Quarterly Letter and a Wilhelmsen Update

I’ve finally gotten around to posting Alluvial Capital Management’s first quarter 2016 letter to clients on my company site. Please go here if you are interested in reading it or any other letters.

Three months ago I wrote about Wilh. Wilhelmsen ASA, a deeply-discounted Norwegian specialty shipping company with an upcoming catalyst in the form of a spin-off. That spin-off has been accomplished, and Wilhelmsen ASA and Treasure now trade independently. The price of each is well, well below a conservative reckoning of fair value.

Treasure ASA

The newly independent Treasure ASA is easy to value. The company’s major asset is a 12.04% stake in a Korean logistics company, Hyundai Glovis. Treasure also holds USD 18 million in cash, contributed by Wilh. Wilhelmsen. On the liability side, Treasure remains a guarantor on Wilhelmsen’s corporate-level obligations, though this liability is minor. (Wilhelmsen has strong liquidity and all its corporate-level bonds will roll off within a few years.)

At current exchange rates, Treasure’s stake in Hyundai Glovis is worth USD 687 million. Adding Treasure’s cash holdings yields total value of USD 705 million. Translated to Norwegian Krone, Treasure’s value is NOK 5,839 million, or NOK 26.54 per share.

Treasure’s last trading price was NOK 15.50, a 42% discount to NAV. It’s normal for a holding company to trade at a discount to the value of its assets, but a discount of this magnitude is unusual and I do not expect it to last. Either Treasure will take advantage of this discount and repurchase shares, or Treasure’s majority owner (Wilh. Wilhelmsen Holding, with a 72% stake) will increase its ownership.

Needless to say, I think Treasure’s current price is driven by non-economic selling pressure and that buyers at the current price will be well-rewarded.

Wilh. Wilhelmsen ASA

While the newly-spun off Treasure ASA looks quite attractive, Wilh. Wilhelmsen may be even more so. Wilhelmsen’s goal in shedding its Korean assets was to highlight the value of its autmotive shipping and logistics operations, but the market has shown no inclination to cooperate thus far.

Wilhelmsen shares last traded at NOK 23.30 per share and a market capitalization of NOK 5,126 million. Meanwhile, Wilhelmsen’s tangible book value is north of NOK 11 billion. (This value will increase materially with next quarter’s results, due to an accounting gain from an acquisition.) So, Wilhelmsen’s price to tangible book value ratio is somewhere below 47%, a level usually reserved for the kind of distressed, unprofitable firm that Wilhelmsen most certainly is not.

For the twelve trailing months, Wilhelmsen’s remaining operations produced free cash flow of more than NOK 800 million, for a free cash flow yield in the mid teens.

I believe Wilhelmsen shares should be valued at a premium to book value. Company management has demonstrated ability to earn robust returns on capital through the cycle, no small accomplishment in a cyclical, capital-intensive, largely commoditized industry. All the same, I do understand the market’s more pessimistic point of view. As was plainly illustrated in Wilhelmsen’s first quarter results, the shipping market remains deeply unfavorable. Auto shipments have held up well, but shipments of mining and construction equipment have fallen markedly. I would not be surprised if the next few years were difficult for Wilhelmsen. Still, I expect the company to remain profitable and to use the downturn to set itself up well for the eventual return to happier times.

At less than half of tangible book value, the market is telling us that Wilhelmsen’s assets are severely impaired, that the firm will fail to earn its cost of capital over the next economic cycle, or that a long period of unprofitability will erode the equity base. I disagree with all of these scenarios, and I expect good things from Wilhelmsen stock.

Alluvial Capital Management, LLC holds shares of Wilh. Wilhelmsen ASA and Treasure ASA for client accounts. Alluvial may buy or sell shares of Wilh. Wilhelmsen ASA and/or Treasure ASA at any time. 

OTCAdventures.com is an Alluvial Capital Management, LLC publication. For information on Alluvial’s managed accounts, please see alluvialcapital.com.

Alluvial Capital Management, LLC may buy or sell securities mentioned on this blog for client accounts or for the accounts of principals. For a full accounting of Alluvial’s and Alluvial personnel’s holdings in any securities mentioned, contact Alluvial Capital Management, LLC at info@alluvialcapital.com.

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Rand Worldwide Revisited – RWWI

Back in late 2014 I wrote about Rand Worldwide, a software reseller and training provider of design products like AutoCAD. At the time, the company had just announced it would repurchase more than half its shares outstanding, allowing Peter Kamin’s 3K partnership to take control. I was bullish on the company, pointing out Rand’s cheap pro forma valuation on both current results and the company’s projections. I purchased shares then for clients and continue to hold them. So, how has the company done since?

It’s a mixed bag. Rand has failed to live up to the cheerful revenue and profit outlook it put forth in its tender offer documents. Revenues have actually declined somewhat since. But, the company has been extremely successful in defending its excellent margins and generating cash flow. The debt the company used to finance the share repurchase has already been reduced by 40% to $12.6 million.

Rand recently released its results for the quarter ended March 31, 2015. Let’s compare those results to the financial projections the company provided during the tender offer. For those projections, I’ll be using weighted fiscal 2015 and 2016 projections, since fiscal 2016 has one quarter left to go.

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Thus far, Rand has fallen far short of its revenue goals, coming in fully $17 million shy of its target. Much of this shortfall can likely be blamed on the revenue model transition that Rand Worldwide’s largest supplier, AutoDesk, is undertaking. AutoDesk is transitioning from a traditional software license sale model to a subscription model. Often, these transitions result in some degree of business interruption for re-sellers and other ecosystem participants. AutoDesk’s revenues have fallen during this transitional period, but the changeover is going well and subscription counts are rising steadily. There may be signs that the worst is over for Rand as well. Revenues for the most recent quarter rose year-over-year for the first time since 2014.

Rand has done better on the expense front, managing to post a 52% gross margin and hold down operating expenses during period of slow sales. But so far, the upshot is operating income well below plan.

This lackluster operating performance is likely the reason why Rand’s stock has treaded water since 2014. While Rand’s operating results may have been lackluster, the company’s aggressive deleveraging actually makes it just as attractive today as it was back then. Rand’s $9.5 million in EBIT and enterprise value of approximately $75 million yields an EV/EBIT ratio of 7.9. That’s fairly cheap for a company that earns pre-tax returns on capital north of 35% and generates gobs of free cash flow, especially if Rand’s revenues are returning to a growth path.

In order to get an idea of what Rand’s controlling shareholder may decide to do with the company, it’s worth looking at some of the other companies that Peter Kamin and Company control, like Calloway’s Nursery, Rockford Corporation, and Abatix. In general, 3K likes to increase its ownership over time via open market purchases or tender offers before ultimately purchasing a company outright. In other cases, 3K holds its ownership steady but directs its controlled companies to pay out large special dividends from time to time. In my view, 3K will have eventually utilize Rand’s increasing debt capacity to fund another large tender offer.

