NASB Financial – NASB:OTC

I am in the midst of my annualish trek through all the community banks that trade over the counter. These range from the truly tiny, with balance sheets under $100 million, to gargantuan institutions that could easily be included in major market indexes were they to list on the NYSE or NASDAQ. As always, I am finding  really interesting opportunities. Banks rapidly attracting deposits and growing their earnings assets, yet trading at or below book value. Banks building valuable mortgage origination or SBA lending franchises, but not getting any credit for these valuable and low-risk income streams. Venerable institutions with long track records of success that nonetheless languish in obscurity.

NASB Financial is one of these venerable institutions. NASB Financial, headquartered in Kansas City, Missouri, owns North American Savings Bank. North American Savings Bank has served its community for 90 years, growing spectacularly along the way. Today, the bank is a major mortgage originator and has developed an innovative lending product for those who wish to invest in real estate via an IRA.

Since 1990, NASB’s balance sheet has grown from $388 million to over $2 billion. Shareholders’ equity has grown from $17 million to $227 million, a 10% annualized growth rate. This 10% growth rate is extremely impressive considering the bank has paid out roughly half its annual earnings in dividends along the way.

Today, NASB Financial trades at a trailing P/E ratio of 9.1 and a price to book ratio of 1.2. The bank’s equity is 10.9%, and the net interest margin is roughly 3.9%. Given this bank’s long history of excellent profitability and growth, this valuation looks extremely low. It certainly is well below peer valuations. Just as a check, I pulled a list of American exchange-listed banks with balance sheets ranging from $1-3 billion. The median price to book ratio was 1.61, and the median trailing P/E ratio was 19. On either basis, NASB Financial trades at a large discount to its peers.

So why does NASB Financial trade so cheaply? Since you’re reading this blog, you can probably already guess that the company’s shares are pretty illiquid. They are, even for an OTC stock. Another reason is that NASB relies more heavily on funding from the Fed than most of its peers. At June 30, Federal Home Loan Bank advances made up 26% of the bank’s total liabilities. This amount will likely trend down as Fed funding becomes more expensive. Finally, NASB is a closely-held corporation. Like many other OTC-traded banks, NASB Financial is a family affair. David Hancock about one third of the company’s shares, and his wife serves as a director. Some investors steer clear of situations where a company is substantially controlled by one individual, but I don’t mind owning these companies when that holder has done an excellent job making money for shareholders. I believe this is one of those cases.

I don’t own NASB Financial, but I present it here as an example of the kind of opportunity that abounds among OTC banks. I highly encourage anyone with the time and the inclination to go hunting in this very fruitful niche.

Alluvial Capital Management, LLC does not hold shares of NASB Financial. Alluvial Capital Management, LLC may hold any securities mentioned on this blog and may buy or sell these securities at any time. 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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A look at D’ieteren – DIE:Euronext


Very long time, no post! Funny how time flies when you’re building a business, helping run a household and chasing a toddler around. But I’ve had some investing thoughts tumbling around my brain for some time, and I’m glad I still have this blog to record them. Today’s topic is on one of my specialties: a deeply-discounted, well-run, family-controlled European conglomerate. Next week, or perhaps the week after (no promises!) I will profile one of Alluvial’s newest and largest holdings.

Long-time readers may remember how much I liked Moleskine SpA, the Italian luxury notebook manufacturer. The company boasted huge margins and was experiencing rapid growth with a long runway ahead of it. I owned the stock and hoped to own it for many years, but my plans were interrupted by a Belgian company, D’ieteren SA. Moleskine’s large private equity shareholders sold their holdings to D’ieteren, which then acquired the rest of the company. I made a very good return on Moleskine, but I believe I could have made much more had I been able to remain an owner. A few weeks ago I was wondering how Moleskine’s business had performed post-acquisition. So I pulled up D’ieteren’s financial statements to have a peek. Turns out, D’ieteren itself is worth a look!

