One for the Watchlist – Elders Ltd.

For the past few months, I’ve been watching with interest as an attempted business turnaround takes place in Australia. The company in question is Elders Ltd., a venerated agrobusiness that has fallen on hard times. Elders provides a suite of services to Australia’s rural wool and beef industries and farmers, including animal feed, wool trading, live export, and financial services. Elders’ lengthy history began in 1839, when Alexander Lang Elder traveled from Scotland to the new colony of Australia to expand his family’s merchant empire. The business took off, and over the next several decades Elders expanded into mining, wool trading, banking, brewing and other businesses. Elders underwent multiple restructurings, ownership changes and name changes, but finally returned to the public markets in 1993. Elders spent the 1990s and 2000s expanding some divisions and divesting others, but generally growing its balance sheet and taking on debt in the process.


The Problem

The financial crisis hit Elders hard. Elders had invested heavily in its forestry operations for years, only to record hundreds of millions in writedowns. The company’s automotive assets began to bleed red ink as global demand for autos crashed. The company’s debt load threatened to drag it into bankruptcy, so in 2010 Elders proceeded to raise $500 million in equity, using the proceeds to pay down debt. Hopes that the restructuring would restore Elders to profitability were soon dashed. The years 2011 and 2012 saw the company report a  further $456 million in losses. Elders’ problems ran far beyond the balance sheet. The company had become a bloated, unwieldy conglomerate with entirely too many lines of business and too little accountability among them.  In 2012, the company’s marquee rural services unit earned an EBIT margin of only 1.6%. Forestry continued to produce losses and automotive limped along. The only bright spots were Elders’ equity investments in various insurance and banking companies.

From June, 2007 to October, 2012, Elders stock plunged 99%. What was once a vibrant company with revenues in the billions was now struggling for life as losses continued and the debt load remained unsustainably high.

Elders began divesting its forestry operations in 2011, and announced it would also divest its automotive holdings. In October, 2012, the company announced it would begin preparations for the sale of its rural services unit. It looked as if a very old business, once an Australian institution, would see itself parceled off to other firms, a victim of over-leverage and poor management.

The Plan

Ultimately, the sale of the rural services business was not to occur. Shareholder dissatisfaction reached a fever pitch, resulting in new management being installed in April, 2014. New CEO Mark Allison has extensive experience in agriculture, and revealed plans to return Elders to an agricultural pure play by selling off remaining non-core investments and focusing on increasing profitability in the rural services unit, with a focus on high-margin, asset-light businesses.

Elders has spent most of 2014 selling off remaining non-core assets (forestry, real estate, feedlots, and many other small operations) and applying the proceeds to reducing its term debt. Earlier this month, the company announced the final steps in this process: an equity raise via a share placement and rights issue, and a new debt package. As a result, Elders will have no term debt for the first time in decades, and will finally be able to focus on profitability and growth rather than survival.

Elders’ new management team has released detailed plans to increase profitability, and hopes to nearly triple EBIT by 2017. Before looking at those plans, let’s take a look at Elders’ new capital structure. Following the share placement and rights issue, Elders has 837.2 million shares on issue. At todays’ price of $0.175, that’s a market capitalization of $146.5 million. Elders also has a class of “hybrid equity” outstanding. This is essentially floating-rate non-cumulative preferred stock. Dividends have been suspended since 2009, and Elders will have to pay 12 months of delinquent distributions before it can declare dividends on common shares. Elders has $150 million par value of hybrid equity shares outstanding, and they currently trade at 55% of par. Following the equity raise, Elders has $21 million in net term debt. However, the company just closed on the sale of its 50% interest in AWH Pty Ltd. for $32.4 million in cash. Finally, Elders’ new banking facility provides up to $308 million in working capital financing, of which $145 million will be drawn.

Elders’ new capital structure and enterprise value look like this:


In connection with its capital raising, Elders’ new management team released a detailed presentation outlining they steps they will take to increase profits and reduce capital requirements. Elders new focus will be on its highest-margin, most profitable business lines. Below are a few selected slides from recent presentations. The first two contrast Elders’ current lines of business with where the firm will now position itself.





Achieving EBIT of $60 million and a return on capital of 20% by 2017 will require a mixture of improved sales margins and reduced corporate costs. Elders has set out its specific initiatives in all its business areas that it believes will help achieve these goals. The entire presentation is worth a read and can be found here.



In my view, Elders’ decision to return to its strengths is a good one. Elders has been a constant presence in many of the rural communities that it serves for generations, and the brand recognition and relationships that come with that kind of longevity carry value. The company’s long experiment in empire-building has rightly come to an end with the company barely surviving the venture. Rebuilding Elders’ profitability requires a return to the company’s roots in serving Australia’s large agricultural sector in rural communities.

The Outcome

If Elders is successful in growing EBIT to the $60 million target, the returns to shareholders could be substantial. For 2014, the company has guided for pre-items EBIT of $23-28 million. At the mid-point, Elders trades at 14.2x 2014 adjusted EBIT. The company trades at only 6.0x its 2017 EBIT target.

Elders hasn’t revealed the cost of its working capital financing (that I can find) so I’ll use an estimate of the 1 year Australian government bond rate of 2.59% plus a 2% spread. I’ll also assume that Elders increases the draw on its working capital facility 5% annually, as sales increase. For the hybrid capital securities with a rate of the ten year swap rate plus 4.7%, I’ll use an estimate of 8.56%. Note that the hybrids cost is an after-tax expense, with Elders passing on franking credits to the holders. Assuming Elders can meet its 2017 EBIT goal in exactly three years, let’s estimate profits at that point.


If Elders achieves its goals, it stands a chance of earning close to $24 million annually for shareholders. This is slightly misleading, however, as Elders will not likely be a taxpayer for quite some time. The company has accumulated deferred tax assets totaling $255.9 million. A simplistic way of valuing these assets is to assume they are used up linearly over 10 years, beginning in 2017. Even at a high discount rate of 11.56% (the hybrid capital cost +3%) this yields a present value of $44.2 million.

Elders’ 2017 value under all these assumptions depends on the multiple assigned by the market to the company’s pro forma earnings, but it’s not hard to arrive at a value much higher than today’s, even using modest multiples. The chart below shows Elders’s prices per share and three year compounded returns at various pro forma earnings multiples, including the present value of the tax assets.


In reality all that matters is whether or not Elders can successfully achieve the goals it has laid out. If they do, the company will stop being valued as a distressed equity and will begin to be valued on an earnings/cash flow basis, and the share price will rapidly appreciate to some multiple of anticipated future profits. The chart above is mostly intended to illustrate what the magnitude of that appreciation could be based on various extremely uncertain scenarios that include a lot of my guesswork and crystal ball gazing.

On the other hand, if Elders’ new management team fails to make progress and investors lose hope, Elders shares will be in trouble as investors begin to contemplate yet more restructurings, write-downs and management turnover. Given the company’s troubled history, investors will understandably show little patience and won’t hesitate to punish the stock price if management’s confidence proves unwarranted.

For those inclined to take a flyer on a successful Elders turnaround, the hybrid capital securities are also an interesting bet. Management has guided for no distributions for at least a while as the company dedicates capital to rebuilding and re-positioning. However, at some point common shareholders will demand a dividend, and hybrid capital holdings will receive a year’s worth of skipped distributions. If the arrears payments equal roughly 8.56% of par, distributions take three years to resume and the securities trade at par when they do, investors buying at today’s 55% of par will earn a total return of 97.4% and a compounded return of 25.4%. That’s competitive with the equity on a risk-adjusted basis. Given the uncertainly of Elders’ ultimate turnaround, perhaps investing slightly senior to the common stock is wise.