The initial loan agreement allowed for total debt of up to 2.75 times EBITDA. Using the same assumptions, Rand currently has the capacity to take on an additional $17 million in debt. If Rand were to announce a debt-financed tender offer tomorrow at say, $2.50, then the company could buy back around 6.8 million shares, or about 20% of the outstanding shares. Question is, will 3K act soon, or will they allow the company to pay down debt by a few million more first? That would allow Rand to buy back even more shares, but it also increases the risk that Rand would have to pay substantially more for the shares if business results trend well. Either way, I think current shareholders win.

Alluvial Capital Management, LLC holds shares of Rand Worldwide, Inc. for client accounts. Alluvial may buy or sell shares of Rand Worldwide, Inc. at any time. 

OTCAdventures.com is an Alluvial Capital Management, LLC publication. For information on Alluvial’s managed accounts, please see alluvialcapital.com.

Alluvial Capital Management, LLC may buy or sell securities mentioned on this blog for client accounts or for the accounts of principals. For a full accounting of Alluvial’s and Alluvial personnel’s holdings in any securities mentioned, contact Alluvial Capital Management, LLC at info@alluvialcapital.com.

 

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More California Real Estate in LAACO, Ltd. – LAACZ

Continuing on the theme of California real estate, today’s post concerns LAACO, Ltd. LAACO is a California partnership. At I write, the partnership has 169,985 units outstanding and a market capitalization of around $338 million. (Units trade at a fairly wide bid/ask spread.) LAACO’s business is real estate. The partnership’s name comes from its ownership of the venerable Los Angeles Athletic Club, but the partnership also owns over 50 self-storage operations as well as some other land holdings in Los Angeles. LAACO is extremely well-run, only modestly leveraged, and trades at a very attractive multiple of net operating income.

I’ll get into the details of LAACO’s holdings, but let’s start with a look at the headline numbers. In 2015, LAACO produced net operating income of $25.7 million. Net operating income, or NOI, is a very important figure in real estate investing because it is a good estimate of the cash flow that properties produce. It isn’t the end all, be all, because it excludes the normal capital expenditures that all properties require. But it is useful shorthand for comparing prospective acquisitions. Naturally, more attractive properties tend to trade at higher multiples of NOI/lower NOI yields. Properties with good potential for increasing cash flows and those in areas with restrictions on new construction also tend to trade at high multiples/low yields. LAACO’s properties satisfy both of these characteristics. The Los Angeles properties are located in desirable areas where constructing new buildings is both difficult (for lack of available land) and expensive. The self-storage facilities enjoy very high occupancy and great potential for rate increases.

LAACO has net debt of $31.1 million, giving it a total enterprise value of $369 million. Using the $27.0 million NOI figure gives an estimated NOI yield of 7.3%. For those of us not living in coastal metropolises, that may seem like a pedestrian figure. Here in Pittsburgh, its still possible to buy multi-family properties at cap rates of 10%, 12%, or even higher. This is not the case in LAACO’s markets, nor in the self-storage industry. In Los Angeles, CBRE put NOI yields for full-service hotels at 6.5% in the second half of 2015. NOI yields on self-storage properties are even lower. National self-storage REITS are currently trading at NOI yields between 3.6% and 4.0%. (To me, purchasing at this valuation seems like a recipe for losing money, but hey, that’s where the market currently is.) The point of this exercise is simply to show that the market is valuing LAACO far, far below comparable businesses.

Self-Storage: Storage West

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LAACO’s self-storage business, called Storage West, was founded in 1978. Currently, the company operates 52 locations, 50 of which are wholly-owned. These properties are located in California, Arizona, Nevada and Texas. For 2015, Storage West’s properties reported 87% occupancy, with rents rising 4.5% to $14.59 per square foot. The company is working on developing three new properties near Houston and improving two existing Orange County locations. Storage West has indicated a preference for developing new properties from the dirt up over buying additional existing properties, citing unattractive valuations for seasoned self-storage facilities. A combination of solid operations and increasing national demand for storage facilities has enable Storage West to produce some excellent results. Storage West produced NOI of $24.5 million in 2015, compared to only $17 million in 2010. That’s a healthy 7.6% growth rate, and the company’s results should only continue to grow as rent increases take effect and new properties are brought to market. In 2016, Storage West should be able to produce at least $25 million in net operating income. LAACO also owns 50% interests in two additional self-storage properties, which produced $601,000 in income in 2015. Assuming margins in line with Storage West’s wholly-owned properties, these joint ventures produce at least another $130,000 in depreciation, meaning LAACO’s share in the NOI of these properties is around $731,000. Adding this figure to the estimated $25 million in NOI from the wholly-owned properties gets us to $25.7 million in NOI.

So what’s that worth? Large national competitors trade at 25-28x net operating income, but I don’t want to be that aggressive. I’ll instead use a more conservative 20x NOI, which still yields a value of $514 million using the $25 million NOI estimate.

Los Angeles Athletic Club

LAACO’s other major asset is the Los Angeles Athletic Club.

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Founded in 1880, the LAAC has counted many prominent Los Angeles citizens among its membership over the years. The club’s athletic facilities have helped train generations of athletes, including dozens of Olympic medalists. Today, the Club operates a 72 room boutique hotel, event and meeting space, plus dining and athletic facilities for its members.

For tax reasons, LAACO leases the Club’s land and building to a fully-taxable subsidiary, LAAC Corp. In 2015, LAACO received $804,000 in rental income from LAAC Corp., and LAAC Corp. earned after-tax income of $276,000. Depreciation of Club assets was $552,000 for total cash flow to LAACO of $1.63 million. In 2014, cash flow to LAACO totaled $1.67 million. Using CBRE’s cap rate estimate for full-service Los Angeles hotels provides an estimated value of $25.7 million for the property. However, there are many reasons to believe this figure underestimates the value of LAACO’s Los Angeles real estate substantially. First, the company is in the midst of an extensive renovation of the Club’s facilities, which should provide an uplift in both revenues and profits. More importantly, the company also owns an adjacent parking garage, plus an empty lot, all located contiguously. The neighborhood is undergoing a meaningful amount of redevelopment, with Whole Foods (ever the bellweather) going in just two blocks away. Through the magic of Google Streetview, I present a look at LAACO’s downtown LA property.


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From left to right is the vacant lot, currently surface parking, then the parking garage, then the Club itself. LAACO controls the air rights on all three lots. If the trajectory of downtown Los Angeles can be sustained, it is easy to see millions in value being created from the redevelopment of the vacant lot and possibly the existing parking garage.

Valuation

Valuing LAACO as a whole is relatively straightforward. Conservatively estimated, the self-storage assets and the LAAC are together worth roughly $539.7 million. Against that value, there is $31.1 million in debt. Finally, LAACO pays annual management expenses to a company called Stability, LLC. Stability is controlled by the family that also owns the majority of all LAACO units, the Hathaways. Stability receives 1% of LAACO’s distributions to shareholders, plus 0.5% of LAACO’s total revenues. In 2015, this amount totaled $597,000. Conservatively capitalizing this fee stream at 20x the 2015 fee yields a liability of $11.9 million.

