Egregious management behavior

A company's management can make or break an investment.  Considering how important a company's management is to returns it's almost absurd to not consider the quality of management when making an investing decision.  At the same time adding a premium or giving a hair-cut to an investment for management quality is akin to double counting.  In theory the quality of a company's managers should be reflected in a company's results.  Companies with long sustainable track records of superior execution will most likely be run by above average managers.  A company that persistently bumps along in the bottom quartile most likely has poor management.  Unfortunately the idea that results always expose the quality of management is false.  Sometimes a great company is run by an idiot, and other times even the most skilled managers can't turn around a bad situation.  

One of the ideas I pound the table over on this blog is the concept of a margin of safety.  The idea is that every company has a fair value such as a private market value, a sum of the parts, or an industry accepted multiple of a given metric which can be considered an intrinsic value.  As outside investors we don't get to see how the sausage is made, so we have to make estimates when we valuing companies.  The idea is that if an investor purchases a stock at enough of a discount to the fair market value, or intrinsic value that if one or more estimates are incorrect the investor at worst won't realize a capital loss, and at best will still experience a gain.

One aspect rarely discussed with respect to the margin of safety concept is that a margin of safety also protects an investor against management stupidity.  In many, or most cases, managers interests are not aligned with outside shareholders.  This is one reason I prefer family-run companies with long operating histories.  As a minority shareholder my chances of being taken advantage of are reduced, not eliminated, but reduced.

Outside shareholders/minority shareholders are the black sheep of the business world.  In daily operations at most companies no one is thinking of how to conduct their behavior to maximize shareholder value.  In some circles maximizing shareholder value is just another synonym for cutting wages or staffing, neither high ideals.  Unless minority shareholders are concentrated catering to their interests and needs is very difficult for a company.  A company with 200 shareholders could have 200 different points of view and opinions on what a company should do next.  The board of directors is supposed to protect shareholder interests, but it's difficult.  Most boards don't know shareholders individually, and they aren't sitting across from them in a conference room like a CEO might be.  The result is often boards side with management when a conflict arises.

The above lays out the problem of shareholder-management relations.  I haven't said anything new, these are issues that people have been writing and speaking about since the corporation was created.  The purpose of this post isn't an expository essay on shareholder-management relations, but instead to inform readers that this is a matter of utmost importance, especially for value investors.  

To understand why this matters to investors I want to show three examples of management misbehavior.

Three examples

Solitron Devices

I've written about Solitron many times in the past, even going as far as writing a letter to the Board encouraging share buybacks and an annual meeting.  As of this post nothing has come from my letter except a boilerplate response.  In response to my letter a reader took it upon himself to research the company and get involved.

The reader is someone who I email back and forth with fairly frequently and is a very intelligent individual.  I say this because after reading his experience some people might just brush off his story with a simple explanation like maybe he didn't ask the right questions, or say them the right way.  Unfortunately his experience with the CEO of Solitron isn't unique, I've heard the same story repeated almost verbatim a few times.  He detailed his experiences in talking to the CEO of Solitron and trying to get in touch with the Board.  The story is chilling for any minority shareholder (myself included):

http://valueprax.wordpress.com/2012/09/26/my-bizarre-treatment-at-the-hands-of-solitrons-board-sodi-corpgov/

Some readers might not follow the link so I want to include a quick summary.  In short valueprax contacted the CEO of Solitron with a number of general questions regarding Solitron's business.  The CEO stated he couldn't talk on the phone and that valueprax should email him his questions.  He did and was given the run around.  Valueprax then decided to try to contact the two independent members of the Board.  The highlight of the story for me was that one Board member refused to talk, he just sat silently breathing into the phone and in the background his wife complained about how annoying the phone calls were getting.

The problem at Solitron is their CEO only owns 30% of the company, yet runs it as his own private company.  The company hasn't held an annual meeting or a directory election since 1994.  According to valueprax's story the company hasn't had an actual board meeting in years, possibly decades.  Corporate governance at Solitron is a complete sham.  There is no board who can or will represent shareholders.

Usually management malfeasance is associated with large salaries and huge perks, that isn't the case with Solitron.  Without a properly functioning board the CEO is running the company unrestricted, and shareholders, the true owners are ignored.  Keep in mind if all of Solitron's shareholders united they could vote out Mr. Saraf along with the Board and replace it with individuals who represent shareholder interests.  

Pioneer Railcorp

Pioneer Railcorp is a holding company that owns a number of shortline railroads across the US.  The assets themselves are very high quality, and the company operationally has done quite well.  Shareholders have done alright, but they would have done much better if senior management hadn't looted the company.  Keep in mind Pioneer is a small company, they did $19m in sales last year, and have a market cap of $18m.