Personally, I require more evidence of progress before giving Elders serious consideration as an investment. Though its short-term financial troubles have been assuaged by the capital raise, the company faces a difficult task in restoring its profitability and expanding its margins. Even if the next financial report’s numbers look good and the stock pops, there will be plenty of time to buy in before the potential returns lose their attractiveness. At least for now, Elders remains one for the watchlist.

Alluvial Capital Management, LLC does not hold shares of Elders Ltd.  for client accounts. is an Alluvial Capital Management, LLC publication. For information on Alluvial’s managed accounts, please see

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


Paul Mueller Company’s Ongoing Recovery – MUEL

A while back I wrote a post on Paul Mueller Company in which I highlighted the company’s promising improvements in profits and margins but expressed reservations about the company’s high financial leverage and large pension deficit. Ultimately, I decided the balance sheet issues were troubling enough to keep me watching from the sideline. Eighteen months later, the results are in.  Anyone who had disagreed with my assessment and bought shares is sitting on a whopping gain. From the end of April 2013 to the present, Paul Mueller shares rose 190% from $18.00 to $52.25.

The big move in Paul Mueller Company’s stock is due to the combination of vastly improved earnings and a de-risked balance sheet. At the time of my original post, I had pegged Paul Mueller’s adjusted 2012 operating income at $5.9 million. Since then the company has made great strides, growing trailing twelve month revenues by 7.5% to $193 million and nearly tripling operating income to $15.4 million. No need for adjustments either, as the severance expenses that depressed the company’s 2012 EBIT are in the rear-view mirror.

Improved profits aside, the company’s leverage has declined meaningfully. Total debt has been slashed by a third, falling from $34.2 million at the end of 2012 to $22.9 million as of June 30, 2014. The reduction was funded entirely through free cash flow, but not by sweating the company’s assets; capital expenditures have tracked with depreciation. The company’s pension deficit remains material, though it has also declined 40% since 2012. The decline is mainly due to strong appreciation in the pension plan’s equity investments. The expected return on the plan assets was held steady at 7.25% from 2012 to the present, though the discount rate on plan obligations was increased from 4.48% to 5.34%. (Increasing a pension plan’s discount rate results in lower present value of future payouts. Changing a discount rate is a totally legitimate response to changing long-term interest rates, but aggressive companies have been known to choose a higher discount rate in order to minimize reported pension deficits.)

Back, for a moment, to Paul Mueller’s greatly improved results. Recently installed CEO David Moore has made several comments about focusing on bringing each business segment into the black and making the heads of individual business lines responsible for results for the first time. The company has also implemented “open book management,” a concept designed to increase transparency, improve management/employee relations and help employees see how their individual contributions result in increased profits and their own rewards. In the 2013 annual report, Moore specifically mentioned the head of each business segment and credits strong performers. Results for the first half of 2014 are up substantially over the same period in 2013, with revenues up 13.5% and operating income up 23.3%. The company’s backlog is $70.4 million compared to $55.1 million one year ago, strongly suggesting continued improvement in trailing twelve months’ results.

Despite the run-up, Paul Mueller Company remains very reasonably priced. Including the reported pension deficit in the company’s enterprise value shows an EV/EBITDA figure of 5.0 and EV/EBIT of 7.0.


These ratios are likely to fall if the company’s higher backlog results in increased earnings and as the company continues to apply its free cash flow to reducing debt.

Paul Mueller’s large pension deficit remains a risk, particularly now that equity securities comprise over 60% of pension assets. A weak stock market could undo much of the progress the company has made in reducing the size of its pension deficit. However, the vastly increased earnings and cash flow combined with significantly reduced debt make the pension much less of a concern than it was a year and a half ago. Paul Mueller Company’s ongoing debt reduction and improving earnings have shifted the risk-reward balance very favorably since I originally wrote about the company, and I no longer see compelling reasons to avoid the shares.

Alluvial Capital Management, LLC holds shares of Paul Mueller Company for client accounts. is an Alluvial Capital Management, LLC publication. For information on Alluvial’s managed accounts, please see

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



Havyard Group ASA – Overlooked Recent IPO: HYARD.NO


I’ve run across an interesting recent IPO by the name of Havyard Group ASA. Based in Norway, Havyard designs and builds specialty service ships. Havyard is majority owned by the Saevik family through their private company Havila ASA.

For completely unoriginal reasons, I rarely find IPOs worth investigating. Companies usually go public after a run of strong business performance and are priced for perfection, often resulting in disappointment if results show the slightest weakness. Also, many companies go public to raise funds to bridge over operating losses during their high-growth phase, and I tend to focus on mature companies that are already generating positive cash flow. However, neither of these factors applies to Havyard. First, Havyard is not riding high on a wave of growth. While still strongly profitable, the company’s results have actually dipped somewhat since 2012 highs. Expectations for Havyard’s future growth likely aren’t demanding. Second, Havyard’s IPO was an ownership shift, not a capital raise. The parent company, Havila, simply monetized a part of its investment in Havyard by offering it to the public. Havila CEO Pers Per Sævik released the following statement concerning the IPO:

”Our family has broad interests in the offshore supply industry. In light of this, and because we see that we need to optimise the conditions for continued growth for Havyard Group, both on technology and ship equipment, we choose to reduce our ownership. Havyard has a significant potential for growth, but the further development of the company requires more than we as a family company have the possibility to contribute.”

Havyard’s original intended IPO price was NOK 36.00, which was then discounted by 7% to NOK 33.50. The discounted IPO price reaffirms my belief that expectations and enthusiasm surrounding Havyard are not high. Since the IPO, shares have slipped another 4.5%.

Before discussing Havyard’s history and business segments, let’s review the company’s history in brief. Havyard was founded in 1999 in Norway and got its start building platform service vessels for the North Sea’s active offshore drilling market. Over time, the company expanded into various other types of specialty vessels and built up a world-wide clientele. Havyard has expanded beyond the oil and gas industry and now designs and manufactures ships for the fishing and aquaculture and offshore wind farm industries. The company expects these new markets to offer great growth potential. Havyard notes that most fish consumption is likely to increase substantially as the world’s population continues to increase and wild fisheries remain in danger of over-harvesting. Offshore windmills will only become more common and economical as wind technology improves and the world’s energy needs increase. Today, Havyard bills itself as a ship technology company focused on “Improving Life At Sea.” Havyard’s self-identification as a technology company is not mere marketing puffery; fully half the company’s operating income is earned by its ship and systems design segments.

Here’s an example of Havyard’s output. The Lewek Inspector is a 110 meter inspection, maintenance and repair vessel designed for fuel efficiency and maneuverability in rough conditions. It was delivered to Forland Shipping in late 2013.

Havyard has four operating segments. The largest by far is the “Ship Technology” segment, responsible for the actual construction of the company’s vessels. Havyard’s hulls are manufactured under oversight by a partner in Turkey, then tested and finished in Norway. This segment is responsible for the large majority of Havyard’s revenues, but only about half its operating income. Havyard’s “technological” segments, “Power & Systems” and “Design & Solutions” accounted for just 20% of the company’s 2013 revenues, but contributed 52% of operating income. The final segment, “Fish Handling & Refrigeration” is a newcomer. Havyard made its initial investment in this segment in 2012. Fish Handling & Refrigeration accounted for 14% of 2013 revenues, but scarcely contributed to operating income. While this segment currently does not provide much in the way of earnings, Havyard considers it a strategic segment with good growth potential. The chart below breaks out Havyard’s 2013 results by segment. The figures diverge slightly from the company’s financial statements due to slight differences in presentation methods and are shown in millions NOK.