D’ieteren’s roots reach back to 1805, when the company manufactured horse-drawn coaches. With the advent of the automobile, the enterprise transitioned to automobile manufacturing, then automobile rental and sales. In 1999, D’ieteren purchased Belron and entered the automotive glass replacement and repair market. Today, D’ieteren Auto is a major distributor of Volkswagen group vehicles in Belgium, with over 20% market share. Belron operates worldwide under a variety of brand names. North American readers will likely be familiar with Safelite, as in “Safelite repair, Safelite replace!” With the additional of Moleskine, the company now operates in the consumer goods market.

Let’s take a closer look at D’ieteren’s three major segments.

D’ieteren Auto manages 125 Belgian auto dealerships and owns an additional 21 locations. The company is responsible for putting 1.2 million vehicles on the road. D’ieteren Auto’s activities also include auto financing and rentals. D’ieteren Auto is consistently profitable, but is not a growing business. As a highly developed nation with a low rate of population growth, Belgium’s auto market is saturated. Unit volume for D’ieteren Auto has not grown in a decade. In 2016, the segment earned €86.7 million. Results weakened slightly through the first half of 2017.

Valuing D’ieteren Auto is an interesting exercise. On one hand, the company enjoys high market share and a strong incumbent position through its relationship with Volkswagen and extensive dealership network. On the other hand, the number of vehicles on Belgian roads is not likely to grow. If anything, it will likely begin to shrink as self-driving cars and ridesharing services develop. Personally, I am quite bearish on the idea of personal auto ownership in the medium to long term. Were I an acquirer, I would not pay more than 9-10x trailing earnings for the segment. That works out to €720-800 million for D’ieteren Auto. That’s a nice conservative figure because the segment also bears some of D’ieteren’s corporate costs which could be removed by an acquirer.

Belron is D’ieteren’s largest segment in terms of revenues and profits. Belron has a global presence with operations on five continents. Belron offers automotive glass repair and replacement under various brand names. Belron’s revenues grew at a healthy 5.7% annual rate from 2007 to 2016. Unfortunately, profits did not grow at the same rate as margins compressed.

Putting a valuation on Belron is easy for one important reason: D’ieteren has just closed on the sale of a 40% stake in Belron to Clayton, Dubilier & Rice, a European private equity firm with an impressive pedigree. The deal was done at at equity valuation of €1,550 million, netting D’ieteren €620 million from the sale. Prior to the sale, Belron also distributed a dividend of €453 million. Prior to the sale, D’ieteren held 94.85% of Belron, so they received €430 million from the dividend. Using the €1,550 million equity valuation for Belron, the 54.85% ownership that D’ieteren has retained is worth €850 million. It’s important to do a reality check on that €1,550 million valuation, but it does appear reasonable. The transaction with Clayton, Dubilier & Rice was done at an enterprise value of €3 billion, which is about 15x trailing EBIT. Perhaps a higher ratio than I like to pay, but fairly normal for a global business with decent growth potential that can fund itself at attractive rates.

Last, there is Moleskine. Recent reports from D’ieteren show Moleskine continuing to grow at a healthy pace, though profits have declined. This is consistent with D’ieteren’s stated policy of making large investments in logistics and IT, positioning the brand for long-term growth. D’ieteren took Moleskine private at a valuation of €500 million. I think it’s fair to use that valuation even though the company’s revenues have grown. Personally, I believe Moleskine can be much more valuation over the next decade with proper management. Against this €500 million valuation, Moleskine has net debt of €300 million for a net value of €200 million.

Using the €720 million value for D’ieteren Auto results in equity value for the three segments (54.85% for Belron) of €1,770 million. To that we can add the €430 million D’ieteren received as a dividend from Belron, and the €620 million that D’ieteren received for the sale of 40% of Belron. Finally, D’ieteren group has loaned €330 million to its operating businesses, €150 million to Moleskine and the balance to Belron. Adding this loan asset creates total value for D’ieteren of €3,150 million. D’ieteren’s market capitalization is €2,190 million, a discount of more than 30%.