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Using these figures, each unit of LAACO is worth $2,922, or roughly 47% more than the current mid-point. This value does not include potentially lucrative development. Each $5 million in value created by redevelopment would benefit LAACO units by $29 per unit or so. It could add up. Finally, just as a thought exercise, what if we did value the self-storage business at a 4% NOI yield? Well, turns out doing so would increase the value of LAACO units by $128.5 million, or a cool $756 per unit. Do what you like with that.

As you can see, its not hard to arrive at a value for LAACO units that is substantially above where the units are trading today. Units are illiquid, and the company is tightly controlled by the Hathaway family, but LAACO could be a nice “lazy” holding for long-term investors.

Alluvial Capital Management, LLC does not hold units of LAACO, Ltd. for client accounts. Alluvial may buy or sell LAACO, Ltd. units at any time. 

OTCAdventures.com is an Alluvial Capital Management, LLC publication. For information on Alluvial’s managed accounts, please see alluvialcapital.com.

Alluvial Capital Management, LLC may buy or sell securities mentioned on this blog for client accounts or for the accounts of principals. For a full accounting of Alluvial’s and Alluvial personnel’s holdings in any securities mentioned, contact Alluvial Capital Management, LLC at info@alluvialcapital.com.

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InterGroup, Santa Fe, Portsmouth – Odd Structure, Significant Value

One unusual company I have enjoyed following over the years is The InterGroup Corporation. InterGroup sits at the top of a strange trio of related companies. This odd triangular ownership structure, as well as the very low liquidity of each company’s stock, conceals significant asset value. Arriving at a reasonable estimate of each company’s value requires some legwork.

InterGroup owns 81.9% of Santa Fe Financial, which in turn owns 68.8% of Portsmouth Square. InterGroup also holds 13.1% of Portsmouth Square directly, giving it an effective ownership interest in Portsmouth of 69.4%. InterGroup is NASDAQ listed, while Santa Fe and Portsmouth trade over-the-counter. This chart casts some light on the clunky structure.

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In order to determine InterGroup’s value, we must start at the bottom and work backwards.

Portsmouth Square, Inc.

Portsmouth Square’s major asset is the entire group’s crown jewel: the San Francisco Financial District Hilton. Built in 1971 and renovated in 2006, the hotel has 32 floors with 544 rooms. While it is perhaps not the most beautiful structure (the influence of Brutalism is obvious) it is nonetheless an extremely valuable property.

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Through its subsidiary, Justice Investors, Portsmouth Square owns a 93% interest in the hotel. For the twelve months ended December 31, 2015, the hotel produced net operating income of $10.5 million. In fiscal 2015, the hotel produced NOI of $9.8 million. Hotels are often valued using cap rates, and these are especially low in a desirable city like San Francisco. Using a cap rate of 5% would value the hotel at $210 million. Using 6% would put the hotel at $175 million. This valuation is supported by the company’s own estimates. In late 2013, Justice Investors increased its stake in the hotel from 50% to 93%, cashing out minority owners at an implied hotel valuation of $182 million.

The Hilton has mortgage debt of $117 million. Using the lower end of my valuation estimate, the hotel’s net value is $58 million, making Portsmouth’s 93% ownership stake worth $53.9 million.

Portsmouth also has various other assets, including $3.3 million in unrestricted cash and $4.0 million in marketable securities. However, 88% of these securities are common shares of Comstock Mining, a chronically unprofitable gold and silver miner. I value these shares at zero, leaving marketable securities of only $0.5 million. The company also holds a small amount of “other investments,” but there is no visibility toward the nature of these holdings and I think it better to ignore them. Against these assets, Portsmouth owes $8.9 million in notes payable, including $4.3 million to its ultimate parent, InterGroup. Portsmouth Square also incurs annual SG&A costs of around $0.7 million. I value this ongoing liability at negative $5.8 million, net of tax.

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Sum it all up and you arrive at a valuation of $43 million for Portsmouth, or almost $59 per share. The stock lasted traded at $55.50, so it looks like the market is largely in agreement with this valuation. (I pulled a quote after I did the valuation, I swear.) My estimates were fairly conservative, so it’s possible that Portsmouth is worth quite a lot more. For example, using a $210 million valuation for the hotel and assuming the Comstock stock is actually worth its balance sheet value, Portsmouth could be worth as much as $108! Clearly, the company’s value depends greatly on the value of its hotel, magnified by the significant leverage the mortgage debt provides.

Santa Fe Financial Corporation

It gets easier from here. In addition to its 68.8% ownership interest in Portsmouth, Santa Fe owns some corporate cash and a 55.4% interest in an apartment complex in Los Angeles, plus some undeveloped land in Hawaii. Portsmouth’s assets and liabilities are consolidated on Santa Fe’s balance sheet, so naturally we must back these out to see what Santa Fe actually owns.

Santa Fe reports $3.4 million in cash, but only $0.4 million is Santa Fe’s. The rest belongs to Portsmouth. Similarly, Santa Fe reports $6.1 million in marketable securities, but again, it’s nearly all in Comstock. Santa Fe’s non-Comstock, non “other investments” investment securities are de minimus. 

The apartment complex produces only a little over $0.3 million in net operating income annually. I value the property at $5 million. There is $3.3 million debt on the property, making Santa Fe’s stake worth $0.9 million. Santa Fe’s undeveloped Hawaii property’s cost basis is $1 million, so I’ll take that as the value.

Santa Fe has no other substantial non-Portsmouth liabilities, and incurs annual SG&A expenses of only around $0.4 million. Valuing the ongoing SG&A at negative $3.6 million yields a value of $28.2 million, or $22.73 per share.

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But wait, the last trade for Santa Fe was at $35.00! Looks like the market thinks far better of the company than I do. Then again, using less conservative estimates for the value of Portsmouth Square gets me to Santa Fe values in the $60-70 range. Once again, it comes back to what the Hilton is really worth.

The InterGroup Corporation

Lastly, we tackle InterGroup. Valuing InterGroup is as simple as summing the company’s corporate-level assets and liabilities, plus its effective 69.4% interest in Portsmouth, plus its 81.9% interest in Santa Fe’s corporate-level assets and liabilities. (Including the value of Santa Fe’s interest in Portsmouth Square would be double-counting.)

InterGroup has the standard cash and marketable securities, but also has some more substantial real estate assets. Cash (net of Portsmouth and Santa Fe’s balances) is $1.7 million. Marketable securities are $4.9, once again excluding the complex’s significant holdings in Comstock and the murky “other investments.” The company also has a $4.3 million loan outstanding to its subsidiary, Portsmouth Square.

InterGroup’s real estate assets include 16 apartment complexes, one commercial real estate property, vacant lots, and three single family residences in the Los Angeles area. The single family residences are categorized as “strategic investments.” This seems dubious to me, but at least the value of the single family residences is small compared to the multi-family properties.

The value of InterGroup’s real estate is actually quite substantial. In fiscal 2015, the properties produced $7.7 million in NOI. This figure declined slightly to $7.5 million for the twelve trailing months. At a 6.5% cap rate, these properties are worth a cool $115 million. These properties carry debt of $62.2 million, for a net value of $52.8 million. I’ll bump that value to $55.8 million to credit the company for its non-revenue producing land investments.