Pioneer fits the stereotype of management abuse, there are too many things wrong to even enumerate them individually.  How about we start with the salary being paid out to the former CEO, $457k a year for 20 years.  Operating income would increase 10% if this overhead didn't exist.  At this point many readers will brush off the salary as a non-issue, of course, what company doesn't pay their CEO an excessive amount?  And who cares about severance pay, everyone's doing it right?

The severance is only the beginning, the former CEO also gets paid $220k a year for being a director.  Taking home $770k for attending a few meetings is quite the cushy job!

The worst part is a complicated transaction the company entered into with a third company Heartland.  Heartland is a vehicle to hold the former CEO's Pioneer stock, Heartland pays the former CEO a payment of $12k a month for the option to purchase his stock.  Heartland might never own any of his stock, but they're paying for that option monthly.

There is another strange transaction with Heartland that I don't quite understand.  For me the value of the assets and the company were overshadowed by the behavior of the former CEO.  What further sealed the deal was when I googled the former CEO's name and found articles alleging that he was channeling money from Pioneer to fund a strip club empire he runs in Las Vegas.  The strip clubs had run afoul of the law numerous times both in Illinois (where he previously lived), and in Nevada.  If an executive is running into legal problems in a known seedy industry with a lot of leniency I can't imagine what that says about how things were run when he was at Pioneer.

TSR Technical

TSR Technical is a company that does IT staffing in the NYC area.  The company is a net-net and is severely undervalued.  I'd seen the company written up on Whopper Investments in the past.  A reader with a lot of experience in both unlisted stocks, and shareholder activism emailed me today.  He mentioned that he wrote a letter to TSR outlining how management behavior was out of line.  Over the past few years as the company's profits have declined management pay has only increased.  A summary on my part would't do Tony's letter justice so I've asked permission to share it below:

How to take action

I hope the takeaway for most readers is that management behavior and actions can't be overlooked when researching an investment.  I'm sure though that some of the egregious behavior called out in this post has some blood boiling, it makes mine boil.  The thought that someone who owns a less than 50% of a company can divert profits from shareholder to their own pockets is disturbing.  The fact that many managers engage in this sort of behavior is completely unacceptable.

So what can a minority shareholder do to fight back?  The first action is to vote proxy's for companies that issue a proxy.  The second is to do what Tony has done and write the Board a letter.  Sometimes writing a letter doesn't work and stronger action is required.  Jeff over at Ragnar is a Pirate is trying to get Solitron shareholders together to force a proxy and annual meeting, this is a huge step in the right direction.

My concluding thought can best be summed up in the following quote: "Don't just sit there, do something!"

Talk to Nate

Disclosure: Long SODI, I own 1 share of PRRR

Performance Technologies, a US net-net with a negative EV

As many deep value investors know pickings have been slim recently.  Acceptable quality net-nets have risen with the market, leaving melting ice cubes with questionable prospects and Chinese reverse merger stocks.  I've been pushed into the land of unlisted and foreign stocks myself, not by choice, but by necessity.  Although the list of net-nets isn't the best I decided I'd rifle through it again looking for hidden gems.  So this brings us to Performance Technologies (PTIX).

Quick Thesis

• NCAV of $1.73
• Tangible book value of $1.90
• EV of -898k
• OCF of $.30 p/s in 2011
• OCF of $.24 p/s in FH 2012
• Last trade at $1.36

Background

Performance Technologies is like many net-nets and near net-nets in that it operates in the semiconductor/hardware business.  The company makes signaling chips and communications related PCI cards.  A chip of theirs might be found in a radar installation or a WAN card.  The company's products all appear to be multi-functional, and their website is clearly geared towards clients who know all the signal and telecom acronyms.  The one common theme that runs through their entire product line is signal processing.  At the most basic level Performance Technologies designs chips and cards that accept a signal (voice, data, anything) and transforms it into a digital message.  The company is located in Rochester, NY, and is listed on the NASDAQ.

The reason I started to look at Performance Technologies is because they're a net-net, if they weren't I probably wouldn't have looked at them.  Here's the net-net worksheet:

Simply put, Performance Technologies is a cashbox with a marginal business attached.  They have a market cap of $15m and they have $16m in cash and securities.

Unfortunately the first ding against Performance Technologies is that while they're a cash box they're a quickly shrinking cash box.  Coming into the year 2009 the company held $29m in cash, and as 2011 ended they had $9m in cash.  Some of the cash was used to purchase investments, but the rest was spent on capitalized software development costs, or purchases of intangible assets.  As a potential investor I'd rather see cash spent on dividends, especially at a business that continues to lose money year after year.

