Category Archives: Company Analysis

Command Center – CCNI

If you have been checking the “Portfolio” tab you would have noticed that I have a position in CCNI. I’ll give some thoughts on the company and hope to instigate some discussion.

Company Description

Command Center, Inc. is a staffing company. The Company operates primarily in the manual labor segment of the staffing industry. The Company provides on-demand employees for manual labor, light industrial and skilled trades applications. Its customers are primarily small to mid-sized businesses in the wholesale trades, manufacturing, hospitality, construction, retail and auto auction industries. The Company owns and operates approximately 60 on-demand labor stores in over 20 states. In addition to short and longer term temporary work assignments, the Company recruits and places workers in temp-to-hire situations.

Some History

From 2007 to 2012 CCNI would bump around from being profitable to losing money, the recession certainly didn’t help and you can see the big drop in revenue from 2008 to 2010. The current CEO was brought in 2013 to turn around operations. And you can see the margin expansion taking place as the focus on operations took hold. Closing unprofitable branches, coaching the under-performing branches/managers, and strategically expanding location count drove margins higher.  Margins were at a record and the company was generating solid FCF. Focus shifted from day to day operations to expanding the footprint. North Dakota became 25% of revenue in 2014 and the future was looking bright.

A few things happened starting in late 2014 and early 2015 and hit margins.

  • the oil and gas industry seen the worst decline in a number of cycles
  • some of the branches (not sure exactly how many) were not taking on the correct work and focus on high margin, high value add work was lost

Management did recognize the issues and put provisions in place to right size them. In the meantime, share price suffered.

Through 2015 and H1 2016 comparable year-over-year results suffered. Investors became fatigued and some have been quite combative. Such things happen when expectations eclipse reality.

I’m not going to comment on the competency of management and what should or should not be done. Obviously, given that I have a position I feel I can trust them with my capital.

Today

The last 3 quarters we have started to see operational improvements and better communication to shareholders. Recent (small) acquisition is delivering as expected and is an example of what the cash can be used for to grow the business.

CCNI now trades at around 8x FCF without any margin expansion. The CEO has clearly stated that he feels that 2017 will see higher revenue and margins. The low multiple and cash generating ability of the business will open up options to increase shareholder value.

Given the risk/reward profile, I think CCNI is worth buying under $0.50.

Feel free to comment.

 

Thanks,

 

Dean

 

*the author is long CCNI at time of writing

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High Arctic Energy Services – (HWO.to)

I started this post in late 2016. Since then the company has released Q4 2016 numbers. Though not 100% up to date, all the arguments are relative today.

I will be the first to admit that I have had mixed results investing in oil and gas related names. I think it’s pretty safe to say that we are closer to the bottom of the cycle than the top, but who knows.

I have owned HWO.to in the past and was lucky enough to sell mid 2014. Recently I have been sniffing around the O&G services companies in hopes of finding a company that will not only survive the current environment, but be bigger and better for the next cycle.

I believe HWO is a great example of a company taking advantage of the downturn by purchasing assets on the cheap in a non-dilutive manner.

PNG

The majority of their revenue comes from Papua New Guinea (see below for quarterly revenue).

geo_split

They own some high quality rigs in an environment where they have been able to keep several rigs utilized at any given time. PNG has been stable due to the large natural gas reserves and their LNG prospects. HWO has operated their for 9 years and built strong relationships with the major players. Admittedly, there is risk that the rigs in PNG are able to find work after their contracts are up.

Canadian Operations

For most part HWO’s Canadian operations have followed the overall business activity in Canada. Some decent Q’s, some lackluster and the typical spring break-up that’s associated with Western Canada.

This summer HWO acquired assets from TerVita. This including 85 rigs with various capabilities, rental equipment, engineering services, 5 owned locations, 300 employees and the right to use the legacy brand (which has a 30 year history in the marketplace). Apparently TerVita had too high of a debt load going into the downturn.

Thesis

The thesis is quite simple. The PNG operations I think are worth at least the current share price. They have a handful of high quality rigs, equipment rentals, and of course their existing presence.