As for liabilities, InterGroup owes $1.6 million in margin debt on its investment securities. SG&A expense amounts to a little under $2 million per year, which I estimate is worth a negative $9.7 million, net of tax.

Time to sum it up!

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The net value of InterGroup’s assets comes to $86.3 million, or a little over $36 per share. You may notice I assign no value to the ownership stake in Santa Fe, net of Santa Fe’s ownership in Portsmouth Square. That’s because without Portsmouth, Santa Fe actually has a negative value as a going concern. The reason that value to InterGroup is zero, not negative, is because InterGroup has no need to fund Santa Fe in any capacity and is not a guarantor on any of Santa Fe’s liabilities.

The last trade in InterGroup stock was at….$$26.01. So here’s truly undervalued security of this complex. Per usual, it’s the ultimate holding company that receives the greatest discount.

While I think that InterGroup trades at a large discount to conservative reckoning of its asset value (valuing Comstock at today’s market value would add almost $5 per share to InterGroup’s valuation) the company does have some substantial drawbacks. First, liquidity. InterGroup has a float of only around 800,000 shares with a market value of only $21 million. Accumulating these shares, not to mention selling them, is extremely difficult. Second, InterGroup and its related companies are tightly controlled by insiders with a love for investing a substantial portion of the company’s resources in penny mining stocks. Maybe that will work out great…but I wouldn’t count on it. And finally, the value of all three companies will be profoundly influenced by the California real estate market, San Francisco in particular. I don’t have any view about which way that market will go, but it is certainly a risk.

Alluvial Capital Management, LLC does not hold shares of InterGroup, Santa Fe Financial, or Portsmouth Square for client accounts. Alluvial may buy or sell shares of InterGroup, Santa Fe Financial, or Portsmouth Square at any time. 

OTCAdventures.com is an Alluvial Capital Management, LLC publication. For information on Alluvial’s managed accounts, please see alluvialcapital.com.

Alluvial Capital Management, LLC may buy or sell securities mentioned on this blog for client accounts or for the accounts of principals. For a full accounting of Alluvial’s and Alluvial personnel’s holdings in any securities mentioned, contact Alluvial Capital Management, LLC at info@alluvialcapital.com.

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Gale Pacific Ltd – ASX:GAP

Now and then I spend some time searching for cheap stocks in Australia. Surprisingly often, I find what I am looking for. While the Australian market is dominated by natural resource companies, there are hundreds of companies operating profitably in the healthcare, technology, industrial and consumer goods sectors, many very much over-looked and trading at discounted valuations. One such company is Gale Pacific.

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Gale Pacific got its start in the 1950s as a scarf and shawl manufacturer, but the company now manufactures and sells sun protection equipment like outdoor sun shades, window treatments, and commercial shadecloth. Products like these are essential in sunny Australia, but the company also distributes its products in North America and the Middle East. Gale’s products can be found at Costco, Home Depot and other major retailers under the “Coolaroo” brand. The company is also the largest provider of artificial turf in Australia, and a major supplier of fabrics used to protect harvested grain from the elements.

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Gale Pacific has had a tumultuous history. The company was an aggressive acquirer before 2006, and was punished severely for its excess leverage when the financial crisis arrived. The company spent years selling off assets and raising equity to remain solvent. Many of the acquisitions the company had performed proved disastrous, like the acquisition of a German garden products manufacturer. The company installed a new leader in 2009, Mr. David Allman. Mr. Allman successfully guided the company away from the financial precipice, eliminating nearly all debt by the end of 2012.

The years following the crisis saw Gale perform better, but problems remained. From fiscal 2012 to fiscal 2015, Gale Pacific’s revenues grew 34%. Yet operating income declined by 15%, indicating real issues with pricing and production costs. The company also suffered from poor working capital trends. Days of inventory rose from 83 to 97 over the three years, and net working capital rose from 25% of revenues to 37%. Naturally, this increased capital intensity resulted in very poor cash flow. Despite producing statutory net income of $22.5 million in the three years ended 2015, Gale Pacific’s free cash flow amounted to just $5.3 million. Ick.

Fortunately, the company is well aware of these issues and began taking steps to address them back in 2014, appointing Mr. Nick Pritchard as group head. Mr. Pritchard began working on a plan to restore profitability, centered around reducing supply chain costs and streamlining the company’s stable of products and brands. The plan called for the company to refocus on innovation within its core product areas and improve global collaboration.

It took a little while for results to show up in the financial statements, but the success of the plan became apparent with Gale Pacific’s half-year 2016 report. For the half-year ended December 31, 2015, the company achieved the following:

  • Revenue up 22%, assisted by the weak Australian dollar and strong sales in the US and the Middle East.
  • Underlying operating income up a whopping 180%.
  • A $10.5 million increase in operating cash flow, driven by improved working capital management.
  • A $6.2 million reduction in net debt.
  • Statutory net income of $3.2 million, a $3.8 million improvement over the same period in fiscal 2015.

Beyond its financial statement achievements, Gale Pacific made good progress in setting the table for future successes. The company opened a new distribution center in Melbourne, improving customer service and reducing supply chain costs. It also achieved a rebranding of its major Coolaroo product line, simplified its supplier lineup and invested in new products to keep its offerings relevant and drive demand.

Gale Pacific is now much better prepared to deliver earnings growth and just as importantly, superior cash flow. The company should continue to benefit from inventory reductions and reduced operating expenses. Despite these positive factors, the company trades at a very modest ratios. On a trailing basis, the company’s P/E is less than 10, and EV/EBIT is below 8. (I use average net debt because Gale Pacific’s business is seasonal. The company’s debt peaks during the Australian summer months.) The company also trades at a slight discount to book value.

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Note that these value are calculated on trailing results. If the company can show similar improvements in the second half of fiscal 2016, these ratios could drop substantially. At present, the company is guiding toward 2016 pre-tax income of $12-14 million. Personally, I find this guidance very conservative given the company has already achieved pre-tax income of over $12 million for the trailing twelve month period. Assuming Gale Pacific achieves the higher end of its 2016 pre-tax income guidance and pays down debt by another few million, forward EV/EBIT could be below 7.

In order to be comfortable investing in Gale Pacific, one has to be reasonably certain that future demand for its sun protection products will not decrease. I think this is reasonable, given the trajectory of global climate and our increased awareness of the risks of excess solar radiation. One also has to trust that the company’s major shareholders will guide the company wisely. Thorney Investments, controlled by wealthy businessman Richard Pratt, is Gale Pacific’s largest shareholder at 27%.

Alluvial Capital Management, LLC does not hold shares of Gale Pacific Ltd for client accounts. Alluvial may buy or sell shares of Gale Pacific Ltd at any time. 

OTCAdventures.com is an Alluvial Capital Management, LLC publication. For information on Alluvial’s managed accounts, please see alluvialcapital.com.

Alluvial Capital Management, LLC may buy or sell securities mentioned on this blog for client accounts or for the accounts of principals. For a full accounting of Alluvial’s and Alluvial personnel’s holdings in any securities mentioned, contact Alluvial Capital Management, LLC at info@alluvialcapital.com.