The first question I'm sure readers are asking right now is "why is he wasting time writing this company  up?", the second question is "what's the silver lining?"

The answer to the first question comes in a couple different parts.  The first attraction to Performance Technologies is that while they're selling at a 2.6% discount to discounted NCAV, they're also selling at a 21% discount to NCAV.  The second part of the answer revolves around the company's cash flows.  While the company lost $24m over the past three on an accrual basis the actual cash flows weren't nearly as bad.  On a cash basis the company lost roughly $578k over the past three and a half years.  The income statement tells a very dire tale, but the cash flow statement doesn't quite support the death bed story.  In the last year and a half the company has thrown off $6m in operating cash flow.  Six million in OCF on a stock with a negative EV is impressive.

The answer to the second question is mentioned above, the significant cash flow over the past year and a half.  The company has generated about $.55 p/s in operating cash flow over the last year.  To put the cash flow into perspective, the company has thrown off almost half of their market cap in the last 18 months.

Investment case

The thesis for Performance Technologies is pretty sound, invest at the current price and get some cash and a business for free.  If an investor thinks the business is worth more as a going concern this is a slam dunk, there's downside protection, and a nice potential upside.  The reality is the business could also be like a parasite sucking up all the company's cash until the host is dead.

What's missing from this post is any reference to if the business's potential, or lack thereof that's the missing piece.  If an investor is knowledgable in the signal processing space they might know whether the cycle is about to turn, or if Performance Technologies is a washed up player holding onto the past.  I didn't get that far in my research before moving on.  For me I want a slam dunk cheap company, and while Performance Technologies has great assets, they've shown a willingness to use those assets to support a failing business over the past few years.  There could be a hidden gem of value in this company, but if it's there, it's very hidden.

Talk to Nate

Disclosure: No position

These boots are made for walkin

"These boots are made for walkin.." That might as well be the tagline for McRae Industries (MRINA), an American boot manufacturer.  McRae has all the characteristics of a stock that you either love, or you hate.  The McRae family holds a majority ownership interest, the company is unlisted, and they're in a boring line of business, western boots.  If that isn't enough, they recently lost a large customer, and their results have been going nowhere for years.  So while the spurs might be a little rusty, the well worn leather of McRae fits like a glove for this blog, a sleepy little net-net is never worth ignoring.

After seeing the name McRae four times in the proceeding paragraph some readers might be starting to think "where have I seen this before?"  I wrote briefly about the company in March, when I talked about how a stock is a business.  The business of McRae is simple, they manufacture leather boots, both work boots and the ever so popular with the square dancing crowd western boots.  This is a small diversion, but I enjoy watching shows on foreign cultures, and the shows always incorporate some sort of native dancing.  I like to imagine if some foreigners were making a show about America the cultural dancing they'd show would be square dancing and bluegrass music.  Square dancing, apple pie, country music, pickup trucks, and western boots, what could be more American?  Before I end my diversion I should mention that while I've never owned a pair of western boots myself I have never had a problem finding a pair to borrow when I needed a costume.  They either aren't as rare as many would think, or I grew up in the Midwest; both true.

What makes McRae interesting isn't their products, but their balance sheet.  Here is my net-net worksheet:

A net current asset value of $17.35 against a last trade of $16.40 isn't the most compelling investment on an asset basis alone.  NCAV is slightly inflated, I included two long term assets as current assets, a life insurance receivable, and investment properties they hold.  Could either of these be liquidated quickly? Maybe, but I'm not sure it really matters much.  What is important is that the company's balance sheet is both stable and risk adverse.  There isn't much downside when 37% of the marketcap is made up of cash.

The last time I posted about McRae I looked at the company from a qualitative angle; where are the boots made, how to buy, are they quality etc.  Some of these questions have answered themselves, but for the most part I still haven't filled in the blanks.  In pursuit of the qualitative I never dove into the quantitative.  The stock isn't cheap enough to ignore the qualitative factors, not many stocks are, but it's also worth looking over some of the numbers.

When I last looked at McRae they had a military work boot division, and a western division.  Since that last post the US government hasn't renewed their military boot contract, so McRae's revenue has taken a bit of a dip.  The military boots contributed $18m towards revenue in 2011, and out of the total $74m in 2011 revenue military boots accounted for 25%.  It would stand to reason that with the elimination of the government contract McRae's revenue and profits should be falling precipitously.  This isn't what happened, revenue is slightly down YoY.  What happened is the western boot business picked up some of the slack.  The company does mention there will be a fourth quarter impact, but given the trend in western boots, I'd suspect McRae will still turn a profit.  I don't really know what's making western boots hot right now, this is one of the qualitative blanks that would need to be filled in.