Havyard’s 2013 results were off somewhat from 2012, even though revenues increased substantially due to the acquisition of the fish handling and refrigeration segment. The company attributes the decline in margins and earnings to the expense of developing and producing product prototypes, though I suspect the company also willingly sacrificed some margin to win contracts that allowed it to expand into new industries. Perhaps not a bad long-term strategy, even if short-term results suffer. Nonetheless, the company remains solidly profitable. Management expressed satisfaction with results for 2013 and the first quarter of 2014, noting successes in attracting first-time customers and in delivering new vessel models on time and on budget. Financial results for the trailing four quarters through Q1 2014 as well as for 2013 and 2012 are presented below.



Havyard’s balance sheet is healthy, with plenty of liquidity and net debt less than trailing EBITDA. Pinning down Havyard’s exact net debt is somewhat subjective due to the presence of substantial investments in associates. As of the end of 2013, Havyard listed a total of NOK 422.7 million in loans to and investments in associated companies, plus NOK 133.2 million unrestricted cash against total debt of NOK 295.2 million for net cash and securities of NOK 260.6 million. Assuming the level of restricted cash remained constant from the end of 2013, Havyard now has unrestricted cash of NOK 50.5 million after deducting dividends payable. The graphic below sets out the various assets and liabilities that go into estimating Havyard’s net cash and securities positions. “Other Non-Current Receivables” is Havyard’s term for long-term interest-bearing loans to asociates, the terms of which are set out in note 20 of the annual report. At quarter-end, Havyard had net cash and securities of NOK 34.4 million.


At a recent trade price of NOK 32.00, Havyard’s valuation is enticing. The NOK 721.0 million market capitalization, combined with a positive net cash and securities position, yields an EV/EBITDA ratio of just 3.7 and an EV/EBIT ratio only slightly higher at 4.1. The company is cheap on an earnings basis as well at only 5.6 times trailing net income.


These ratios are simply too low for a conservatively-financed, asset-light company with good prospects. I expect some raised eyebrows at my characterization of a shipbuilder as “asset light,” but you can check the financial statements to see for yourself. Depreciation accounts for less than 1% of Havyard’s annual revenues, an astonishingly low figure for an industrial company. In 2013, Havyard managed EBIT of NOK 180.6 million on average invested capital of only NOK 474.3 million, a 38.1% EBIT/Invested Capital figure. Havyard accomplishes this feat by outsourcing the capital intensive part of its manufacturing process, hull-building, to other companies.

Though Havyard’s low valuation and reasonably good business prospects support a valuation much higher than where shares currently trade, the company does face risks that must be evaluated. The primary risk is a slowdown in the global oil and gas industry, and in the North Sea in particular. Though it has had success in entering new markets, Havyard’s results are still sensitive to the level of demand for oil and gas support vessels. A sustained decline in demand would have a serious impact on Havyard’s results. The company also has large exposure to the performance of its associated companies, mostly ownership stakes in and loans to ships and shipping companies. The book value of these holdings is equal to 61% of Havyard’s current market value, so their performance may have a serious impact on Havyard’s results and value. If these assets perform poorly, large writedowns may result. Investors should also remember that Havyard remains a controlled company. Havila ASA has a long track record of success in the maritime industry, but investors still must trust the Saevik family to manage Havyard well.

Alluvial Capital Management, LLC does not hold shares of Havyard Group ASA for client accounts. is an Alluvial Capital Management, LLC publication. For information on Alluvial’s managed accounts, please see

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

Capital Drilling – CAPD:L

Now that I’ve done a few consecutive posts on US companies, I hope my readers will indulge me as I profile another foreign stock. Today’s topic is Capital Drilling, a former high-flier that now trades at a discount to asset value. Capital Drilling’s earnings have suffered along with other terrestrial drillers, but the company is in fine position to weather the slow period with little debt, a modern fleet and multiple contracts with blue-chip operators.

Capital Drilling owns a fleet of drilling rigs that it provides to mining companies. The company focuses on emerging and frontier markets, with the large majority of its rigs operating in Africa. These rigs are contracted to major operators such as BHP Billiton, Kinross, and Barrick. Capital owns six different categories of drilling rigs, all suited for different types of drilling activity such as blasting and grading. Capital Drilling was founded in 2004 with only a few rigs, but the company now owns 96. Capital Drilling went public in 2010, using the IPO proceeds to expand its drilling fleet. Capital Drilling also provides drilling management and communications services, though the great majority of revenues and earnings are attributable to its rigs.


Rocketing gold prices following the financial crisis had Capital Drilling riding high. Its rigs were in great demand and the company enjoyed high utilization and contract rates. Revenues and earnings rose steadily as the company expanded its fleet. However, it was all too good to last. Gold prices took a tumble, leading miners to curtail their exploration and production programs. Capital Drilling’s rig utilization fell from the upper 80%s to below 50%, and operating income dropped to nil. Below are figures showing Capital Drilling’s results for the past five years. Note the extent of the drop-off in revenues and earnings in 2013, the price of gold having fallen 25% during the year. Figures are in USD, Capital Drilling’s reporting currency.


While 2013 was undoubtedly a disappointing year for Capital Drilling, a few factors helped keep the company alive to drill another day. First, Capital Drilling never leveraged itself to the hilt in order to build its fleet. Even at its most leveraged, Capital Drilling’s net debt never surpassed 22% of equity. While competitors were forced to scramble to stay solvent, Capital Drilling simply used its operating cash flow to reduce its net debt as business slowed. At year end, the company’s net debt stood at only 10% of equity. Second, Capital Drilling’s young, efficient fleet allowed it to maintain a higher utilization ratio than its competitors. As of year-end, the average age of the company’s rigs was only four years. In any commodities slow-down, the first projects to be mothballed are those with the highest operating costs, and the same holds true for drilling equipment. Capital Drilling’s ability to offer more efficient, reliable rigs than its competitors enabled it to keep more of them in the field and earning income while its competitors’ rigs sit rusting.

All this is not to ignore the fact that 2013’s results were decidedly uninspiring. Rig utilization for the year may have been higher than competitors’, but was still just 55%. Fortunately, there are signs of improvement in Capital Drilling’s fortunes. The company has not yet released official results for the first half of fiscal 2014, but it has released interim trading updates. These reflect multiple positive data points.

  • Revenues for the first half of 2014 were approximately $52.9 million, an increase of 21% over the second half of 2013. The company is nowhere close to achieving its previous revenue highs, but the boost in revenues is an encouraging sign that the worst of the washout in mining activity is over.
  • Average revenue per operating rig rose to $194,000 in the second quarter of 2014, compared to $186,000 in the same quarter a year earlier. This 4.3% increase helps the company’s margins, even as utilization rates remain tepid.
  • The company won two new five year contracts, one a drilling contract for AngloGold Ashanti in Tanzania, and the other a production contract for Centamin in Egypt. The company spent $11 million acquiring suitable rigs for these contracts, but still managed to avoid increasing its leverage.
  • The company expects strong free cash flow in the second half of 2014, having already completed most of its capital expenditures for the year.