Following the sale of a partial stake in Belron, D’ieteren will likely owe some taxes on the gain. But the fact remains that D’ieteren trades at a distinct discount to the value of its assets. Why? I think the usual suspects are in play. D’ieteren’s float is small and the D’ieteren family is firmly in control. Only €876 million worth of shares are publicly-traded. The company defies easy categorization. Auto services and pricy Italian notebooks together? Strange. The company is also undergoing a generational transition. After 40 years as chairman, Roland D’ieteren has stepped aside in favor of his son, Nicolas. Finally, there is the issue of reinvestment. Following the sale of a sizable stake in Belron, the company is sitting on €1 billion or more of cash. What will the company buy next? It has indicated it wishes to expand its activities to new areas, but that invites the possibility of “diworsification.”

Still, I believe D’ieteren could be very attractive to the patient investor who is willing to trust the D’ieteren family to continue doing what they have done thus far: build the company in a judicious fashion, always taking the long-term view.

Alluvial Capital Management, LLC does not hold shares of D’ieteren SA/NV. Alluvial Capital Management, LLC may hold any securities mentioned on this blog and may buy or sell these securities at any time. 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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Compagnie Lebon SA – LBON:France

I enjoy delving into the many family-controlled investment vehicles that European markets have to offer. Many trace their roots back to the Industrial Revolution when new technologies created fortunes and wealth unrelated to nobility, or back to storied banking houses.

There are fewer and fewer of these vehicles, and that makes complete sense. If you were part of a generationally wealthy European family, would you want to invite the public to scrutinize your financial dealings? I am essentially the opposite, coming from a line of farmers and coal miners, but I still would prefer my family’s finances remain unobserved. So the steady trend has been for these family-controlled firms to buy out minority holders and go private.

One family company has has bucked this trend is Compagnie Lebon SA. The company was founded in 1847 to provide gas lighting and eventually came to control gas distribution monopolies in France, Spain, and Northern Africa. Following the wave of nationalizations after World War II, the company expanded into industry, banking, financial services, and hospitality. The company even had a role in creating the first modern mutual funds with Merrill Lynch. Today, the company operates a portfolio of of hospitality and real estate assets, plus a private equity arm.

Since its founding, the company has been controlled by the well-established Paluel-Marmont family. In 2015, an article in a French publication ranked the family #479 on its list of the 500 largest French fortunes. The family controls 61% of Compagnie Lebon’s shares, though it has turned over management responsibilities to professionals from outside the family. The family patriarch, Jean-Marie Paluel-Marmont, serves as a non-voting director. As is often seen with such old fortunes, the current generation of Paluel-Marmont heirs has expanded into fashion, banking, even entrepreneurialism in the baked goods market.

Compagnie Lebon’s hospitality assets are Esprit de France and Sources d’Equilibre.

  • Esprit de France consists of 9 Paris hotels, 8 being four-star properties and 1 a three-star, plus 1 five-star property in Aix-en-Provence. Esprit de France also seeks to manage hotels for third parties and has a club of affiliated houses and properties sharing similar values across France.

  • Sources d’Equilibre is a 60% holding of Compagnie Lebon. It owns and operates three health spas and two hotels at the site of historical thermal springs.

Compagnie Lebon’s real estate division is known as Paluel-Marmont Valorisation. It invests opportunistically in public and private real estate companies and assets among many different real estate types. The total portfolio is worth 85 million euros.

Finally, the company has an active private equity arm. Paluel-Marmont Capital consists of two funds, SCR PMC 1 and FPCI PMC II. The first consists of pre-2012 investments and is in run-off. The second is currently making new investments, and has accepted capital from investors other than the company. Paluel-Marmont Finance invests both in venture capital and large buyouts. Last, the company has a 5% ownership position in another holding company, Salvepar.

What’s it all worth? Well, here at OTCAdventures, we’re in the business of providing readers with interesting ideas for further research, not making recommendations or providing price targets. So I’ll let you draw your own conclusions. It’s more fun that way anyhow, right? However, the company very helpfully publishes its own calculation of value. For 2016, it was 240.3 per share. Earnings for the year were 17.5 per share, so the company’s estimate of value works out to 13.7x earnings. That’s pretty reasonable. Shares last changed hands at Eur 181.3 for a trailing P/E of 10.4 and a discount to estimated NAV of 25%. So if you do accept the company’s figure as reasonable and would be willing to pay more than 10x earnings for Compagnie Lebon, the current price looks pretty cheap. 2016 summary figures are here.