Valuing McRae

This is where McRae gets interesting, on an asset basis alone there isn't much upside.  Buying here and riding the stock to NCAV would result in a 5.8% gain.  Let's presume the company breaks even in Q4, but the $1.71 in earnings is sustainable going forward.

The company throws off much more cash than they can reinvest.  For the past nine months the company generated $6.39m in operating cash yet only made $746k worth of investments.  This year's results aren't an anomaly either.  The company's cash hoard has been growing faster than they can reinvest or or wish to pay it out as dividends.  On a back of the envelope basis I'd assume $10m of the company's cash is excess and could be returned to shareholders.

So $10m in excess cash plus a business earning $1.71 at 8x of earnings is $17.78, reasonably close to NCAV.  The company will probably return around 10% on equity this year, and grow book value.  If this is worth 10x earnings McRae could be worth $21.20.  In a sale scenario I would expect an acquirer to pay 10x earnings, but to be honest I think an acquisition is off the table.  The McRae family still controls the company, and it's hard to imagine them giving up such a good thing.  The CEO was making over $200k back in 2004, and in Mt Gilead, NC that isn't just a comfortable payday, it's borderline obscene.

McRae Industries is a decent little family business.  They have all the markings of things I like in a stock, consistent profitability, selling below NCAV, family run, and a sleepy business.  They're just missing the most important thing, a big enough discount to merit a purchase.  Until McRae's shares drop through the floor I'll be sitting this one out, waiting patiently for my dosado with McRae.

Talk to Nate

Disclosure: No position.

Every company I've ever written about..

I've been writing this blog for close to two years, and over that period of time I've covered a lot of companies.  I originally started this blog as a way to capture my thoughts on companies I was researching.  Somehow an audience found me and the site went from some quick and dirty notes to a place where stocks that have little to no information available online (sometimes little to none period!) are profiled and exposed to the greater investing world.

I thought it might be a good resource to compile a list of every company I've written about in one central place so users can find past posts easily.  Going forward I want to make this post a permanent page on the right side of the blog, that I'll update each time I write.

3U Holdings
http://www.oddballstocks.com/2012/01/3u-holdings-true-ben-graham-net-net.html

Ace Aviation
http://www.oddballstocks.com/2011/04/international-net-net-5-ace-aviation.html

Adams Golf
http://www.oddballstocks.com/2011/11/adams-golf-has-margin-of-safety-and.html
http://www.oddballstocks.com/2012/03/adams-golf-gets-buyout-and-other-net.html

Addvantage
http://www.oddballstocks.com/2011/10/trying-to-figure-out-why-addvantage-is.html

AMC Networks
http://www.oddballstocks.com/2011/05/why-not-all-spinoffs-are-plated-in-gold.html

Ampco-Pittsburgh
http://www.oddballstocks.com/2012/07/is-it-cheap-or-just-cyclical.html

Asics Trading
http://www.oddballstocks.com/2011/06/asics-trading-co.html

Ash Grove Cement
http://www.oddballstocks.com/2011/12/two-very-different-un-researched.html

Argo Group
http://www.oddballstocks.com/2011/07/argo-group-uk-net-net.html
http://www.oddballstocks.com/2011/08/argo-group-revisited.html

Astron Ltd
http://www.oddballstocks.com/2011/04/international-net-net-7-astron-ltd.html

Audiovox
http://www.oddballstocks.com/2011/05/perennial-net-net-audiovox.html

Aztec Land and Cattle
http://www.oddballstocks.com/2012/04/meanwhile-back-at-ranch.html

Basler
http://www.oddballstocks.com/2011/12/hidden-champion-basler.html

Best of the Best
http://www.oddballstocks.com/2011/06/best-of-best.html

Bioqual
http://www.oddballstocks.com/2012/01/bioqual-beginner-net-net.html

Boss Holdings
http://www.oddballstocks.com/2012/06/some-sentimental-investment-ramblings.html

Bowl America
http://www.oddballstocks.com/2012/08/a-strike-or-gutterball.html

Brawlira
http://www.oddballstocks.com/2012/07/how-far-off-beaten-path-for-moat.html
http://www.oddballstocks.com/2012/07/is-bralirwa-actually-investable.html

Caltagirone
http://www.oddballstocks.com/2011/03/opportunity-in-italy.html

Career Education
http://www.oddballstocks.com/2012/05/think-youre-contrarian-then-keep.html

Central Natural Resources
http://www.oddballstocks.com/2012/02/one-heck-of-hidden-asset.html