So what’s Capital Drilling Worth? Shares currently trade hands at 28.5 GBp, giving a market cap of £38.4 million , or $64.5 million. At year-end, Capital Drilling had a tangible book value of $88.4 million. The company’s current trading price represents a discount to tangible book value of 27%. Assuming the company’s cash and receivables are worth book value, the current market cap implies a haircut of 41% to the book value of Capital Drilling’s rigs and rig-related assets. That figure might make sense for distressed rig operator with poor quality, aging rigs, but I’d argue it’s far too conservative for a modern fleet like Capital Drilling’s. If Capital Drilling is capable of earning its cost of capital over time (and I believe it is) then the proper value of the company is much closer to the book value of its assets.

Alternatively, we can value Capital Drilling by normalizing its return on invested capital and comparing the company’s current enterprise value against normalized operating income. From 2010 through 2013, Capital Drilling’s EBIT/Invested capital (which I am defining as EBIT/(Net Debt+Equity)) ranged from -0.2% to 37.6%, averaging 22.6%. These figures represent both boom and bust years, so we can reasonably assume the company’s long-term average ROIC will fall between these numbers. I shy away from choosing a number toward the top of that range, believing gold’s rocket trajectory from 2006 to 2012 to be something of a fluke and not likely to be repeated any time soon. That said, I also believe it to be unlikely that Capital Drilling will stagger along earning mid single-digit returns on capital indefinitely. Such poor returns over a long enough period of time would decrease rig supply and tilt the competitive balance more toward rig owners’ favor, sending ROIC numbers upward. I think the most likely case is the Capital Drilling’s long-term return on invested capital settles between 10% and 15%, neither of which is an aggressive figure.

The chart below illustrates Capital Drilling’s implied valuation at various long-term ROIC rates.


At a very modest normalized pre-tax EBIT/Invested Capital estimate of 10%, Capital Drilling’s implied valuation is an undemanding 7.3x normalized EBIT. In this case, 10% is a very conservative estimate of ROIC, as the standard post-tax ROIC calculation would be well below 10%. Higher but still quite reasonable estimates of 12.5% and 15% imply bargain EV/Normalized EBIT ratios of 5.9 and 4.9 respectively.

Capital Drilling’s short-term returns will likely be determined by levels of mining activity in Africa and by the movement of gold prices, but today’s price may represent an attractive value for long-term investors. Buying well-financed cyclical companies during business troughs can often work well, provided investors forecast normalized earnings power conservatively and management is reasonably competent.


Alluvial Capital Management, LLC does not hold shares of Capital Drilling Limited for client accounts. is an Alluvial Capital Management, LLC publication. For information on Alluvial’s managed accounts, please see

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


Pope Resources Offers Cheap Inflation Protection: POPE

Something I’ve been trying to do for Alluvial’s “Global Quality and Income” strategy is to build in a little additional inflation protection. Equities offer a decent inflation hedge in and of themselves, but I believe certain industries offer especially good protection, typically industries that own hard assets. One specific industry with attractive inflation hedging qualities is timber. In the course of seeking out a suitable investment candidate, I’ve come across what I believe to be an extremely well-managed but over-looked timber company: Pope Resources, LP. Pope Resources boasts a long history of success, an astute management team and a strong collection of forestry and development assets.

There’s something delightfully simple about the timber industry. Plant a forest. Tend to it as it grows. At the proper time, harvest the timber and re-start the process. I don’t mean to imply that forestry is easy or doesn’t require a lot of skill. On the contrary, I’ve seen what goes into a well-managed forestry practice, and it requires an incredible level of scientific and market knowledge. And the labor involved at the ground level can be backbreaking and dangerous. But compared to the complicated financial engineering, frantic advertising and ruthlessly short product lifecycles that characterize many industries and companies, forestry seems a calm, timeless enterprise that has occupied mankind for thousands of years and will continue to do so.

Pope Resources was spun out as an MLP from Pope & Talbot in 1985. Over the years, the company has stewarded its forests, harvesting according to market conditions and also selling off various parcels to real estate developers. Today, Pope Resources owns 110,000 acres of timberland in Washington and Oregon, plus another 2,900 acres of property held for development in Washington. Additionally, Pope Resources has a private equity business that manages timberland funds holding 91,000 acres. Pope’s own interest in these funds is approximately 15%.

I’m no timber expert. I did grow up in a timber-producing region and spent a miserable summer toiling in a sawmill, but my knowledge of the financial and investment aspects of the industry come solely through my readings on the subject. I don’t know if the acreage held by Pope Resources is more or less productive than other parcels in the Pacific Northwest, nor if the company’s specific species mix and tree age profile will result in higher or lower yields in coming years. However, I believe I can trust management to get the most from its assets. I may not be a timber expert, but I believe I can recognize a well-managed company when I see one.

Short-term stock returns are driven by all sorts of factors, some within management’s control and others, not. But long-term returns to shareholders are strongly influenced by the quality and composition of a company’s assets, and the competency with which those assets are managed.  A look at Pope Resources’ historical returns to unitholders indicates just how potent the combination of good assets and good management has been. Short-term performance has been competitive, while long-term performance has been superior.


I did my best to construct a set of comparable companies, against which to compare Pope Resources. Some of these companies also have operations in pulp, newsprint and other timber-adjacent businesses, but for the most part they make their money the same way as Pope Resources. Besides Rayonier, which benefited from its performance fibers business for most of the time periods in question, Pope Resources is the clear champion, multiplying unitholder wealth more than sevenfold over the past two decades. Of course, past success is no guarantee of future excess returns. But I have found that competent management teams typically continue to behave competently, while inept management teams usually continue to…..well, just take a look at Louisiana-Pacific. I trust Pope Resources’ leaders to continue to steward the company well. Management’s own holdings in the company are currently worth nearly $40 million, easily enough to incentivize them to continue to growth the company’s worth. It’s not just me who thinks highly of Pope’s management. Rayonier recently split into two companies, with the CEO headed to the spin-off fibers company. Who did Rayonier tap to take over leadership at the legacy company? None other than the CEO of Pope Resources, David L. Nunes. Pope has since replaced Mr. Nunes with Mr. Thomas M. Ringo, previously the CFO. With 25 years at Pope, Mr. Ringo is a fine choice to take the reins.

Pope’s management has put out a series of helpful presentations to investors which highlight the company’s strengths. Among them are:

1. An attractive asset mix – Pope’s standing timber has a high concentration of Douglas Fir, which commands a pricing premium.

2. Strong export capabilities – Pope’s location allows it to meet surging demand from Asia for premium wood products. The export market accounted for 40% of revenues in 2013.

3. Excellent development opportunities – Pope’s development properties are situated just outside the Seattle. The Seattle metro is one of the best-performing markets in terms of job creation and unemployment in the US, a fact that should help Pope profit on sales of land to developers. Thus far in 2014, Pope has reaped $15 million from land sales, more than twice the book value of the land sold, and expects to “harvest” large rewards from land sales in the Seattle area from the present through 2015. At quarter’s end, Pope’s land held for development had a book value of $27.6 million.

Pope Resources may possess a strong mix of assets and a savvy and an incentivized management team, but I still wouldn’t be so interested if the company’s trading price exceeded the value of its assets. Fortunately, that’s not the case. On a per-acre basis, the market values Pope at a discount to comparable timber properties in the Pacific Northwest.

Because GAAP rules force the company to consolidate its managed funds, Pope’s GAAP balance sheet is a little misleading. Fortunately, since the company provides detailed information on the timber acreage and associated debt of each fund, it is possible to determine the company’s proportional acreage and to compare this against adjusted enterprise value. First, the acreage.


