Tag Archives: VLN

Velan – $VLN.to

I mentioned Velan way back in 2010 when discussing excess cash on the balance sheet. Shares are down about 60% since then. 10 years and you’ve lost 60% of your wealth. This doesn’t include dividends the company paid over the last 10 years. Depending on when you purchased you would have received $2.50-3.00 in dividends. You would still be down about 40% including dividends.

Background

Velan Inc. designs, manufactures, and markets industrial valves worldwide. It offers cryogenic valves comprising cast steel cryogenic, small forged cryogenic, cryogenic triple-offset, ball, and cryogenic control valves; gate, globe, and check valves, including pressure seal, cast steel, small forged, dual-plate check, bolted bonnet high pressure, cast stainless steel corrosion resistant, bonnetless, and knife gate valves, as well as maintenance valves for nuclear service; and quarter-turn valves, such as ball, metal-seated ball, forged ball, power ball, high performance three-piece ball, general purpose ball, triple-offset butterfly, high performance cryogenic butterfly, coker ball, and cap-tight batch digester capping valves. The company also provides cast steel and small forged hydrofluoric acid valves; and bellows seal bolted bonnet high pressure, seal cast steel, and seal API small forged valves. In addition, it offers bimetallic steam and thermodynamic steam traps. It serves power nuclear power, power generation, oil and gas, refining, chemical, pulp and paper, marine, mining, LNG and cryogenics, and water and wastewater sectors. It primarily sells its products through independent third-party distributors and sales agents. The company was formerly known as Velan Engineering Ltd. and changed its name to Velan Inc. in February 1981. The company was founded in 1950 and is headquartered in Montréal, Canada.

Market cap is 90mil US. EV is 88.9mil US. There are about 21.5mil shares outstanding. I’m using USD because that’s the currency they report in.

The business has been around a long time. They have had several economic cycles to navigate and are involved in many different industries. Each specific industry as well as broader economic activity determines overall demand for the valves.

Business Performance

The top line hasn’t moved much in the last 15 years. The business bounces around a fair bit, but they never run large losses for long periods of time.

Not big ROE and ROIC numbers, but again not negative. It may seem easy from the outside, but managing a business that isn’t constantly growing can be more difficult than it seems. Managing expenses and having hard conversations with stakeholders is not fun. The operators of this business deserve some credit for keeping costs in line with revenue.

Mgmt

The CEO has been with the company since 2015. He has about half of his total compensation in common shares.

The Velan family is peppered throughout the business. There are 3 family members on the board, including the Chair. The CEO, CFO and many senior executives in charge of operations are not from the Velan family.

Share Structure and Ownership

There are 15,566,567 Multiple Voting Shares (“Multiple Voting Shares”) and 6,019,068 Subordinate Voting Shares (“Subordinate Voting Shares”) of the Corporation were issued and outstanding. Each of the Multiple Voting Shares carries the right to five votes per share and each of the Subordinate Voting Shares carries the right to one vote per share.

Velan Holdings Co. Ltd (“Velan Holdings”) owns all the multiple voting shares and controls the direction of the company. Some other funds own collectively 15% of the Subordinate Voting Shares. The board owns 0.2% of the outstanding shares. Non Velan family members own 86k shares or about 0.3% of the company.

Valuation

As with most of the company’s I have mentioned recently, this isn’t the software compounder bro stock. This is an traditional industrial business.

The company is currently trading at less than NCAV of $6.75/share. It has traded below NCAV before during the GFC. This is not a company that trades as a perennial net-net.

The company has a current assets of 387mil. 95% of current assets are cash, receivable and inventory. That includes 87mil is in cash, 117mil in accounts receivable and 166mil in inventory.

Total Liabilities are 241mil. There is a mix of tax, payable, accrued short term liabilities, customer deposits and debt.

I think looking at working capital to revenue, asset turns and the cash conversion cycle give an idea of how this business operates. Given that this company is trading so cheap (below NCAV), the goal is to make sure that our investment thesis does not revolve around a business with obsolete inventory, receivables that are unlikely to be collected or some form of liquidity crunch in the short term.

After the end of the last quarter the company sold a plant in Montreal for 12.6 mil gross. The sale will be effective Oct 31, 2020 and is subject to the plant receiving a clean environmental report.

Dividend has been cut to conserve cash.

Backlog

The company’s backlog has come down in the last few years, but still stands at just over 400mil. This provides some visibility on activity and overhead cost absorption.

V20 Transformation Plan

The company started the V20 plan in January 2019. They are progressing ahead of schedule and starting to see some benefits to operating results from the plan.

I’ve been an employee when a business has done a major restructuring and it can be confusing when you are just an individual contributor in a large organization. Given how much attention this gets in the annual reports, investor presentation, conference calls and updated website information helps build confidence that every employee is kept up to date.

Covid

They were deemed an essential business, though they did have some disruption. The CEO does weekly videos to share updates with the entire organization, which I thought was a good example of leadership. Given the large backlog and V20 initiatives, they have not been hit as hard as I would have thought. It’s uncertain what the long term impacts are on the economy from covid and the lockdowns are at this point.