The upside comes from two places:

  1. Increased activity in Western Canada. I’ll let the reader draw their own conclusions, but prices and activity seem to have stabilized in Alberta. Many service companies are recalling crews for the winter.
  2. Strong management team with several levers to pull to grow the business. I think the recent acquisitions show a patience and discipline in the current environment. Holding cash and waiting for the right opportunity takes time. I have seen several companies enter this downturn with excess cash only to wait too long to cut expenses and waste the opportunity. The chart below shows when HWO made major growth expenditures. (I did have to make some assumptions on what constitutes “growth”) As you can see the majority has been in the last quarter. The interim CEO was the former President and CEO of IROC Energy Services. He is interested in growing HWO given the current opportunity.

capex

Valuation

Market Cap and Enterprise Value are around $260mil. Using some assumptions, I think 40-50 mil in FCF is reasonable from operations. Making HWO trading at 5-7x FCF. Pretty cheap without having much contribution from Canadian operations.

I’ll be at the AGM in May.

hwo-investor-presentation-oct2016

Q4_Investor_Presentation_March_2017_03232017

Anyone else own HWO or finding value in the O&G market?

 

Thanks,

 

Dean

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BioSyent – RX.v

This post will be a short post as BioSyent is well known in the investment community and I have nothing material to add. Instead I will focus on how my view of a BioSyent type company has changed.

BioSyent almost perfectly embodies my maturity as investor. The company has grown rapidly, operates in a market that I am not well versed on, and is expensive.

In the past I would have overlooked BioSyent immediately. And to be honest I had initially overlooked it when it was first mentioned on twitter when shares where less than $1.00. As I was developing my qualitative skills as a microcap investor I wanted to get exposure to best in class management teams. A tagged along with a friend as was introduced to management of BioSyent. I was impressed and was willing to at the very least follow RX.v to see if there would ever be an opportunity to purchase shares at a more reasonable valuation.

I started formally tracking BioSyent in mid 2015. Shares were trading about where they are today after running all the way from under $1.00 to over $12.

I have seen a pattern with many high growth companies. The company usually is dramatically undervalued and shares trade extremely cheap. Then something changes the future of the business and the market is slow to react. The share price increases but not as quickly as the fundamentals of the business. As the company continues to execute the increase in valuation is higher than the increase in earnings. Suddenly, the company can do no wrong. Eventually the company’s momentum wanes and there is nothing to support the high valuation. Shares come back down to earth on the slightest stumble or pause in growth.

There are a few different likely outcomes:

  1. The rise in earnings was a temporary phenomenon and the shares will continue to trade lower.
  2. The rise is earnings is sustainable but the growth has disappeared as the share price needs to re-rate to the new reality.
  3. The rise in earnings is temporarily paused and the company enters transition mode. New products/services are being introduced, but do not drive enough revenue to have an impact to overall results. While the transition period drags on the shareholder base is slowly churned through. Many start to question whether or not they will see growth again. Short term investors are slowly replaced by longer term investors who believe in the story.

Being long RX.v I obviously believe we are in the middle of the 3rd outcome. The valuation of RX.v is high, but I am comfortable that my capital is being put to work wisely and management is aligned with shareholders.

The share price may be volatile in the short term, but looking out 2-5 years, I beleive $8/share will appear cheap. BioSyent may have fallen victim to tax loss selling and/or additional selling pressure as a Canadian investor’s shun all things pharma related after the blowup of Valeant.

Are there company’s that you are willing to pay a premium for?