Pope’s net acreage of 123,650 excludes the 2,900 in development land, but I’ll account for the that in the enterprise value. Net comes the task of calculating enterprise value.


The final step in calculating Pope’s value per acre of timber is to adjust enterprise value for the company’s development land. This is more of an art than a science, since the selling price of the Washington land can’t be predicted with any degree of accuracy. Recent land sales have occurred at more than twice book value, so I’ll consider three scenarios: one where the land is worth book value, one where it’s worth 1.5x book value and one where it’s worth 2x book value.


Book value multiples of 1.0-2.0 imply per acre valuations of $2,112 to $2,335. Either end of this range is below the average valuation of comparable properties in Pope’s location and market segment. The most recent data from NCREIF pegs valuations for Northwestern US timberlands at right around $2,400 per acre. Pope’s strong asset profile likely justifies an above-average valuation, but I’m fine using NCREIF’s estimate as a measuring stick. NCREIF notes that timber valuations are experiencing support from Asian demand, but housing starts in the US remain well below their pre-crisis levels, tempering prices. Should housing starts pick up steam, timber prices may rise. Or, they may fall. I don’t waste my time trying to predict moves in commodities prices. As uncertain as the market can be in the short run, I am confident of one thing: Pope Resources will continue to reward unitholders for many years to come.

Pope Resources, LP is a master limited partnership. MLPs carry unique tax considerations, especially for tax-deferred accounts. Investors should carefully examine these tax effects before investing in MLPs. 

Alluvial Capital Managment, LLC holds shares of Pope Resources, LP  for client accounts. is an Alluvial Capital Management, LLC publication. For information on Alluvial’s managed accounts, please see

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




North State Telecommunications Corporation – NORSA/B


North State Telecommunications is a North Carolina telecom provider that has transformed itself from a sleepy traditional telco into a growing provider of high margin services like data centers and broadband access. Despite  the company’s success, the market still values North State like the stagnant company it once was, with a double-digit free cash flow yield and an 8% dividend yield.

North State Telecom’s root stretch all the way back to 1895, when it was established as a local telephone exchange serving the High Point, North Carolina area. The company grew and grew, purchasing nearby telephone systems and expanding into wireless and internet services. North State has long been run for cash, paying out most of its free flow in dividends. In recent years, this approach has tried the patience of a set of activist investors, who have attempted to compel the company to uplist to a major exchange, leverage up, or sell itself outright. Thus far, North State shareholders have voted down the efforts of the minority group to force change. Still, North State has made moves to free up capital and invest  in high-growth business lines. In 2012, it agreed to sell its operated wireless operations to AT&T for $23.5 million dollars. In 2013, North State opened a data center in Raleigh and began construction on another in Charlotte. Most recently, North State announced it would provide gigabit internet to certain service areas by the end of 2014.

North State’s labels its data centers, consumer broadband and business wireline business its “strategic” segments, which have superior profit margins and better growth potential than its legacy consumer wireline and wholesale businesses. For the first quarter, strategic revenues rose 4.3% year-over-year while legacy revenues declined 2.5% for net revenue growth of a positive 1.8%. Residential broadband and data center revenues were the standouts, helping to push strategic revenue to over 65% of the total for the first time.



North State’s investment in data and broadband has resulted not only in top-line growth, but also in restored profit margins. North State’s margins and results had been flagging as consumers let go of their wireline service, but the new revenue streams have pushed the company’s EBITDA margin comfortably over 30% once again, and its EBIT margin back over 10%.  Below are North State’s results for 2012 and 2013, and the twelve trailing months through the end of Q1 2014, in millions.


Readers should note that North State earns a substantial portion of its income from ownership interests in non-consolidated affiliates. The primary asset in this category is a 5.81% stake in Alltel of North Carolina LP, a wireless company operated by Verizon. North State’s interest in the Alltel LP and a much smaller interest in a municipal telecom provider earned them $7.4 million for the twelve trailing months.

While North State’s operations have gained momentum, the company has used its strong cash flow and asset divestment to reduce debt and build cash. Combined with a much smaller pension liability, North State is a much less leveraged company than it was in 2012.


Net leverage is now a very comfortable 1.0x EBITDA + equity income. North State’s pension liability has been cut dramatically via strong stock markets gains, and also by closing the pension to new participants and making other benefit reductions. The pension is invested approximately 50/50 between equities and fixed income, and carried an 8.0% return expectation as of 2012. Should equity market turn south, the pension deficit will widen, but it’s not likely to be at an issue with cash and securities holding so much higher and debt lower than in 2008.

North State has two share classes: A and B. Both are very illiquid, but the A shares are much, much more so. B shares are fewew in number and non-voting, and currently trade at a bid/ask spread of $63.75/$65.00 while the A shares trade at $68.75/$80.00. In looking at North State’s valuation, I’ll use B shares figures, since they’re much cheaper. At these prices it’s rather pointless to purchase the A shares, unless one wants to mount an activist campaign.


North State’s valuation points to market expectations of flat revenues, earnings and cash flows, but I suspect the market is wrong. After all, EBITDA + Equity Income rose a very healthy 6.5% in Q1 2014 versus Q1 2013, better by leaps and bounds that what a typical traditional telco could produce in the current technological and economic environment. If Q1 figures are a good indication of what North State can do for the entire year, EBITDA + Equity Income will rise 7.4% over 2013’s figures. This figure does not include the additional revenues that North State will earn from its Charlotte data center once that is opened, or from its gigabit internet initiative if that proves popular. If North State truly is the internet and data company it says it is, it’s worth much more than the modest ratios its stock now commands.

Alluvial Capital Management, LLC does not hold shares of North  State Telecommunications Corporation for client accounts. is an Alluvial Capital Management, LLC publication. For information on Alluvial’s managed accounts, please see

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

Blog and Business Updates

Today’s post is a brief departure from my usual discussion of micro-caps and illiquid stocks, and instead contains some updates and news on the blog and on my RIA firm. Regular posting will resume later this week with a profile of a true rarity in today’s market: a profitable net-net, this one in Australia.

The Business

It’s been nearly six months since I started my RIA firm, and I’ve never had so much fun at work! It’s been a great pleasure to manage portfolios for many readers. Being a one-man shop is a lot of work, but finally being able to buy promising securities for clients rather than merely writing about them online is such a great feeling. Assets under management is growing quickly, but there’s still plenty of room for new clients! Drop me a line if you’re interested.