 

 

 

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Wilh. Wilhelmsen ASA – Deeply Discounted Blue Ship Specialty Shipping Company With A Major Catalyst

I’m back with what I believe is the best value idea I have dug up in some time, one I haven’t seen covered anywhere else. I submitted it to Value Investors Club, but they didn’t like it. (So no membership for me, at least for now.) Nonetheless, I believe this is an extremely compelling scenario, so I present it to you.

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Wilh. Wilhelmsen ASA – WWASA:Oslo

Deeply Discounted Blue Ship Specialty Shipping Company With A Major Catalyst

Wilh. Wilhelmsen ASA is one of the world’s largest owners and operators of roll-on roll-off “roro” carriers, specialized ships designed to transport automobiles and other large equipment between continents. Broadly speaking, shipping is not an attractive business. The industry is capital-intensive, deeply cyclical, and heavily commoditized. Most shipowners and operators are price-takers. Wilhelmsen, on the other hand, has a knack for identifying and investing in specialized shipping niches that require differentiated vessels and deep operational expertise. As a result, Wilhelmsen is less exposed to the shipping cycle and earns healthy margins returns and returns on capital.

The company also operates an extensive global automotive shipping logistics network. Wilhselmsen’s activities are carried out through a series of joint ventures and associated companies. Wilhelmsen categorizes its business activities in two segments: shipping and logistics.

Shipping – Wilhelmsen owns 40% of EUKOR Car Carriers, 50% of Wallenius Wilhelmsen Logistics, and 50% of American Roll-On Roll-Off Carrier. Together, these companies account for 25% of the global roro market. EUKOR’s largest customers are Hyundai and Kia, while American Roll-On Roll-Off Carrier’s main customer is the US government.

Logistics – Wilhelmsen’s main logistics joint venture is Wallenius Wilhelmsen Logistics. Its other joint ventures are American Auto Logistics and American Logistics Network. These companies provide terminal services, technical services (repairs, quality control, etc.) and inland distribution, moving vehicles from port to final destination. Wilhelmsen’s logistics division also includes an extremely valuable ownership stake in a publicly-traded Korean auto shipping and logistics company, Hyundai Glovis Co. Ltd. Wilhelmsen was an early investor in Glovis and their 12% ownership stake is worth $720 million.

Shares of Wilh. Wilhelmsen trade at an extremely attractive price of 5.5x trailing earnings, adjusted for one-time gains, provisions, and excess corporate cash. Wilhelmsen shares also trade at just 57% of book value. However, Wilhelmsen shares will experience an extraordinary catalyst in the upcoming spin-off of their stake in Hyundai Glovis as a public entity to be named Treasure ASA. Assuming Treasure trades at any reasonable discount to the value of the Hyundai Glovis shares it will hold, buyers of Wilhelmsen shares today are creating the company at below 3x trailing normalized earnings and less than one-third of book value.

First, a look at Wilhelmsen’s earnings. Though shares trade in NOK, Wilhelmsen operates and reports in US Dollars. Because it operates through so many joint ventures and associates, Wilhelmsen’s income statement is reported via the proportional method. For 2015, Wilhelmsen reported $2.31 billion in revenues, $435 million in adjusted EBITDA and $278 million in adjusted EBIT. (EBITDA and EBIT are adjusted for a $200 million provision against possible anti-trust penalties, and a $29 million one-time gain related to the sale of Hyundai Glovis shares.) Interest expense is a little trickier, as Wilhelmsen does not report proportional interest expense. The company does provide proportional total debt: $2,026 million at year-end 2015. The average rate on Wilhelmsen’s debt was 4.4% in 2014 and was extremely similar in 2015, based on the minimal variation in interest expense reported for the full 2015 year in the company’s fourth quarter report. At a 4.4% rate, interest expense on the company’s $2,026 million in proportional debt is $89 million, yielding pre-tax income of $189 million. Finally, taxes. Norway’s corporate tax is 27%, which puts Wilhelmsen’s adjusted 2015 net income at $138 million.

On a market-capitalization basis, net income of $138 million puts Wilhelmsen shares at 6.9x adjusted trailing earnings. However, Wilhelmsen holds substantial cash and short-term investments at the company level: $349 million. (The company’s proportional interest in its joint ventures provides another $263 million in cash, but the conservative approach is to ignore these assets.) Of this $349 million in corporate cash and equivalents, I estimate at least $200 million to be excess capital available for investment. Backing that $200 million out of the company’s market capitalization yields a trailing adjusted P/E ratio of 5.4. Of course, Wilhelmsen’s actual financial statements rarely show net income close to normalized levels. The company conducts a lot of bunker, interest rate and currency hedging, which creates a lot of noise in the statements. The complicated statements may be one reason why shares trade so cheaply.

Now: on to the spin-off! Wilhelmsen has announced it will spin-off its ownership of Hyundai Glovis in summer 2016. The new company will be named Treasure ASA, and its only assets will be the 12% stake in Hyundai Glovis, plus de minimus cash. The gross value of the Hyundai Glovis shares is currently $720 million, but Wilhelmsen’s $346 million cost basis in Hyundai Glovis does create a tax liability. At the 27% tax rate, Treasure ASA’s tax liability in a sale of all Hyundai Glovis shares would be $101 million. I expect shares of Treasure ASA to trade at a moderate discount to the value of the Hyundai Glovis shares, less tax. At a 15% discount, Treasure ASA would be worth $526 million. In their fourth quarter earnings call, the company said it would consider taking steps to narrow the gap if Treasure ASA traded at a meaningful discount, so I believe that 15% is a reasonable estimate.

Though the spin-off’s pro forma market value is more than half of Wilhelmsen’s market capitalization, the spin-off’s impact on Wilhelmsen’s earnings will be much smaller. In 2015, Hyundai Glovis contributed only $36 million in equity income to Wilhelmsen’s results, 26% of pro forma net income.

Assuming Treasure ASA trades with a market capitalization of $526 million when spun off this summer, Wilh. Wilhelmsen’s current implied market capitalization is $421 million. Net of $200 million in excess corporate cash, Wilhelmsen’s market capitalization is $221 million. Pro forma net income is $102 million after deducting Hyundai Glovis’ $36 million contribution. That leaves Wilhelmsen trading at a pro forma trailing cash-adjusted P/E ratio of 2.2, a price to book ratio of 32%.

I do not expect the market to allow a conservatively run, consistently profitable, well financed blue chip shipping company trading at 2.2x earnings for long.

Risks to this analysis include the possibility that Hyundai Glovis shares trade down significantly, perhaps on news of lower Hyundai and Kia sales in the US or a weakening appetite for imports. The company is exposed to the global auto market as well as the market for heavy mining and construction equipment, and slowdowns in those sectors have had an impact and will continue to do so. There is also the risk that Wilhelmsen’s liabilities for anti-trust penalties within the roro market exceed the company’s own estimates, or come due faster than anticipated. (I view the company’s $200 million provision as exceedingly conservative, as future penalties will arrive piecemeal and over the course of many years. Courts don’t move quickly. The value of potential anti-trust liabilities in both absolute and present value terms is likely far less than $200 million.) Regardless, potential penalties are adequately funded by cash within the company’s joint ventures.