CIBL
http://www.oddballstocks.com/2012/01/cibl-spinoff-yes-catalyst-yes-possible.html
http://www.oddballstocks.com/2012/04/cibl-followup.html

Charlemagne Capital
http://www.oddballstocks.com/2011/08/another-undervalued-asset-manager.html

Chicago Rivet and Machine
http://www.oddballstocks.com/2012/06/sleepy-company-to-keep-on-radar.html

Chromcraft Revington
http://www.oddballstocks.com/2012/08/chromcraft-net-net-but-not-buyat-any.html

Coast Distribution
http://www.oddballstocks.com/2011/03/coast-distribution.html

Conduril
http://www.oddballstocks.com/2012/08/a-european-net-net-with-pe-of-2x-and.html

Conrad Industries
http://www.oddballstocks.com/2012/03/conrad-industriesunanswered-questions.html
http://www.oddballstocks.com/2012/09/conrad-part-deux.html

Corticeira Amorim
http://www.oddballstocks.com/2011/07/looking-at-hidden-champion-corticeira.html
http://www.oddballstocks.com/2011/07/hidden-champion-corticeira-amorim-part.html
http://www.oddballstocks.com/2011/07/cork-company-comparison.html

Craig Wireless
http://www.oddballstocks.com/2011/04/international-net-net-6-craig-wireless.html

Dainichi
http://www.oddballstocks.com/2011/05/evaluating-margin-of-safety-on-dainichi.html
http://www.oddballstocks.com/2011/05/dainichi-redux.html

Daiwa
http://www.oddballstocks.com/2011/05/buying-company-for-less-than-net-cash.html

Daxor
http://www.oddballstocks.com/2011/07/daxor-gamble-on-management.html

Delta Galil
http://www.oddballstocks.com/2011/09/is-delta-galil-magic-six-stock-cheap.html

Einhell Gruppe
http://www.oddballstocks.com/2011/10/einhell-gruppe-ag.html

Flexsteel
http://www.oddballstocks.com/2011/08/is-flexsteel-actually-cheap-stock.html

Formfactor
http://www.oddballstocks.com/2011/09/formfactor-selling-for-close-to-cash.html

Fortune Industries
http://www.oddballstocks.com/2012/07/fortune-to-be-made-chance-to.html

Gencor
http://www.oddballstocks.com/2011/10/gencore-selling-below-net-cash-but-is.html

George Risk
http://www.oddballstocks.com/2011/08/george-risk-ignored-yet-very-cheap.html

Gevelot
http://www.oddballstocks.com/2012/04/french-small-cap-gevelot-cest-bon.html

Guinness Peat Group
http://www.oddballstocks.com/2012/06/oddball-liquidation-stock-guinness-peat.html

Hanover Foods
http://www.oddballstocks.com/2012/04/hanover-foods-part-1-story.html
http://www.oddballstocks.com/2012/04/hanover-foods-part-2-figures.html

Heelys
http://www.oddballstocks.com/2011/09/heelys-selling-for-less-than-net-cash.html

Hershey Creamery
http://www.oddballstocks.com/2012/04/hershey-creamery-multibagger-or.html

HF Company
http://www.oddballstocks.com/2012/05/does-this-company-deserve-to-hover-just.html

Hickok
http://www.oddballstocks.com/2012/02/hickok-intangibly-cheap.html

Hooker Furniture
http://www.oddballstocks.com/2012/06/hooker-furniture-and-minutia-of.html

Huntington Ingalls
http://www.oddballstocks.com/2011/04/is-huntington-ingalls-cheap.html

Hyrican Informationsystems
http://www.oddballstocks.com/2011/03/international-net-net-1-hyrican.html

Ingram Micro
http://www.oddballstocks.com/2011/09/almost-net-net-ingram-micro.html

Keweenaw
http://www.oddballstocks.com/2011/12/small-cap-pure-timber-play-keweenaw.html

Kiewit Trust
http://www.oddballstocks.com/2012/04/coal-trust-with-berkshire-connection.html

Kreisler
http://www.oddballstocks.com/2012/08/a-catalyst-that-could-make-this-company.html

KSK
http://www.oddballstocks.com/2012/03/trading-slightly-above-net-cash-ksk-co.html

LookSmart
http://www.oddballstocks.com/2012/07/when-dot-coms-die-looksmart-tender.html

Maxco
http://www.oddballstocks.com/2012/03/net-net-thats-liquidatinghow-unusual.html

Micropac
http://www.oddballstocks.com/2011/03/micropac-industries.html

Mills Music Trust
http://www.oddballstocks.com/2012/03/true-oddball-mills-music-trust.html