Thanks,

Dean

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Pulse Seismic (PSD.to)

I recently purchased some shares in Pulse Seismic. I have been loosely following Pulse for several years but never in any detail. It has been profiled on a couple of blogs some time ago.

http://www.aboveaverageodds.com/2011/01/24/investment-analysis-pulse-data-inc-psd-to-it-doesnt-get-more-asymmetric-than-this/

http://www.punchcardresearch.com/pulse-seismic-a-wide-moat-company-drowning-in-cash/

I mentioned on twitter way back in August that I was looking at O&G service companies again.

og_twitter

Thankfully I didn’t have to look far. My thought process for investing in oil and gas companies in the current environment is:

  1. Must have the ability to cut expenses and run at or near break even (on a full year basis) at the current level of activity
  2. Must have a clean balance sheet so the company can use the downturn as an opportunity to expand the business
    1. The last thing I want is to have the company do a large dilutive share raise and multi-year lows in the share price
  3. Must have a capable management team with high integrity and spacial awareness to understand where the current opportunities are

The idea is to find a company that can ride out the downturn and be a larger business providing more value for all stakeholders during the eventual recovery. If I am able to find a company that meets all three of these, then I should theoretically be hoping for a long pronounced downturn as it will only expose more opportunities for the business to grow.

Brief description of Pulse

Pulse Seismic Inc. is a Canada-based seismic data library company. The Company is engaged in the acquisition, marketing and licensing of two-dimensional (2D) and three-dimensional (3D) seismic data for the energy sector in Western Canada. The Company has a seismic data library in Canada, which includes approximately 28,600 net square kilometers of 3D seismic and 447,000 net kilometers of 2D seismic. The Company’s library covers the Western Canada Sedimentary Basin (WCSB). The Company’s seismic data is used by oil and natural gas exploration and development companies to identify portions of geological formations that may to hold hydrocarbons. The Company’s seismic data is used in conjunction with well logging data, well core comparisons, geological mapping and surface outcrops to create a map of the Earth’s subsurface at various depths. It designs, markets and operates participation surveys and grants licenses to the seismic data acquired to parties that participate in the surveys.

Let’s take a closer look at Pulse to see if it ticks all the boxes.

  1. Ability to cut expenses to get to breakeven.

Given the nature of their product and the overall cost of the survey relative to the large expense of drilling for oil, they are able to maintain high margins regardless of activity. Their product is a very minor expense relative to the overall cost to drill. They are not interested in racing to the bottom in regards to pricing. That only damages their brand and will be very hard to claw back in the eventual upswing. Pulse has less than 20 employees and most costs for shooting the surveys are contracted out. As you can see below they have been able to maintain their margins with less business activity. The last chart shows that they have reduced opex to align with business activity. It’s reassuring that they are not sitting on their hands waiting for a recovery. They have also cut their dividend to preserve cash.

psd_ttm_s

psd_ttm_margin

psd_opex_ttm

2. Clean balance sheet to leverage as opportunities arise.

The company has paid back all the debt it took on from a large acquisition in 2010 and is now in a net cash position. They have also purchased shares and used to pay a dividend.

psd_bs

Given the ability to mirror opex with business activity, this company could take on a decent amount of debt without concern.

3. High integrity management team with ability to see opportunities.

This part of the due diligence process is subjective. The qualitative part of an investment is always the trickiest. The board is completely independent, experienced in the industry, versed on capital markets, and together own over 30% of the company. They also give a skill matrix in their MIC.

board_comp_psd

Management compensation is reasonable for a company this size. Their competition is global, were as they are not. So they need to know the geography inside and out. As well, the sales team needs to know the ins and outs of every project in the territory.

They have a couple of levers in regards to business growth.

  1. They can make a straight up purchase from E&Ps directly. The value of the contract may not be material to the overall costs associated with drilling for oil. Having said that, during a downturn all options are explored to be monetized.
  2. They could buy surveys from a competitor. Though not likely, it is always possible.
  3. They could conduct another participation survey. They help by doing some pre-funding but most initial costs are paid by end users.

Summing it all up

I think Pulse ticks all three boxes. In order to invest in this company you have to get comfortable to their exposure to oil and gas.

Pros

  • able to mirror expenses with activity quite easily
  • high value add product to customers
  • no debt

Cons

  • given how unique the business is, growth opportunities may not present themselves
  • they never really get expensive on a P/E or EV/EBITDA valuation
    • It’s likely from the fact that their revenues are not recurring and they have exposure to an industry which is extremely cyclical

Let me know if you are finding any value out there.