That brings me to an important announcement: the name of my RIA firm is changing from Catalpa Capital Management, LLC to Alluvial Capital Management, LLC. Nothing else about the business is changing except for the name. The change should show up on FINRA soon, and the new website is

The Blog

Long-time readers may have noticed a decline in the frequency of new posts on OTC Adventures. The main reason for the decline is my RIA duties. Writing new blog posts necessarily falls lower on the list of priorities than performing research and managing client accounts. Besides that, it’s simply more difficult to locate clearly cheap stocks. It’s not impossible, in fact I think anyone who claims all the good values have been eliminated by the rising market is just not searching very hard. However, the days when I could browse through filings for an hour and come up with a list of a dozen dirt cheap American OTC stocks are over for now. That’s the reason that more than half of the new posts I do are on exchange-traded companies outside the US. Many international markets still abound with tiny, cheap companies waiting to be discovered by investors. Here are a few of the areas where I am finding a good number of promising stocks:

  • Western Europe, particularly France, Germany and Switzerland – These nations abound with family-controlled micro-caps and larger companies with low floats due to the presence of controlling shareholders. So long as the owning families or controlling shareholders have a history of stewarding their companies well and treating outside shareholders fairly, I’m happy to buy in at valuations and ratios that are a distant memory in US markets. So far, I’ve found bargains in real estate and manufacturing, though nearly every sector offers value.
  • Australia – The perception of Australia that many investors have is of an economy dominated by raw materials and energy and beholden to China’s appetite for coal and iron ore. There’s a grain of truth to that, but it obscures the hundreds of small Australian companies that have nothing to do with the resource economy. For example, I’ve found bargains in agriculture, consumer goods and logistics, and I’ve only just begun my search. Another nice feature of Australian companies is the dividend culture that exists there. Australian companies normally pay out high portions of their earnings in dividends, which I find tends to discourage management from frittering away earnings on dubious investments.
  • Mexico – Mexico suffers from a reputation for shaky creditworthiness, high inflation and social issues. Investors who focus on these perceptions may miss that fact that Mexico’s per capita GDP rose 27% from 2009 to 2012, and will likely keep growing following the liberalization of the nation’s energy sector. I’ve found bargains in consumer staples and auto suppliers.
  • “Exotic” Exchanges – Lately, I’ve been spending time seeking out local exchanges in developed nations that for whatever reason aren’t widely available to Western investors. I’ve not yet found ways of accessing many of these exchanges, but several offer incredible value, if the stocks can be bought. In the interest of keeping it that way, I won’t be talking about them here…..

Thank you, as always, for reading OTC Adventures. I’ve benefited immeasurably as a writer, analyst and investor from your comments and e-mails. Nearly without fail, each time I write up a company I get several e-mails from company or industry experts offering insights and perspectives that I would struggle to arrive at myself. Please feel free to contact me at any time.

Teak Holz International AG – Vienna Exchange: TEAK


Now and then I run across a company with a truly unusual business model. So far as I know, Teak Holz International AG is the only pure-play publicly-traded producer of teak wood in the world. (If I’m mistaken, I welcome corrections.) Teak Holz is established in Austria and traded in Austria and Germany, but owns nearly 4,800 acres of teak producing land in Costa Rica. Teak is a tropical wood that has long been prized for use in furniture, boatbuilding and construction due to its excellent durability and water resistance. The tree is native to Asia, but is now cultivated in Central and South America as well. The teak industry increasingly uses sustainable forestry methods and complies with fair labor practices, and Teak Holz emphasizes its leadership in these areas. The company’s teak plantings are not yet mature, and many years will pass before Teak Holz realizes meaningful cash flows from harvesting timber. Teak Holz’s unusual cash flow profile complicates the valuation, which makes the company all the more interesting to me. Even more interesting is the company’s 79% discount to tangible book value.

Most of the companies I evaluate and invest in are dependable cash generators. Valuing these companies is a process of normalizing this cash flow and applying the appropriate multiple based on industry prospects, capital structure and management quality, among other factors. Businesses like Teak Holz present a different challenge because their cash flows are far off and highly uncertain. The present value of the future cash flows generated by Teak Holz’s timber harvest is highly sensitive to factors like discount rates, harvest timing and teak prices, all of which are impossible to predict with any degree of accuracy.

According to the company, the growth period for Central American teak crops is 15 to 20 years. The majority of Teak Holz’s trees are 5 to 6 years old. Not saplings, but also not ready for harvest. Between now and then, these plantings will be thinned multiple times, allowing the remaining trees to increase in diameter and become much more valuable. These thinnings will generate a small amount of positive cash flow, but the big payday will not arrive for another 10 to 15 years. Teak Holz provides an estimate of the present value of its teak crop. Discounted at 12.75%, Teak Holz’s own estimate of its cost of capital, the company values its teak assets at €97.65 million at the end of fiscal 2013. This figure is net of all costs to plant, manage and harvest the teak crop.

As of fiscal 2013, Teak Holz’s balance sheet looked like this, in millions of Euros.


Teak Holz has EUR 77.24 million in balance sheet equity value, yet its market capitalization is only EUR 14.97 million. That’s among the largest discount to book value I’ve seen, especially for a company not in dire financial straights. Teak’s 79% discount to tangible value is just as stark.

That leaves us with a question: why? Why does the market assign such a massive discount to the stated value of Teak Holz’s assets? Turns out, there may be some solid reasons.

Possibility #1Overstated Assets

Perhaps Teak Holz is simply wildly over-estimating the value of its teak plantations. It’s a reasonable hypothesis because Teak Holz recently took a huge writedown, reducing the estimated value of its teak assets from over EUR 135 million to the current figure of nearly EUR 98 million, a reduction of 28%. Ouch. The writedown was done in response to a new valuation survey commissioned by the company after a significant leadership change. For the first time, the company contracted an outside expert, Legacy Appraisal Services of Gainesville, Florida, to provide a new estimate of the teak crop’s value. Legacy Appraisal Services’ valuation process incorporated much less optimistic inputs for teak prices and harvest yield than the company’s own process, resulting in a substantially decreased balance sheet value. The new balance sheet value is likely closer to the actual present value of the company’s teak harvest, but investors may remain suspicious of the company’s published figures. Nobody wants to invest in Teak Holz, only to suffer through another 10% of 20% writedown.

Possibility #2 – Financing Issues and Dilution

While Teak Holz may ultimately realize a handsome profit on its teak harvest, the company will have to fund its ongoing corporate expenses in the interim. These expenses reduce the value that shareholders will ultimately realize from the teak crop, moreso because they are current expenses while the teak harvest cash flows will not be received for several years. In fiscal 2013, Teak Holz spent roughly EUR 3.2 million on operating expenses, compared to EUR 2.6 million in fiscal 2012. Because Teak Holz has minimal cash reserves and nearly no revenues, these operating expenses must be funded by raising capital or selling assets. This is where the company’s depressed stock price becomes a serious issue for the company and for shareholders. Selling equity as a means of funding operations is extremely unattractive, because selling shares at 19% of book value is extraordinarily dilutive. Traditional debt financing is only marginally feasible because the company has little capacity to make periodic interest payments. Payment-in-kind debt would circumvent this issue, but such debt usually comes at a cost of high, high rates. In order to finance its ongoing operations, the company has settled on a mix of bank debt, loans from a related party and convertible debt. Teak Holz’s bank debt of EUR 4.96 million is secured by a mortgage on the personal property of a company insider, who in turn holds a contingent mortgage claim on one of Teak Holz’s plantations. The same insider has also provided Teak Holz with a EUR 3 million loan, again secured by one of the company’s plantations. Finally, the company has EUR 11 million par convertible bonds outstanding, bearing interest at 5%. These bonds come due in 2015 and are convertible at a share price of EUR 5. Since the last annual report was filed, Teak Holz sold an additional EUR 2.35 million in convertible bonds with the same terms. Refinancing the convertible bonds is a looming issue for the company, one that sustains uncertainty and contributes to the depressed valuation.

Simply put, Teak Holz’s small size, ongoing cash needs and depressed valuation leave the company with few good financing options. The market may rightly be pricing in the possibility of significant dilution between now and the eventual teak harvest, an outcome that would reduce investors’ pro rata shares of the eventual harvest proceeds.