MJ Gleeson
http://www.oddballstocks.com/2011/08/way-to-play-uk-housing-recover-mj.html

Molins
http://www.oddballstocks.com/2011/09/molins-magic-six-stock-pe-6-pb-60-div-6.html

National Presto
http://www.oddballstocks.com/2011/08/national-presto-ben-graham-ncav-stock.html

Nexeya
http://www.oddballstocks.com/2012/05/asset-and-earnings-discount-for-nexeya.html

Novabase
http://www.oddballstocks.com/2011/04/cheap-portuguese-stock-novabase-with.html

OPT Sciences
http://www.oddballstocks.com/2011/12/two-very-different-un-researched.html

PC Connection
http://www.oddballstocks.com/2010/09/pc-connection.html

PostNL
http://www.oddballstocks.com/2011/10/postnl-spinoff-opportunity-in-parent.html

Precia Molen
http://www.oddballstocks.com/2012/04/even-better-french-small-cap-precia.html

Queen City Investments
http://www.oddballstocks.com/2011/12/investigating-unlisted-stock.html

RadioShack
http://www.oddballstocks.com/2012/07/radioshack-as-net-netwell-sort-of.html

Randall Bearings
http://www.oddballstocks.com/2012/05/cheapest-stock-ive-ever-seen-and-why-im.html

RCM Technologies
http://www.oddballstocks.com/2011/03/rcm-technologies.html

Reconditioned Systems
http://www.oddballstocks.com/2012/09/calling-all-cube-dwellersreconditioned.html

Rella Holdings
http://www.oddballstocks.com/2012/01/rella-holdings-profitable-company.html

Renault
http://www.oddballstocks.com/2011/11/sum-of-partsrenault.html

Rimage
http://www.oddballstocks.com/2011/02/rimage.html

Ryoden Trading
http://www.oddballstocks.com/2011/05/international-net-net-8-ryoden-trading.html

Satara
http://www.oddballstocks.com/2012/08/there-is-something-sweet-with-this.html

Sangoma
http://www.oddballstocks.com/2011/07/sangoma-technologies-cheap-turnaround.html

SeaEnergy
http://www.oddballstocks.com/2012/02/seaenergy-lots-of-cash-but-no-energy.html

Seahawk Drilling
http://www.oddballstocks.com/2011/06/seahawk-drilling-value-in-bankruptcy.html

SFC Energy
http://www.oddballstocks.com/2011/04/international-net-net-4-sfc-energy.html

Societe Francais
http://www.oddballstocks.com/2011/04/international-net-netsorta-3-societe.html

Solitron Devices
http://www.oddballstocks.com/2011/05/introducing-solitron-devices.html
http://www.oddballstocks.com/2011/06/solitron-assets-and-liabilities.html
http://www.oddballstocks.com/2011/06/solitron-wrapping-things-up.html
http://www.oddballstocks.com/2011/07/solitron-q1-results-out.html
http://www.oddballstocks.com/2012/05/whats-going-on-with-solitron.html
http://www.oddballstocks.com/2012/06/my-letter-to-solitrons-board-of.html
http://www.oddballstocks.com/2012/06/why-one-reader-wont-invest-in-solitron.html
http://www.oddballstocks.com/2012/07/is-it-fraud-walk-through-example.html

SPK
http://www.oddballstocks.com/2011/05/another-profitable-japanese-net-net.html

Sycamore Networks
http://www.oddballstocks.com/2011/03/sycamore-networks.html
http://www.oddballstocks.com/2011/11/why-sycamore-networks.html

Takachiho Koheki
http://www.oddballstocks.com/2011/06/japanese-net-net-takachiho-koheki-co.html

Titon Holdings
http://www.oddballstocks.com/2011/06/titon-holdings.html
http://www.oddballstocks.com/2012/08/rethinking-titon-holdings.html

TNT Express
http://www.oddballstocks.com/2011/06/evaluating-spinoff-tnt-express.html

Treasury Wine Estates
http://www.oddballstocks.com/2011/08/treasury-wine-estates-attractive-spin.html

Tsutsumi Jewelry
http://www.oddballstocks.com/2012/04/japanese-net-net-with-adr-listing-and.html

Vianini Industria
http://www.oddballstocks.com/2011/04/international-net-net-2-vianini.html
http://www.oddballstocks.com/2011/11/what-was-cheap-gets-cheaper.html

Calling all cube dwellers...Reconditioned systems

What's better than sitting in a cubicle all day? How about investing in a company that makes cubes!  Reconditioned Systems (RESY) is a very simple company, analyzing them was very simple as well.  But an investment that's simple isn't necessarily bad.  If this company appears attractive after reading the post I'd wager that an investor could read their past seven years worth of letters and financials in an hour or less.  Reconditioned Systems could be an excellent return on your time.