Thanks,

Dean

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Why I Sold MUEL

I recently sold Paul Mueller Co. I thought I would go into a little detail on the decision. The decision relates to how I have evolved as an investor. For those who want the history, please read my previous post.

Paul Mueller Company is a provider of manufactured equipment and components for the food, dairy, beverage, transportation, chemical, pharmaceutical, and other industries, as well as the dairy farm market. Overall I think that the company has done a decent job running the business. Of the four segments (Dairy Farm Equipment, Industrial Equipment, Field Fabrication and Transportation); Dairy and Industrial make up the majority of the top line for the consolidated company.

MEUL_segment_split

Dairy has been stable  since the acquisitions post 2007-08. I was hoping for the Industrial segment to post some sort of turnaround in 2015. That has not happened.

MUEL_dairy_and_ind

The company’s valuation is still quite cheap without any contribution from the Industrial (or Field Fab and Transportation) segments.

MUEL_valuation

So there are a few questions to get comfortable with the company as an investment:

  1. Does the Dairy segment continue to do well?
  2. Does Industrial turn around?
  3. If yes to the first two, does the valuation of the company improve?
  4. And aside from all 3 of those, is this a business run by quality mgmt?
  5. Lastly, does the pension liability on the balance truly reflect reality?

I honestly can’t really answer any of the above. I never really could. My original thinking was that if I buy shares cheap enough, I don’t really need to answer any of these questions. That’s not a bad way to invest, it’s just not the way I have gotten the most comfortable with.

When you buy a business like MUEL, you are buying a business with low(ish) product differentiation, capital intensive, and the business is subject to shocks that are beyond the control of the current management team. As well, you aren’t getting a ton of communication with the outside investor world. When buying microcaps, you hope for a business that is somewhat nimble, you aren’t getting that with MUEL.

It should be mentioned that MUEL has recently announced a share buyback. With such low volume on the stock, it could really move the stock higher.

In order to properly accommodate all the specific risks with MUEL you would need a portfolio that has 20-30 names. As well the amount of churn in the portfolio would have to be high. Something I don’t have time nor the personality for.

You may think that I will shun commoditized businesses or a business with little product differentiation to end users, that is not entirely correct. I have been putting a lot of thought into whether or not you buy companies that are part of a market that is commoditized or with little barriers to entry, and the answer of course….it depends. I’ll try and get some thoughts down to encourage conversation.

Thanks,

Dean

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Paul Mueller Co (MUEL)

Microcaps are not for the faint of heart. The same thing that can give a small investor like myself an edge also leads to volatility around earnings time. Many small and microcaps don’t do much to keep investors in the loop regarding business updates (especially when they are negative). They also lack institutional following to assist in the information dissemination process.

I was recently reminded of such volatility when MUEL reported earnings a few days ago. The share price responded by dropping nearly 30% on the day. Since the shares started the week pretty much where I originally purchased them, I am essentially down 30% on my position. I need to re-evaluate the position and make a decision to add, maintain or sell.

Here is a quick rundown on the business segments.

  • Dairy Farm Equipment
    • Milk cooling and storage for dairy farms
    • Processing and storage tanks
    • Refrigeration products
    • Heat transfer equipment
  • Industrial
    • Standard and customized stainless steel and alloy processing and storage tanks
    • Pure water equipment
    • Heat transfer products
    • Over the road tank trailers
  • Field Fabrication
    • Large field erected tanks/vessels
    • Equipment installation
    • Process piping
    • Retrofit and/or repair of process systems
    • Turnkey design and construction of compete processing plants
  • Transportation
    • Delivery of products and components to customers and field fabrication sites
    • Backhauls of materials and contract carriage

Company Website

The original thesis was a function of a few different factors (those interested should check out OTC Adventures latest post on MUEL):

  1. Continued deleverage of the balance sheet, including:
    1. minimal impact from the company’s pension liabilities
    2. pay down of debt (or at least not increasing leverage)
    3. management of working capital
  2. Execution of the largest reporting segments (Dairy and Industrial), including:
    1. continued execution on the Dairy segment
    2. progress on turning around of Industrial segment
    3. overall margins on a consolidated basis
    4. strong message from CEO on the other segments

Balance Sheet

Pension Liabilities

I am no expert on company pensions. Over the years I have strayed away from companies that have large pension liabilities. For the most part, they have a ticking time bomb feeling to them. But that is truly an unfair statement. There are companies that have defined benefit pensions that are not underfunded or at the very least are not dramatically underfunded enough to be a worry.