Risks

  • there are also some employment agreements with senior officers that need to be kept in mind
  • demand for their products can be affected by the economy
  • illiquid and hard to build a position and exit if needed
  • controlled by the Velan family

Conclusion

Expectations are really low and the business is cheap on an earnings and asset value. I have pivoted my thinking around net-nets. I like how Geoff Gannon phrased it when talking about net-nets on the Focused Compounding Podcast. (I would link it but I’m sure which one because they post so much lol). He essentially said “would you lend this business money?” I would lend Velan my capital.

These small companies trading at such cheap valuations can stay cheap forever. Management has taken steps to align expenses, serve customers and preserve the balance sheet. These companies generally do rerate, but who knows when.

Anyone else finding some net-nets out there?

Thanks,

Dean

*the author is long shares of $VLN.to at time of writing

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Excess Cash

What exactly is excess cash? To me it means cash that is on the balance sheet that is not needed in day-to-day operation of the business. Some companies have no excess cash and some have enormous amounts of excess cash. This post may seem like review to some, but a younger version of myself would have benefited from this insight.

What can affect the amount of cash needed for day-to-day operations:

  • How cyclical/seasonal is the company
  • Length in sales cycle
  • Whether the company does large amounts of contract work, making revenue and expenses lumpy
  • Customer concentration
  • Working capital requirements
  • Capital expenditure requirements
  • Access to funds (reasonable borrowing rate)
  • Dividend rate

Lets look at some examples:

Velan (VLN on TSX) manufactures and markets industrial valves. Revenue growth over the last 10 years has been slightly better than inflation. The company has a very long sales cycle, as evidenced from the CCC being over 200 days. Currently stated net cash is just over $5 per share. This seems extremely attractive to anyone buying the shares now (around $13). You can say that I am buying the business for $8 ($13 minus $5). Average EPS for the last 5 years is $1. So I am paying 8 times earnings, which seems very cheap. This of course is oversimplistic, but it proves my point. But wait a minute, over the last 10 years there has been at least $25 million in cash on the balance sheet (or about $1 per share). This may mean that there will always have to be $25 million cash on hand. Now your valuation goes to 9 times earnings, ($13/share minus $4/share in excess cash divided by $1 in EPS). Also we must consider that VLN has had revenues fall sharply during the recession and are not likely to return for quite some time. Working capital will need to be adjusted as well. Something that is very important is the voting structure of the company. The Velan family has voting power, which leaves almost no chance of activist involvement. The family can take the company private, but I am reluctant to speculate on that. I think there is little chance that the cash will be returned to shareholders anytime soon, meaning there is excess cash in the company, but I wouldn’t consider net cash in any part of my valuation. The cash position should be considered when examining balance sheet strength though. Buying this company at 13 time average earnings is not cheap, especially considering how far away average is from here.

Jewitt-Cameron (JCT on TSX) was originally analyzed by Adam over at ValueUncovered here. JCT has also been extremely hard hit by the recession. The company usually carries some cash on the balance sheet, usually a couple hundred thousand, against revenue (usually) in excess of $50 million. Recently, the company has come into a large amount of cash. Given the fact that the company doesn’t carry much cash usually, and isn’t afraid to use short-term borrowings, I think it is safe to include all net cash as part of the valuation.

Westjet (WJA on TSX) has been mentioned before. The CEO said on a conference call that he thinks the company needs around 40% of revenues in cash on the balance sheet. I think he is being too conservative. I think it is more like 20%. I will have a more detailed post on Westjet shortly. I think you can include some of the cash as part of your evaluation as management seems to be able to deploy it at attractive rates.

Many investors love to use enterprise value (EV) in their valuation, myself included. EV is equity plus debt minus excess cash. But determining that cash part can be very tricky. Lets run some numbers to give you an example:

ABC is at $10, have sustainable earnings of $1, net cash of $5. Net cash P/E is 5. Very cheap. You could consider “fair value” at 10x earnings plus net cash, making $15 a target. You are buying at 67% of fair value. What if the company was like VLN, meaning there is cash, but you aren’t likely to see it. Your 10x earnings plus net cash now yields a $10 stock, or current purchase price. You have NO margin of safety. What if the earnings are $0.75 and the company has $7.50/share in cash. Fair value is still $15 (10x earnings of $0.75, plus $7.50 cash), but now the valuation is 50/50 business and cash. If you are not going to see that cash, then fair value moves to $7.50, meaning that buying at $10 gives you negative margin of safety. I think you get the point.

A big thing to consider is how much of fair value is cash and how much is earnings power. In the previous example, $15 fair value was 67% earnings and 33% cash. If fair value is mostly cash, then I think there is an added element of risk that isn’t discussed enough. Most of the value is cash, then a simple return to shareholders is best, but the company can go on an acquisition streak at the height of a leveraged economic expansion. Buying back your own shares at a huge premium to book or earnings is not accretive, yet most companies to just this. My point is the larger the cash portion is of the total valuation, the better the company should be at deploying that cash. Makes sense, right?

It is up to each investor to determine what exactly is excess in the excess cash calculation. It is easy to punch some numbers in a spreadsheet and have it spit out a fair value, but investing is an art not a science. Despite what many think, the market is pretty efficient, and it takes some pretty big extremes to get outsized returns with little work.

Disclosure:

The author own share in WJA at time of writing, and would like to own shares of JCT (if it was cheaper).

Dean

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Filed under Random Thoughts, Valuation examples