As mentioned above Reconditioned Systems is simple, they take old office furniture, recondition it, and resell it as recycled office furniture.  The company receives over 1,000 tons of furniture annually at their facility in Arizona.  They receive over 200 truck loads of used cubes and uncomfortable chairs in various states of disrepair a year.  The company then takes the furniture, refinishes it, re-paints it, and resells it as environmentally friendly and new.  In todays market I'm sure there is no shortage of old office furniture ready to be recycled.

The US Government is a large purchaser of the company's wares.  They state on their website they are veteran owned which might give them preferred treatment in the government supply food chain.

The company appears to have earning power that would support book value, placing them in a category I like to call two pillar stocks.  Recent results have been depressed due to an early lease buyout and a lawsuit settlement.  The company's quarterly letters don't give much detail on these two items, so we have to take them at face value.

Quick Thesis
-Last trade at $2.49
-Book value of $4.25 per share
-Paid a $.12 dividend this past year for a 4.81% yield
-P/E of 8.3
-Max earnings $.73, min earnings -$.33

The two pillars

The first pillar of the two pillars is book value.  The company's balance sheet doesn't appear to be terrible.  They don't give any detail on long term liabilities so I would assume they are debt related.  Due to the lack of a easy to use balance sheet (they only provide a summary on their site), I've created my own below:

This spreadsheet doesn't need much explanation, about half of assets are comprised of their Tempe location, and the rest are current assets.  Liabilities are payables, customer deposits, and the mysterious "other long term liabilities" category.  Other long term liabilities make up $3.4m.

The second of the two pillars is earnings, the company's earnings record over the past eight years is shown below:

The earnings trend is pretty clear, everything was going well until the financial crisis.  Companies tightened the purse strings, and office furniture wasn't replaced.  I wonder aloud how much of the company's supply was from Bear Sterns and Lehman Brothers in 2008?  Coming out of the recession Reconditioned Systems appears to be getting back to business.  Sales have slowly recovered, while profits have recovered a bit quicker.  The company has been buying back shares, and has a note on each press release offering to buy back shares from shareholders at any time.  A decreasing share count is never a bad thing, especially when the company is undervalued.

Conclusion

When it comes to a turnaround I'm reminded of a comment someone left on a post a few weeks back.  They said turnarounds are easier when cost cutting can lead to profitability rather than a company needing an increase in sales.  A company who only needs to cut costs holds the future in their hands.  A company who is relying on the marketplace for increased sales is beholden to whatever economic environment exists.  The company could use a mix of the two; reduced expenses, and a slight bump in sales.  Without the lease breakage fee in 2012 the company's net income would have been close to $600k, double what it was..  This current year the company's profits have been depressed due to more one time events.  If the one time events are truly one time there's no reason a company earning $.40-$.50 a share shouldn't trade at or above book value.  If the company does eventually trade up to book value it will take a 70% move to get there.  I would say that 70% for an hour of time is probably a good return.

Talk to Nate

Disclosure: No position

Conrad, part deux..

My last post on Conrad ended in a bit of a cliffhanger, I asked a question which I never answered.  It's been five months since that post and I haven't forgotten about Conrad, or the question I had bouncing around in my head, "why are they cheap?"  They'd been in the back of my mind until a friend brought them up recently in an email exchange.  Almost simultaneously I received an email from the author of Credit Bubble Stocks mentioning Conrad.  A quick aside, Credit Bubble Stocks is the absolute best place to go for information outside of Conrad's filings.  The blog has been covered the company for the past year and a half.

If you're too busy to read the previous post here's a cliffnote background on Conrad.  The company is a shipbuilder mainly producing barges for inland waterways in the US.  The company consists of two segments, construction and services.  Construction is fairly stable whereas services revenue can be lumpy depending on client usage patterns.  Facilities are located in Texas and Louisiana, with headquarters at Morgan City, LA.

How the thesis has changed

Conrad has released half a year's worth of earnings since my last post, so it's worth getting a good overview of how they stand now:

-Market cap dropped from $112m to $97m.
-EV/EBIT of 2.34x
-P/B of .94x
-ROE of 17%

Free cash flow over the last twelve months is essentially zero due to a large capex spend in the latest quarter.  But otherwise everything is humming along as it was the last time I posted, the company has continued to execute and has drifted lower.

Why is it cheap?