What I have decided is good enough for me in order to pursue an investment in the company is:

  1. pension that is not enormous enough to distract the company’s management team from executing on growing the business. it should be mentioned that the size of the obligation can be crudely modelled into a fair value for the stock
  2. conservatively valued (low discount rate and return expectations)
  3. underlying investments are not “junky” or high risk
  4. most importantly, management recognizes the potential risk and puts appropriate measures to mitigate risks involved

MUEL seems to have this part under control in my mind. The size of the obligation is high, but there is little mention of it by the CEO in the letters to shareholders and (due to the next few points) I don’t think it consumes a ton of management attention.

Discount rates currently at 5.34% and expected return is 6.78%. Seems reasonable over the long term. It should be noted that both have been trending down over the last 6 years.

Investments in the plan are a mix of equities and fixed income. Equities include a broad range of publicly traded securities (including US listed and ADRs). Fixed income is made up of high quality corporate debt and government debt. Currently 61% of the plan is in equities and 38% in fixed income. It passes this test for me.

Lastly, there has been some initiatives put into place to reduce the total liability over the long term. There is a couple of moving pieces here, here’s the language from the latest 10-k.

MUEL_pension

You can see the initiative bearing fruit as the service cost under the benefit obligation summary has been zero for the last 3 years.

Overall, I am mindful of the pension liability, but feel the right measures are in place to simply include some form of the obligation into the valuation of MUEL.

Pay Down of Debt

Given the pension liability, I view this as important to minimize balance sheet leverage. In this instance management has been executing for the last number of years.

MUEL_debt

Working Capital Management

There have been stories of some businesses running into hard times simply because they don’t manage their working capital. Here I look at 2 metrics; CCC and working capital as % of TTM rev. To be fair, I haven’t smoothed these numbers out to take an average amount over the course of a year, so they are not perfect. But from my vantage point, they are enough to show that the company is not in a risky position with it’s working capital.

MUEL_WC

 

Overall I am happy with MUEL deleveraging the balance sheet. The main sore spot over the last year has been the pension obligation increasing on the liability side of the balance sheet.

Business Execution

The Diary and Industrial segments have been 80-90% of revenue for the past 6 years. So if you wanted to see what will move the needle, you need to understand the underlying mechanics of each and have confidence in execution.

Dairy Segment

A couple of acquisitions in 2008 changed the segment dramatically. Sales rose dramatically due to the acquisitions. Since 2008, sales have been between 70-90 mil with EBITDA slowly expanding to the 15 mil mark in 2014. This is the most valuable part of the business by far. Having said that, starting in 2015 there will no longer be a quota on mild production in Europe. This will impact the Diary business to a large degree. At this point, it seems to be a short term non-event with a medium term tailwind. You can read about it here. Something to monitor for sure.

Industrial Segment

The other large segment is the Industrial segment. Results have not been good over the last 10 years.

MUEL_industrial

There is no surprise something labelled Industrial is cyclical. Part of the reason I invest in small companies is that expect them to be nimble to a certain degree. The other part is that I would the CEO to be able to make change to culture of the business in shorter order than a larger company.

Processing Equipment is the largest part of this segment. In 2013 the Processing Equipment portion earning 6.3 in pretax profit on better efficiencies and margins, meaning the remaining parts of the business lost around 8.1 mil. In 2014, the Industrial segment as a whole lost 0.652 mil and the Processing Equipment had a “small loss”. One can infer that the other Industrial portions of the segment were around breakeven. That’s quite an improvement. This is confirmed in the letter to shareholders with the statements being generally positive with the other parts of the Industrial segment.

I do have a concern with the Industrial segment on a consolidated basis. I would assume that some tough decisions are in order for this part of the business as the CEO has now been in place for 2 years and yet the Industrial segment is not performing.