The coming spin-off of Hyundai Glovis into a vehicle named Treasure ASA will force the market to recognize how extraordinarily cheap Wilh. Wilhelmsen ASA’s remaining operations are trading. Treasure ASA’s market value is over half of Wilhelmsen’s total market capitalization, yet Treasure ASA accounts for only 26% of Wilhelmsen’s pro forma net income. Wilh. Wilhelmsen’s pro forma valuation of 2.2x normalized ex-cash earnings and 32% of book valuable is untenable and the situation will be corrected by the market.

Alluvial Capital Management, LLC holds shares of Wilh. Wilhelmsen ASA for client accounts. Alluvial may buy or sell shares of Wilh. Wilhelmsen ASA at any time. 

OTCAdventures.com is an Alluvial Capital Management, LLC publication. For information on Alluvial’s managed accounts, please see alluvialcapital.com.

Alluvial Capital Management, LLC may buy or sell securities mentioned on this blog for client accounts or for the accounts of principals. For a full accounting of Alluvial’s and Alluvial personnel’s holdings in any securities mentioned, contact Alluvial Capital Management, LLC at info@alluvialcapital.com.

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Toronto MicroCap Conference and a Canadian Merger Play

I am happy to announce I will be speaking at The MicroCap Conference in Toronto, April 11-12. This conference will be a great opportunity to network, hear presentations from many promising small companies outside the natural resources sector and to meet with management. The Canadian market is a rich hunting ground for quality microcap companies, many of which have seen their share prices unfairly punished by the turmoil in the oil and gas industries.

Best of all, this conference is free to attend! Blog subscribers are eligible for a special rate on rooms at the Toronto Hilton, plus half off the price of tickets for the investors’ dinner on the 11th. I’ll be e-mailing the details to blog subscribers in a few days, so please be sure to subscribe to OTC Adventures by then if you would like to be included in the mailing.

I really enjoyed meeting many blog readers at the last conference in Philadelphia. Please let me know if you will be attending the Toronto conference and we can grab coffee or a beer.

While on the topic of Canada, I’d like to present an interesting merger arbitrage opportunity in a very obscure income fund.

Dominion Citrus Income Fund is a tiny, tiny Canadian trust that operates produce growers and logistics companies. The company grows, processes, and distributes various fruits and vegetables in multiple Canadian cities. Some of the company’s subsidiaries are nearly 100 years old. The company’s history is rather complicated. Dominion Citrus Limited was once a subsidiary of Algonquin Mercantile Corp. Algonquin spun off Dominion Citrus Limited to its shareholders in 2000. (Algonquin Mercantile would go on to become Automodular Corp., which will be well-known to some value investors.)

For the next few years, Dominion Citrus Limited operated as an ordinary corporation. The company issued Series A Preferred Stock in 2002 to help finance the acquisition of a subsidiary. In 2006, the company merged with the newly-created Dominion Citrus Income Fund. Under Canadian law at the time, income funds were exempt from corporate taxation as long as they paid out substantially all their earnings to shareholders, much like a REIT. The income fund acquired all of Dominion Citrus Limited’s common shares in exchange for fund units. The fund did not acquire Dominion Citrus Limited’s preferred shares. The fund intended to do so, but the necessary shareholder vote failed. So, the preferred shares remained outstanding, an unusual feature for an income trust. Most critically, the transaction created a substantial amount of inter-company debt owed by the operating company to the fund. Dominion Citrus Limited now owed the fund $19.3 million in participating notes due in 2016 at effective interest rates as high as 18.5%.

Changes to Canadian law soon made the income trust legal structure unattractive, so in 2008 the fund decided to convert back into a corporation. Throughout the 2000s, Dominion undertook a variety of small acquisitions and marketing efforts in an attempt to grow its sales and earnings, but nothing ever really worked for long. Revenues and profits entered a long slow decline and in 2009, the fund and the operating company restructured the participating notes. The base rate on the notes was cut to 5%, but the notes still contained provisions that could require the operating company to surrender all its pre-tax income to the fund as additional interest. Even the restructuring wasn’t enough, and the fund provided an extended interest “holiday” to the operating company, forgoing payment on the participating notes in exchange for an option to purchase the operating company’s main operating asset at fair market value.

Things came to a head in 2014. The operating company had not made principal or interest payments to the fund for a number of years, and the fund had long since ceased making dividend payments to unit holders. Holders of the preferred shares had essentially no chance of seeing a dividend, as the terms of the participating notes would shuttle all of Dominion Citrus Limited’s potential earnings to the fund itself. The fund announced it would explore strategic alternatives and made efforts to market the operating company for sale. However, these efforts fell apart as holders of the preferred stock sued over the original terms of the participating notes, arguing the fund had unjustly enriched itself at the expense of the preferred shares. The search for a solution continued throughout 2015.

If this all sounds a little byzantine, it is. I’ve created an ownership chart below.

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To summarize, the fund itself owns three assets: 100% of Dominion Citrus Limited’s common stock, $19.3 million in intercompany participating notes, and an option to purchase Dominion Citrus Limited’s most substantial subsidiary, Dominion Farm Produce Limited. The fund does not own Dominion Citrus Limited’s preferred stock, which is publically traded.

In November of 2015, with the participating notes coming due in just weeks, Dominion Citrus Income Fund indicated it would no longer be willing to excuse its operating company’s lack of payment and indicated it would exercise its option to purchase Dominion Farm Produce Limited. The fund commissioned a valuation company to prepare a valuation report for the subsidiary. Klein Farber’s report valued Dominion Farm produce at between $7.9 and $9.8 million, and the whole of Dominion Citrus Limited at between $10.3 and $13.5 million. Of course, the fund never really intended to purchase the subsidiary, as it would essentially just be paying itself and reducing the balance of the participating notes. The purpose of the exercise was to establish a valuation for a third party to purchase the fund’s entire asset base, participating notes, option to purchase and all.

The fund found its purchaser in Paul Scarafile, the interim CEO of Dominion Citrus Limited. Mr. Scarafile offered $10.8 million for all of the fund’s assets. This works out to CAD $0.51 per fund unit. Because the offer price falls within the valuation range produced by Klein Farber, the fund’s board has recommended the offer to unitholders. The fund itself has no material liabilities.

Should the offer go through, fund owners could realize a large gain. Fund units are currently offered at CAD $0.37, with a wide bid/ask of $0.25/$0.37. 51 cents per fund unit would represent a gain of 38% from the ask price. However, there are several uncertainties. The press release describing the offer indicated that the offer is not entirely cash, so the fund may end up owning risky promissory notes. Also, the offer itself is conditional and includes financing and due diligence contingencies. Even if the transaction goes off without a hitch, the fund may incur substantial costs during its wind-down, including additional litigation from the holders of the preferred stock. There may be an opportunity here for aggressive investors, but caution is necessary. Personally, I am always sad to see one of the truly strange companies of the microcap world disappear.

