successfully navigate the current difficult business environment.

All Things Rubber

AirBoss is one of the largest rubber compounding and specialized rubber product manufacturers in North America. In addition to operations in the U.S. and Canada, the firm also has manufacturing and research facilities in Malaysia.

The company has organized its business into three operating divisions: Rubber Compounding, Engineered Products, and Automotive. Each segment’s contribution to revenue is shown in the accompanying pie chart.

Rubber compounds and products are customized for applications in the mining, industrial, military, and automotive sectors. Examples include specially designed conveyor belts and truck-bed liners for heavy moving equipment used in mining operations.

In the wake of the commodities crash, sales in the Rubber Compounding division dropped markedly, though profit margins remained relatively high. To achieve this performance, management shifted focus to higher-margin products, while finding greater operational efficiencies and cheaper raw materials.

The Engineered Products segment creates personal protective equipment for military and civilian use. For example, AirBoss is the U.S. military’s sole supplier for certain types of rubber equipment, including gloves and overboots. This division also makes a variety of rubber products for industrial applications, such as specialized tread, tires, and industrial hoses.

Automotive, which is the company’s largest segment, manufactures anti-vibration and noise-dampening products used in auto production. Its main customers are the Big Three U.S. automakers. This division performed well over the past few years thanks to the recovery in the North American auto industry.

Tough Times

The past year was a difficult one for AirBoss. Revenue for full-year 2016 is expected to decline by 10%, mirrored by a similar decline in adjusted earnings per share.

Management attributes this performance to weaker activity in the mining and energy sectors and delays in defense spending.

Analysts forecast a moderate rebound in sales and profits over the next two years. However, the extent of the improvement will depend on the recovery in the resource space, as well as a continued resurgence in the auto sector.

A Dividend Champion

AirBoss has been consistently paying dividends since 2007, and the company has grown its payout by 20% annually during that time.

In addition to strong dividend growth, AirBoss boasts a solid balance sheet, a relatively conservative payout ratio (20% of free cash flow), and excellent cash flow.

Bluer Skies Ahead

As its financial performance weakened, AirBoss saw its stock take a big hit. By late November, the share price had fallen by nearly 60% from its all-time high the year before. Over the past several weeks, the stock has staged an impressive rally, up 31% off its low, but still down about 47% from its peak. 

Other major publicly listed rubber compounders, such as Hexpol AB and Avon Rubber, have also struggled during this time, but not nearly as much as AirBoss.

With a forward enterprise value to EBITDA (earnings before interest, taxation, depreciation and amortization) ratio of 7 times, the stock’s valuation is near its cheapest level of the past 15 years. AirBoss also trades at a significant discount to its peers, in some cases by as much as 50%.

Although the stock’s forward yield of 2.4% is below our normal target range, rapid dividend growth should resume after 2017, as the recovery in the resource space continues gathering momentum.

In the meantime, as value-conscious income investors, we’re happy to have an opportunity to invest in a high-quality business at a bargain price.

We estimate the fair value of the stock at C$17, or US$13, which means investors at these levels should see considerable upside on a total-return basis.