This was the question that kept me from investing, I couldn't figure out why a company with such great growth and margins was selling at a EV/FCF of 2.8.  My post spawned a few response posts which helped clarify my answer, but the real connection was when Credit Bubble Stocks connected something I wrote with Conrad.

The first reason the company is cheap is that their results might be a bit misleading.  The company has an incredible return on equity, 20% in 2011 and on track to be close to 17% for 2012.  My question was how could a company like this not be attracting competition, and why was it valued so low?  It turns out some of the book value is understated.  A few of the company's properties are held on the books at cost.  Cost for these properties means the price paid to construct in 1948.  In 1948 the annual salary in the US was $3600 a year, the current average US salary is $63,000, a 17 fold increase.   If we had a current appraisal of the company's properties it's reasonable to assume that book value would increase considerably and return on equity would drop as a result.

The more important metric to me is book value growth, this is a better measure of value creation.  Conrad doesn't pay a dividend, and earnings have been growing, so something has to happen with the free cash.  Either the company pays down debt (it has $1.4m worth), pays a dividend/buys shares, or reinvests in the business.  Since the company doesn't pay a dividend the other options should all be book value accretive.  The reason for this is any growth in assets such as tools, equipment, or property is recorded on the books as an asset.  In theory the asset acquisitions should translate to earnings growth.  The company is now able to build more barges, or service more boats.  The only time this doesn't happen is when a company needs to consume cash just to stay afloat.  I try to avoid cash consuming companies, but I've been bitten once or twice then the price is low enough.

Conrad's book value has grown by 9.8% annually over the past 10 years, and 37% annually over the past five years.  These are impressive numbers but keep in mind the context, replacing a machine that cost $100,000 in 1970 with one that costs $450,000 today creates a small jump condition in book value, some of this could be what we're seeing with Conrad.  If Conrad ever needs to move facilities book value would increase considerable and ROE would shrink considerably as well.

The connection that Credit Bubble made that I referenced above was tying the post where I discussed how an average business can be a great investment to Conrad Industries.  In the post I talk about how some companies appear to have moats but in reality they're just niche companies.  Conrad fits this perfectly, the company can earn generous returns on equity (even if it's understated) because they operate in a small barge building niche.  Credit Bubble has done some great work getting information on competitors and the industry is very consolidated, there are only a few competitors and not a lot of companies rushing to join the barge building gold rush.  As long as barriers to entry remain high, which the US Gov is working hard to keep Conrad will probably continue to earn their outsized returns.  The difference between a niche and a moat is scalability. Conrad's growth is constrained by barge retirements and demand for new barges.  Barges aren't exactly a high tech growth industry at this point.

What's the end game?

If you've made it this far in the post you're probably actually interested in Conrad.  I think there are three developments or aspects which could keep Conrad charting a straight course for the next few years.

The first is the company is party to settlement money from the BP spill fund.  There's no indication how large the settlement might be, but the company thought it was important enough to include it in their earnings release.  The company might use the money to buy back further shares, or possibly pay a one time special dividend.

The second item is the long term outlook for the industry.  In my last post I was worried Conrad was a cyclical at the top of the cycle.  I still think the company is cyclical, but after reading more about the barge industry I realized there is a barge supply problem.  The barge industry's production rate is lower than retirement rate.  Barge usage has actually increased straining supply.  As a result there are secular tail-winds for barge builders.  Conrad continues to mention in their disclosures that customers are slow to sign new contracts, but their backlog is telling a different story.  The company's backlog was $57.2m on June 30th 2012.  As of Aug 20th 2012 the company's backlog was $88.7m, a big increase for two months!  The current backlog translates into earnings of roughly $2.80 per share for 2012 giving Conrad a forward P/E of 5.71x.

The last thing worth mentioning is the end-game for this company.  Conrad delisted so they could save the listing fees, the company is family owned, and family run.  They've also been buying back shares consistently over the past few years.  I wonder aloud if the goal is to slowly take the company private by eventually buying out minority shareholders.  The company listed so it could have access to capital to expand, but they've decided their listing didn't facilitate capital access very well.  Without the market serving their main purpose it makes little sense to be listed at all.

Conclusion

When I research some companies I have to strain my eyes to see past the company's warts to develop an investment case.  Conrad is different, the question I've continued to ask myself is why shouldn't I invest?  Sometimes the decision to make an investment is anti-climatic, no red flags, just a cheap boring company with an unclear upside.  This is the way I've felt with Conrad.  The company is clearly cheap on just about any basis.  In the end I think I'm going to take a position in Conrad, I just can't ignore them anymore.

Talk to Nate about Conrad

Disclosure: No position, but will be buying shares at some point soon.