Alluvial Capital Management, LLC does not hold shares of Dominion Citrus Income Fund or Dominion Citrus Limited Series A Preferred Stock for the accounts of clients or principals. Alluvial may buy or sell shares of Dominion Citrus Income Fund or Dominion Citrus Limited Series A Preferred Stock at any time. 

OTCAdventures.com is an Alluvial Capital Management, LLC publication. For information on Alluvial’s managed accounts, please see alluvialcapital.com.

Alluvial Capital Management, LLC may buy or sell securities mentioned on this blog for client accounts or for the accounts of principals. For a full accounting of Alluvial’s and Alluvial personnel’s holdings in any securities mentioned, contact Alluvial Capital Management, LLC at info@alluvialcapital.com.

 

 

 

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Alluvial Capital Management, LLC Fourth Quarter 2015 Letter to Clients

Follow the link below to view Alluvial Capital Management’s fourth quarter letter to clients. 2015 was a strong year despite a difficult market environment. I welcome your comments and feedback.

Alluvial Capital Management, LLC Fourth Quarter 2015 Letter to Clients

I don’t get to write here at OTC Adventures as much as I used to or as much as I would like. As my professional and personal responsibilities increase, I no longer possess the hours in my week necessary to put out content at the level I feel I owe my readers, at least with any frequency. But readers can expect me to pop up here and there in 2016 with a profile of some interesting company, domestic or international. Thanks again for taking the time to read my humble blog.

-Dave Waters

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Central Parking Finance Trust – CRLKP

One more investing idea to close out the year. And for the first time on this blog, it’s a fixed income security. Central Parking Finance Trust Convertible Preferred Securities offer a very attractive current yield and yield to maturity, plus a valuable embedded put option.

The Central Parking Finance Trust was created in 1998 to invest in junior subordinated deferrable interest convertible debentures issued by Central Parking Corporation. Despite the complicated title, these were essentially just convertible bonds with a provision for temporarily postponing interest payments if necessary. The bonds had a maturity of April 1, 2028, and were convertible into common shares of Central Parking Corporation at 0.4545 shares per $25 par value bond. To finance the purchase of this bond issue, the trust issued convertible preferred securities with substantially identical terms. These preferreds trade over-the-counter with the ticker CRLKP.

CRLKP’s current bid/ask is $19.40/$19.75. Yield-to-maturity in 2028 is a juicy 8.2%. The current yield is 6.8%, adjusting for accrued dividends. Looks like a nice rate of return. But then again, yield never exists in a vacuum. Long-term fixed income securities offer multiple ways to lose. Rising interest rates and widening credit spreads can create a lot of tears for yield-chasing investors.

However, remember the convertible part of these securities’ title? Well, Central Parking Corporation was acquired by a consortium of private equity firms lead by KKR in 2007. As a result of the transaction, the conversion rights of the trust preferred securities were canceled. From the time of the transaction until their maturity in 2028, holders instead have the ability to redeem their shares at any time for $19.18 per share. Currently, these units are the ultimate liability of SP Plus Corporation, which acquired Central Parking from its private equity owners in 2012.

This is a put option, and it dramatically decreases the risk of holding CRLKP. Interest rate risk is all but eliminated. Even a dramatic rise in yields across the curve would produce a maximum loss of 2%, the difference between CRLKP’s current price and the put strike of $19.18. Credit risk is greatly reduced, because holders can effectively choose their own maturity and put the securities back to the company at any time should SP Plus’ financial ratios begin to deteriorate.

If there’s a downside to these securities, it is definitely their illiquidity. By my calculation, only about 60,000 of these securities remain outstanding following years of redemptions by holders. Additionally, SP Plus has been in the market buying CRLKP back. SP Plus’ cost of debt is only around 4.7%, so naturally they are eager to retire these expensive securities. Anyone purchasing these securities should view the investment as long-term.

Alluvial Capital Management, LLC does not hold shares of Central Parking Finance Trust for client accounts. Alluvial may buy or sell shares of Central Parking Finance Trust at any time. 

OTCAdventures.com is an Alluvial Capital Management, LLC publication. For information on Alluvial’s managed accounts, please see alluvialcapital.com.

Alluvial Capital Management, LLC may buy or sell securities mentioned on this blog for client accounts or for the accounts of principals. For a full accounting of Alluvial’s and Alluvial personnel’s holdings in any securities mentioned, contact Alluvial Capital Management, LLC at info@alluvialcapital.com.

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Global Ports Investments Plc – GLPR:London

Before I begin, I wanted to let readers know I will be in NYC on November 10 and 11 for a series of meetings. If anyone would like to schedule a meeting or just grab coffee, let me know and I’ll see what I can do. I always enjoy meeting blog readers. They’re a sophisticated set. 

So, who’s interested in buying shares in a leveraged, capital intensive business operating in one of the world’s least attractive geographies and fraught with political risk? What if I also told you that this company’s revenues are down 25% year-over-year and that this weakness may continue for the foreseeable future? If you’re still reading, I suppose I should also tell you this company produces huge and sustainable cash flows, operates with barriers to entry, enjoys the backing of the world’s premier operator in its industry, and benefits from US dollar strength.

This company is Global Ports Investments Plc. True to its name, the company owns and operates 10 different marine terminals, in whole or in part. Despite the ambitious moniker, the terminals are actually clustered in and around St. Petersburg, with two in Finland, one in Estonia, and the final terminal on Russia’s eastern coast.

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Global Ports Investments has existed in its current form since late 2013, when the company merged with rival NCC Group to form Eastern Europe’s largest container terminal operator. The resulting firm has 537.2 million shares outstanding, of which 20.5% are publicly floating. Global Ports Investments shares trade as Global Depositary Units on the London Stock Exchange, where one GDR equals three shares. The GDRs are denominated in US Dollars. The remaining 79.5% of Global Ports’ shares are held by various large port and marine terminal operators. Major international terminal operator APM Terminals (part of the A.P. Moller-Maersk empire) owns 30.75%, and Russian transportation group TIHL owns another 30.75%. The remaining 18% is held by the former owners of NCC Group.

 

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St. Petersburg’s proximity to Moscow and Russia’s populated regions makes it the port of choice for Russian imports and exports to the West. In 2014, Global Ports had throughput of 2.7 million container equivalents. This represented 53% of Russia’s total 2014 container volume, which has grown rapidly over the last decade. Unfortunately, Russia’s current woes (slumping commodities prices, the plunging ruble, internationally condemned military actions, crippling social issues, and more!) have taken their toll and the nation’s import and export activity has plunged. Container market volumes are set to finish 2015 at 2008 levels, down 26% from 2014.

CaptureGlobal Ports has not avoided the carnage. The company’s first half 2015 report showed consolidated revenues down 25%. Below is a look at Global Ports’ recent results as reported. I have adjusted EBIT and EBITDA for one-time figures like writedowns, but otherwise I am simply parroting the company’s earnings releases. The presence of minority interests complicates the financial reporting somewhat, but I’ll get to that in a bit. Results are in USD, Global Ports’ operating and reporting currency.

