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.