Overall Margins

Gross margins are down in Q4 2014 from a year ago. As the chart shows, given the low gross margins inherent in the business, one needs to be really comfortable with the management team’s focus on doing business that makes sense financially and not “making work” to stay busy which is a struggle for many production related businesses with unionized labour.

MUEL_margin

CEO Message Around Business Culture and Shareholder Interests

The company doesn’t have quarterly conference calls, and doesn’t participate in investing conferences. However, the annual letter to shareholders does set a tone of accountability by naming the various manager of the various divisions. It also mentions revenue and margins to some degree, but does not give exact numbers for analysis purposes. Also, managers compensation is more closely tied to the business segments in which they are responsible for.

There is mention of efficiencies in processes and right sizing of headcount a few times. For this to be talked about openly is a positive and gives at least some confidence that the management team can make tough decisions if needed.

Other things of importance

  • The other 2 segments (field ops and transportation) are performing well except an accident at a customer site with a field fabricated unit where the company has taken a 2.9 mil reserve against the accident
  • MUEL used to pay a dividend, but stopped in 2009
  • Lower Euro hurts the Diary operations in Europe
  • Backlog is down from a year ago, but within is last 3 year range
  • David Moore has taken over as CEO in 2013, he has been with the company since the late 90s

Valuation

I think the best valuation metric for this type of potential investment is either EV/EBIT or EV/FCF.

MUEL_valuation

Including the pension in the calculation is up for debate. Something should be included in my opinion. How much, I’m not sure. Given the way pensions are calculated leads to wild swings in value. This is why it makes no sense to use book value as a metric for this business. I think given the ROC potential (20%+), even just the crude measure of including the entire liability still makes this company cheap.

As far as upside goes, one could paint a picture with continued strength in Dairy and some modest profit from Industrial. Couple this together with some operating earnings from Field Ops and Transportation, I could get to 16 mil in operating earnings. This would put current shares at 4.14 EV/EBIT or 6.35 EV/EBIT if you include the pension obligation. If the business is earning those kinds of margins, I would think a valuation almost double today’s would be fair.

Caveats

There are some things I need to understand before making any sort of a move:

  1. Increased context on the pension calculation and more information on the employees on the defined benefit plan. What does this look like on a go-forward basis
  2. More information on the accident that caused the 2.9mil provision. Specifically, what is the company’s risk mitigation strategy when one accident can make up a reserve charge that equal to 20% of the segment’s revenue
  3. What is going to be done with the Industrial segment and when can we expect some sort of stability in that business
  4. Additional context on the milk quota removal and what it means to the dairy segment
  5. Some color on the backlog

I plan on attempting to contact management over the next week or two to get this information over the phone.

Feel free to comment.

Dean

 

Disclosure:

The author is currently long MUEL, but that can change at any moment, so do your homework.

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Superior Industries International

Superior Industries (SUP) has been on my “to research” pile for over a year. I never got around to spending some time on the company until the last 2 weeks. There are a few others that have opinions on SUP, so check them out.

I though I should share my thoughts to timestamp my research and potentially get a discussion going around the name.

Background

From their website:

Superior Industries International, Inc. is engaged in the designing and manufacturing of aluminum road wheels for sale to original equipment manufacturers (OEMs). The Company is a supplier of cast aluminum wheels to the automobile and light truck manufacturers, with wheel manufacturing operations in the United States and Mexico. The Company operates five manufacturing facilities in the United States and Mexico. Products made in its North American facilities are delivered to automotive assembly operations in North America, both for domestic and internationally branded customers. Its OEM aluminum road wheels are sold for factory installation, as either optional or standard equipment, on many vehicle models manufactured by Ford, General Motors (GM), Chrysler Group LLC (Chrysler), BMW, Mitsubishi, Nissan, Subaru, Toyota and Volkswagen.

Here is a quick summary of how the business has performed over the last 10 years.

SUP_10_year

You can see a tough time before the Great Recession and a decent recovery. Now lets take a look at the income statement.