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At first glance, things look bleak. Revenues, EBITDA, EBIT, free cash flow, all down. But there’s something extraordinary here, the EBIT margin! In an environment of falling revenues and utilization, Global Ports managed to expand its operating margin by a full 1,240 basis points. That is an extraordinary achievement. The company credits the results to cost control. Indeed, Global Ports’ cash operating costs declined 37% from 2014. The cuts were achieved by heading headcount by 10%, idling 15% of equipment and looking for administrative cost savings. Impressive. Not many companies mount this kind of all-out assault on costs during difficult revenue environments. However, the company also had a very important tailwind: the crash of the ruble. Nearly half of Global Ports’ operating costs are staff-related, and the plunging Russian currency accomplished the company’s goals quite neatly, effectively reducing salaries for Russian employees by 40%.

So that’s how Global Ports has been able to withstand a dramatic decline in revenues: an equally dramatic decline in operating costs. I do expect that trade volumes will recover eventually, and continue their growth path in the long run. I am confident that on the whole, world trade will continue to increase in the decades to come. I also expect the trend toward containerization to increase. It’s simply efficient. Nonetheless, I would not be surprised to see Russia’s shaky economic standing leave traffic at Global Ports’ facilities depressed for quite a while. Assuming no recovery in trade volumes, just what level of profitability and free cash flow can Global Ports sustain?

Figuring that out requires a bit of digging. First, let’s take a look at exactly what Global Ports owns. Below is a listing of the company’s various terminals and their capacities, plus the company’s level of ownership in each.

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Global Ports’ share in its Russian terminal holdings equates to 94.3% of the total throughput capacity of these terminals. That’s great, because these operations account for the lion’s share of the company’s profits. The oil terminal, Vopak EOS, is the second largest source of profit. The Finnish ports are only marginally profitable, though they are growing quickly. Global Ports very helpfully provides a high level of disclosure for each of their operating segments. The graphic below shows 2014’s segment results and Global Ports’ ratable share of profits. Though it’s impossible to tell exactly how profitable each particular Russian asset was, I’ll be using the 94.3% capacity ownership figure to estimate Global Ports’ share in profits. It’s the best I can do.

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Looks like in 2014, Global Ports’ share of its segments’ EBIT was about $281 million. That’s really not so far away from the reported figures after all, but it is a difference. Now I will perform the same exercise for the first half of 2015’s figures. I’ll go a step farther and provide some pro forma net income and free cash flow figures for each segment as well. Global Ports’ financial statements have some huge one-time currency-related items and tax effects, which I’ll ignore. Instead, I’ll use the statutory tax rate for each geography.

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Again, Global Ports is looking pretty good with $129 million in proportional EBIT in the first half of 2015, and $112 million in pro forma free cash flow. This is not a particularly seasonal business, so assuming no further deterioration in trade volumes, it seems likely that Global Ports will be able to post nearly $258 in annual proportional EBIT and $224 million in free cash flow in 2015.

So what do you have to pay for that kind of EBIT and free cash flow? I could compare that free cash flow with the company’s market cap and show a yield figure (hint: it is high) but I always prefer to evaluate businesses on an enterprise value basis. In order to do that, one more step remains: figuring out the company’s ratable net debt. Fortunately, the company once again provides that level of disclosure.

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That wasn’t too tough. On a proportional basis, Global Ports is carrying a cool $1.11 billion of debt. That’s high, but not beyond reason for a capital intensive firm with a toll-taking business model and strong margins. In the depressed environment in which the company is operating, Global Ports has wisely decided to cease paying dividends and to devote excess cash to deleveraging. The company paid down $92 million in debt in the first half of 2015 alone. The upcoming debt maturity profile is prudently staggered, with annual principal payments through 2018 at below trailing operating cash flow.

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The average interest rate on the company’s debt is 6.0%. And most importantly, virtually all of the debt is USD-denominated. I can hardly stress enough how important this is. No matter how the Russian ruble may fluctuate, Global Ports debt service requirements will remain constant and matched by USD revenues.

Now back, finally, to what we have to pay for all of this. At present, Global Ports’ market capitalization is $764 million. Add the $1.111 billion in proportional net debt and you get an enterprise value of $1.875 billion. Based on my 2015 projections, Global Ports shares trade at 7.3x current year EBIT, and a massive 29% free cash flow yield. On an unleveraged, fully-taxed basis, the free cash flow to the enterprise yield would be 14.1%.

Those are rock-bottom figures for a business with this competitive position and free cash flow profile. Seems to me that the current valuation reflects excessive pessimism and a myopic focus on near-term results. But before anyone goes out and buys shares in the morning, please read on. There are also real risks to Global Ports Investments shares.

First, there is no getting around the fact that this is a Russian business. Yes, its tax domicile is in Cyprus and it operates in USD, but substantially all the company’s major sources of income are quite literally on Russian soil. Investors in undemocratic societies with weak rule of law always run the risk that their company’s assets, or their own shares, will be “liberated” at a time and valuation not to their liking. After all, why should greedy, hegemonic Westerners profit from the labor of the Russian people? The Motherland, and all that business. It’s a real risk. I do think the involvement of a major European conglomerate (A.P. Moller-Maersk) reduces the risk of anything untoward going down, but at the end of the day, just under half of Global Ports’ shares are owned by Russian billionaires. These guys don’t exactly have a sterling reputation for treating minority interests with fairness.

Second, investing in Global Ports is placing a bet on stabilization and recovery taking place in the Russian economy. Yes, I did say that I believe that global trade has nowhere to go but up in the long run, but that doesn’t mean investors won’t feel quite a lot of pain in the meantime. Every investment one makes comes at the cost of not buying something else, and those waiting for a Russian economic recovery may find themselves waiting for a long time. Nobody really knows when or if commodities prices will bounce back, or if Putin will see fit to end his warmongering and economic sanctions will be rolled back. Things could easily get much worse before they get better.

Finally, I can see one more scenario in which Global Ports shareholders would lose out: one in which shipping volumes are stagnant or decline further, but the ruble climbs. This would reverse the cost-saving effects that Global Ports has enjoyed, and could put a serious crimp on operating margins. The ruble is actually down 13% since June 30, but it’s a volatile currency and it could easily soar. I don’t view this risk as all that likely since shipping volumes and a rising ruble are likely positively correlated, but it is real and difficult to hedge against.

Of course, none of these potential pitfalls could come to fruition, and investors buying at this price could realize a very nice return as the company deleverages and its earnings recover. I view this as the slightly more likely scenario, but I am not quite confident enough in that assessment to take the bait. Still, Global Ports will be a fun one to watch for now.

Alluvial Capital Management, LLC does not hold shares of Global Ports Investments, Plc for client accounts. Alluvial may buy or sell shares of Global Ports Investments, Plc at any time. 

OTCAdventures.com is an Alluvial Capital Management, LLC publication. For information on Alluvial’s managed accounts, please see alluvialcapital.com.

Alluvial Capital Management, LLC may buy or sell securities mentioned on this blog for client accounts or for the accounts of principals. For a full accounting of Alluvial’s and Alluvial personnel’s holdings in any securities mentioned, contact Alluvial Capital Management, LLC at info@alluvialcapital.com.

 

 

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