Possibility #3 – The Market is Wrong

Questions concerning asset value and financing risks notwithstanding, it’s possible that the market simply has Teak Holz all wrong. Perhaps the teak assets are fairly valued or even under-valued, and perhaps the company manages to fund its operating expenses at a reasonable cost between now and the first big harvest in several years. In that case, investors buying at this price will likely do very well.

Unfortunately, I can’t get comfortable enough with Teak Holz’s financial position to even consider possibility #3. Rather than rely on expensive and short-term convertible debt financing, I’d rather see the company execute some long-term forward timber sales or selectively sell acreage/plantation ownership interests. (A little strategic self-liquidation doesn’t hurt anyone. If Teak Holz’s acreage is really worth what they say it is, they shouldn’t have too much trouble liquidating a little each year at a price sufficient to fund operations.) The company has announced some medium-term forward timber sales, but I’d be happy to see them explore this financing method further. Another factor that gives me pause is Teak Holz’s management team. The corporate officer and director ranks seem to be a revolving door of Austrian businessman who know each other through outside business dealings. I am not suggesting any nefarious activities are in progress, but I’d rather see some consistency in leadership and a few more experts in teak and Costa Rican forestry.

That said, Teak Holz is a fun one to watch and a nice change from the typical industrials, banks and telecoms that are my bread and butter. As a final note, Teak Holz’s convertible bonds may make an interesting speculation. They trade on the Vienna Exchange with the ISIN AT0000A0K1F9. The last trade was at 76.101 for a yield to maturity of 29.1%. More importantly, they have plenty of asset coverage if Teak Holz’s harvest valuation is even remotely realistic. Please note I am not any kind of authority on Austrian fixed income and bankruptcy law, so I have no idea what special risks these bonds would carry.

Alluvial Capital Managment, LLC does not hold shares of Teak Holz International AG  for client accounts. is an Alluvial Capital Management, LLC publication. For information on Alluvial’s managed accounts, please see

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

Sanluis Corp. SAB de CV: Fast-Growing, Deleveraging Auto Supplier at a Cheap Price

Today’s investing idea takes us to Mexico, where a small company has quietly become the world’s leading producer of light vehicle leaf springs, and the top provider of suspension components for light trucks in the Western hemisphere. Sanluis Rassini made its first sale to Ford’s Mexican operations in 1938 and began exporting to the USA in 1970. Sanluis spent the 80s and 90s adding plants and offices in Mexico and the United States, and expanding into Brazil. From 1988 to 2013, Sanluis grew its revenues at an astounding 19% annually. However, for most of that period, Sanluis was hampered by a crushing debt load. This debt load lead to a default and restructuring in 2010. Sanluis emerged from the restructuring with a strengthened balance sheet and has continued to reduce its net debt, both in absolute terms and relative to EBITDA and cash flows. Results at Sanluis have climbed to record highs, powered by the strong sales of light trucks like the Ford F-150 and the Chevrolet Silverado. Sales growth for light trucks has outpaced the recovery in small automobiles, and the trend seems likely to continue as the US labor market improves. Results at Sanluis’ Brazilian subsidiary have lagged, but could provide an additional tailwind when and if the Brazilian economy recovers. Despite its reduced leverage and bright business outlook, Sanluis trades at very low multiples of EBITDA and EBIT, and offers a double digit free cash flow yield.

Results and Outlook

Since the lows of 2009, Sanluis’ revenues have nearly doubled, topping $900 million USD for the twelve trailing month period. Forward revenues should be considerably higher. According to data provided by the Wall Street Journal, US pickup truck sales volume rose 3.6% year-to-date through May versus 2013, strongly outpacing cars. Sanluis’ components can be found in eight of the top ten selling pickup trucks in the US, so the sales increases are benefiting Sanluis’ results. To wit, revenues for the first quarter of 2014 were up 20% year over year. The chart below summarizes Sanluis’ results from 2009 to present. Amounts are in millions and are translated to USD at $1 USD: 12.91 MXN.


Sanluis’ margins have cooled off a bit since 2009 and 2010, but have stabilized at levels comparable to US-based auto suppliers. For the first quarter of 2014, Sanluis reported EBITDA of USD $30.8 million. This increase came solely from strong activity in North America, as EBITDA at the company’s Brazilian subsidiary fell 48% year over year as the Brazilian economy slowed. At this pace, Sanluis is on track to produce USD $123 million in 2014 EBITDA. I expect quite a bit more, as the US market for pickups continues to improve. Any improvement in Brazil’s results would simply provide an additional tailwind, though I don’t count on it in the short run.

Improving Balance Sheet

Below is a chart of Sanluis’ net debt in recent years, and multiple of trailing EBITDA that it represents.


Since peaking in 2010, Sanluis’ net debt has been reduced by 42.2% in absolute terms. More importantly, net debt has fallen from 5.99x EBITDA to only 1.89x on a trailing basis. If we annualize first quarter results, the company’s net debt is only a hair over 1.5x EBITDA, a thoroughly sustainable level. Sanluis has accomplished this improvement in its financial footing mostly via dramatic increases in revenues and earnings, but also by dedicating the majority of its free cash flow to debt reduction. For fiscal 2010 to 2013, Sanluis produced a total of USD $168 million in free cash flow and reduced gross debt by USD $113 million. Slightly over 44% of Sanluis’ gross debt comes due in December, 2014, but I expect the company to have no trouble refinancing the debt on as good or better terms, give then substantially better operating performance the company has produced since the original debt agreement was reached. The company’s next series of debt comes due in 2017.

Now that Sanluis is on sustainable financial footing, it will be free to dedicate its free cash flow to growth investments or payments to shareholders.


Due to the growth of the US market for pickup trucks, Sanluis’ results are highly likely to rise in coming quarters. For the sake of conservatism, let’s annualize Sanluis’ first quarter results to arrive at a yearly estimate of EBITDA and EBIT. Based on the first quarter of 2014, Sanluis is poised to report $123 million in EBITDA and $96.7 million in EBIT for 2014. However, these figures are slightly misleading. Sanluis has a 50.1% stake in its Brazilian subsidiary, which causes those results to be consolidated under standard accounting principles. However, half of the subsidiary’s EBITDA and EBIT doesn’t actually “belong” to the parent company. By the same token, half of the subsidiary’s debt must be taken out of the equation to arrive at a true measure of enterprise value. My calculation of the company’s liabilities included in enterprise value also bears some explanation.

  • EBITDA and EBIT: Sanluis’ Brazilian subsidiary is called “Autopecas.” This business produced USD $4.0 million in EBITDA in the first quarter. The EBIT figure was not disclosed, but assuming the same margin as the company as a whole, Autopecas would have produced USD $3 million in EBIT. (In reality, it was probably lower as the sting of negative operating leverage was felt.) Annualizing these results reduces Sanluis’ estimated 2014 EBITDA by USD $8.0 million and its EBIT by USD $6.0 million.
  • Net Debt: The Brazilian Autopecas segment has USD $12.8 million in debt. Adjusting this figure for Sanluis’ 50.1% stake in the business results in a USD $6.4 million reduction in net debt. Autopecas likely also has some subsidiary-level cash, but this figure is not disclosed and I’ll ignore it. I’ve been fairly conservative in all my other assumptions.
  • Pension deficit: Sanluis reports a pension deficit of USD $23.2 million, which I add to enterprise value. In most cases where a pension is involved, it is important to look at the assumptions involved. Sanluis uses an expected return of 7.5% on its plan assets. With a high-quality Mexican corporate bond index currently yielding 5.30%, the return figure is in the realm of reasonability. Other important figures like the assumed discount rate and expected salary increases are also reasonable.
  • Special Tax Liability: In late, 2013, Sanluis was hit with a large increase in taxes payable due to a change in the Mexican tax code. These new taxes payable sum to USD $52.8 million and must be paid over the next five years. Using a discount rate of 10%, I’ve included the tax liability in enterprise value at a present value of $41.8 million.