10_yr_income_statement_SUP

10yr_SUP_inc_margins

The previous 2 charts are further evidence of a rough time during the recession and hint at the nature of how tied the business is to the new auto market.

Once you get a glimpse of the company over a business cycle, you can see how little they control their fate if there the ultimate end user stops purchasing products. Having said that, the purchase of new autos can really only be delayed as eventually cars and trucks wear out and need to be replaced.

Another chart will give some additional context to the business. This is from their latest conference call presentation.

IR_on_shipments_001

You can see that the company shipments of wheels tracked the NA vehicle production closely until the end of 2011. The main reason for this is that they have hit their peak capacity from their current PPE while the NA production continued to grow. They even operated above capacity for a few quarters, but that is unsustainable.

Remember those negative gross margins in the last downturn? That is the price you pay to keep capacity idle during a downturn. If you read Frank Voisin’s post, it mentions how they shut down some plants due to lack of demand from end users. Though the idea likely seemed good at the time, I wonder if given the hindsight of today they would have made the same decision.

Currently, the company is building a new facility in Mexico that will give them an additional 20% capacity jump when finished.

Some of the characteristics mentioned and some not mentioned:

  • limited top line by PPE capacity
  • for the most part a price taker
  • historically has had a tough time earning excess returns on invested capital

Given these factors, I would think the valuation of choice would be some sort of earnings power value (EPV). Buying at a discount to EPV or buying at a replacement value and selling at EPV (if the gap is large enough to provide a margin of safety) makes sense to me for a company where the dynamics of their business does not change dramatically over 10 years.

Earning Power Value (EPV)

Before I get to my interpretation of EPV for Superior, I should make note of capex. For a business with a large portion of assets being fixed, capital expenditures are important to analyze. Here is a quick summary. Capex

Nailing down maintenance capex is important to properly understand EPV and a distributable cash flow or owner earnings. We know what revenue took a dive during the recession, so one could assume that only the most basic expenditures were being made. But maybe there were under-investing in the PPE and would eventually pay the price for it. Either way I assumed 3% of rev or 20% of average net PPE must be spent on maintenance. Here is what those numbers look like relative to Depreciation. The conference calls and annual reports I researched didn’t give a hard number for maintenance capex, so I have to take an educated guess.

Maint_capex

You can see how close they have tracked each other over the last 5 years. So I took the average of the 2 and used that as maintenance capex.

Here is what I get for EPV.

EPV

 

You can see a strong recovery in EPV after the recession. But is struggles to eclipse NAV (which I have kept as tangible book value). This coincides with ROIC being little more than their likely cost of capital outside the really low interest rate environment.

Conclusion

I ended up passing on SUP. Even with some cheap(ish) valuations based on EV/EBITDA and P/TB. I see 3 reasons why I want more margin of safety:

  1. Tangible book and EPV haven’t moved much over the last 10 years for a business that doesn’t pay a huge dividend. Meaning that they won’t grow additional margin of safety for me.
  2. Very low gross margins will lead to operating leverage that cuts both ways.
  3. My history with large capacity expansions has not been positive. There can be something that goes wrong that spooks the market and presents opportunity.

Some Potential Positives I haven’t Mentioned

I mentioned that they are building a new plant in Mexico. There is some additional scale in the fixed SG&A costs that may bring up EBIT margins.

There is also a large cash balance on the books that can give them additional flexibility if needed.

I have taken a rough stab at what the income statement could be like with the successful integration of the new plant and eventual scale from lower SG&A spread out over the entire business. This is based on a jump in revenue, 11% gross margins, and 3% of revenue spent on SG&A. The business could see a run up to 82 million in operating earnings. That’s dramatically higher than the current 36 million. But with a more normalized 9% gross margins we get 62 million in operating earnings. If a person put a 10x EV/EBIT on these numbers you would get around $36 and $28 as a rough estimate of where the share price could move to. At around $20 today, I would like a little more room for error given that we are likely 18-24 months away from full operation of the new platn.

I would look at SUP again in the mid teens. It may never get there, so do your own research if you like the name.

Dean

Company Website

 

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