After all those adjustments, Sanluis’ projected 2014 valuation looks like this.


At 4.8x projected EBITDA and 6.1x projected EBIT based on very conservative assumptions, Sanluis is about the cheapest auto supplier I’ve found. This despite Sanluis’ prime industry positioning in the hot market of pickup trucks. The market seems to be catching on to Sanluis’ progress, and shares have rallied quite a lot over the past few months. However, I think they have quite a way to go before they begin to reflect reasonable valuation multiples.


Though the company appears very cheap to me, Sanluis is not without its share of risks. The company has been through two separate rounds of restructuring in the past decade. Sanluis is far larger, more profitable and less leveraged than it has been at any point since its troubles, but “this time it’s different” are famous last words in the investing world. Though the company’s finances (and those of its customers) appear strong at present, a return to a deep recession with an accompanying decline in vehicle sales would hurt Sanluis. Currency risk is also a factor. Sanluis earns the majority of its revenues in USD, but its debt is denominated in Mexican Pesos. A strong US dollar is great for Sanluis, while a strong Peso reduces earnings. (Interestingly, this fact also provides somewhat of a natural hedge for US investors in Sanluis. Though a strong Peso would hurt the company, it increases the value of Peso-denominated investments. The opposite is also true. A weak US dollar benefits Sanluis’ earnings and debt position, yet it decreases the value of Peso-denominated investments.)

There’s a lot more to the story with Sanluis, but that’s quite enough verbiage for now. I always welcome discussing any company I write about with readers, so feel free to drop me an e-mail or leave a comment.

Alluvial Capital Managment, LLC holds shares of Sanluis Corp. SAB de CV  for client accounts. is an Alluvial Capital Management, LLC publication. For information on Alluvial’s managed accounts, please see

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

Pental Limited – PTL:ASX

The market values companies from various economic sectors at widely different multiples of earnings, assets and cash flows, and for good reason. In general, non-cyclical sectors receive higher valuations, while industries that are strongly exposed to the business cycle receive lower valuations. It’s a function of cost of capital; industries with deeply cyclical and/or unpredictable revenues and earnings are riskier, and therefore carry a higher cost of capital. Finance 101. One of the most stable market sectors is consumer staples, and that stability is usually reflected in the valuations of companies selling ordinary, necessary products.  Manufacturers of toothpaste, soap, cereal, and like products deserve their premium valuation, because consumers will continue to purchase these products in all but the most extreme economic climates.

For this reason, I pay particular attention when I find a healthy consumer staples company trading at a large discount to market averages, let alone the premium valuation that its peers receive. Today’s example is Pental Limited. Pental is an Australian manufacturer of several household brands, including White King bleach, Huggie fabric conditioner, Martha’s wool cleaner and AIM toothpaste, among other brands. Most of Pental’s products are well-known in Australia and New Zealand and command high market share. Household cleaning is Pental’s leading product category, followed by private label products, then personal care products.

Pental has a broad set of quality product offerings, little debt and reasonable operating margins, yet the company trades at a single digit P/E and a discount to book value. In my view, this humble valuation is caused by two major factors.

Outdated Market Perceptions – Until recently, Pental was a highly distressed and indebted company. Then known as Symex, the company operated a specialty chemicals business in addition to its household products business. The chemicals business once produced substantial profits. However, 2012 saw earnings hammered by rising input costs, a strong Australian Dollar, and strong competition. Symex’s large debt load suddenly threatened the company’s existence. At June 30, 2012, Symex carried AUD 59.70 million in net debt, more than ten times the fiscal year’s EBITDA. As part of an agreement with its bankers, Symex agreed to take a number of steps to reduce its debt, including selling off real estate holdings, raising equity capital, and securing receivables financing.

By the end of 2012, the company (now renamed Pental) had succeeded in raising AUD 17.55 million in equity capital, closed down the specialty chemicals business and sold associated real estate, and made principal repayments on its debt. In return for succeeding with these initiatives, the company’s lender wrote off AUD 10 million in debt. The company secured a new credit agreement expiring in 2015. The company also reported improved profitability in its consumer products business.

Today, Pental has reduced its net debt to just AUD 4.70 million, less than half of trailing EBITDA. Consumer products sales and earnings are on the rise, and the company is constructing new bleach manufacturing facilities, which should reduce costs and increase capacity. The market, however, still treats Pental as the heavily indebted and struggling company that is was a year ago.

Capital Structure – In order to fund its equity capital raising, Pental undertook multiple initiatives. The first was a simple share sale to a strategic investor. Concurrent with the share sale, Pental made a rights issue to its shareholders of seven purchase rights per share. These rights, allowed the purchase of one Pental share at AUD 0.015 per right. Three months after the expiration of these rights, Pental distributed one “loyalty option” for each four shares of Pental, which entitled investors to buy one share of Pental for AUD 0.02 for the following 18 months. Finally, Pental encouraged holders of these loyalty options to exercise the options by distributing “Piggyback Options.” For every loyalty option exercised before November 30, 2013, Pental issued one “Piggyback Option.” These piggyback options allow the purchase of one share of Pental at AUD 0.03 for the following 18 months.

Complicated enough?  After all those moves, Pental has 1,504.58 million shares outstanding. It also has 87.61 million loyalty options still outstanding with a strike of AUD 0.02, plus 287.57 million piggyback options with a strike of AUD 0.03. Estimating a fair value for Pental’s shares requires adjusting for options exercise, which may obfuscate Pental’s worth.

For the twelve trailing months, Pental reported adjusted EBITDA of AUD 10.66 million and EBIT of AUD 9.11 million. (Results in the first half of fiscal 2014 were substantially improved over the first half of 2013, but I’ll refrain from annualizing these in the interest of conservatism.) Reported net income from continuing operations was AUD 4.97 million for the trailing twelve months. Computing Pental’s trailing valuation requires adjusting for the exercise of Pental’s loyalty options. At Pental’s current share price of AUD 0.027, the piggyback options are anti-dilutive. Full exercise of the loyalty options would raise AUD 1.75 million in cash for Pental.


4.3x EBITDA and 5.0x EBIT is a bargain valuation for a growing consumer staples company with little debt and market-leading products. Moreover, Pental’s already conservatively-estimated results are likely to improve once its new or upgraded production facilities are fully online. Already, the company has won new private label production contracts for Woolworths, Aldi, and Coles on the basis of its new, more efficient bleach plant.

Were the market to value Pental at a more conventional multiples of EBITDA, Pental shares could see significant appreciation. The chart below displays potential share prices and appreciation at various EBITDA multiples, assuming full options exercise. Worth noting is the fact that many other basic consumer products producers currently trade at double-digit EBITDA multiples.



Pental is considering reinstating its dividend in 2014, which could lead investors to take a second look at the company’s much-improved balance sheet and improving profits. The company’s loyalty options expire in late 2014, which will serve to simplify the capital structure and will further reduce net indebtedness. Combined with continued revenue and profit growth, Pental shares could be significantly higher a year hence.

Alluvial Capital Managment, LLC does not hold shares of Pental Limited  for client accounts. is an Alluvial Capital Management, LLC publication. For information on Alluvial’s managed accounts, please see

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