Who knows how long Compagnie Lebon will remain public? Maybe the Paluel-Marmonts will finally tire of the nosy hoi polloi peeking at their holdings. But perhaps not. It does seem that family-controlled companies that have ceded their management to professionals are both more willing to remain public and less likely to suffer from poor corporate governance. So maybe Compagnie Lebon will be publicly-owned for much, much longer. Either way, it’s fun to watch these terrifically old companies morph into 21st-century firms.

Alluvial Capital Management, LLC does not hold shares of Compagnie Lebon SA. Alluvial Capital Management, LLC may hold any securities mentioned on this blog and may buy or sell these securities at any time. 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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Thoughts on Advanced Emissions Solutions – ADES

Advanced Emissions Solutions, Inc. trades at a price that does not reflect the optionality of its pollution control assets. These assets include various “refined coal” power plants, emissions-reducing chemicals, and intellectual property. While only the refined coal facilities currently produce meaningful cash flow, the company’s other assets could have significant value.

“Refined Coal” – Tinuum Group, LLC

Let me first say that “refined coal” or “clean coal” are nothing more than marketing terms. Burning coal to generate power is a filthy process and no current technology can remedy that. But there are ways to reduce the impact of coal pollution and limit the release of mercury and nitrogen oxide into the atmosphere. “Refined Coal” plants have been fitted with equipment that treats coal and the resulting combustion gasses, resulting in less pollution and environmental impact. The US government wishes to encourage these technologies and has provided special tax incentives to operators who employ them.

Advanced Emissions Solutions, through its investment in Tinuum Group, LLC, owns many coal-fired power plants equipped with these technologies. About half of these have been leased to various operators, including utilities and non-utility financial investors interested in generating tax benefits. Simply from the plants now in service, Tinuum will earn hundreds of millions in lease revenues between now and the end of 2021. After that, the tax provision that created the incentives for using refined coal technology sunsets and presumably, Tinuum will receive no further cash flows.

Tinuum signed another plant lease at the end of March, bringing the number of plants in service to 14. Another 7 refined coal facilities are equipped and ready for an investor, and Tinuum can install its technology at another 7 if demand materializes. Acquiring new operators for the remaining plants has been a challenging process for Tinuum, given some uncertainty over IRS treatment of various types of investors in refined coal and general uncertainty over the future of coal-generated power. But the company feels the worst of the uncertainty is behind, and is optimistic about placing idle plants into service.

Advanced Emissions Solutions owns 42.5% of Tinuum, and expects its share of distributions to total $275-300 million between now and the end of 2021. Depending on Tinuum’s success in leasing out additional plants, the total distributions to Advanced Emissions Solutions could be much higher. By the company’s estimation, each additional plant leased to an operator could add $5-7 million in annual distributions.

Emissions-Reducing Chemicals

Advanced Emissions Solutions once did a large business selling emissions control equipment. But this turned out to be an unattractive business model and the company has exited, choosing instead to focus on its proprietary chemicals. In 2015 and 2016, coal-fired power plants by and large installed mercury-scrubbing equipment to meet environmental mandates. These systems now require chemical consumables that keep them running effectively and make them last longer by reducing corrosion. Advanced Emissions Solutions estimates the total annual market for these consumables is $400-600 million, and the market for the specific product types that Advanced Emissions Solutions offers is around $100 million. Thus far, the company has managed to capture only a small portion of this market. But the company believes its offerings are competitive, and the industry seems to be agreeing. Chemicals revenue grew over 400% quarter-over-quarter to $2.3 million. If the company’s products continue to take market share, the chemicals business could be a very valuable one for Advanced Emissions Solutions.

Intellectual Property

Advanced Emissions Solutions holds 36 US patents, plus additional international and/or pending patents. Some of these patents are related to technology used at the Tinuum facilities, for which the company receives royalties. Others relate to the chemical business. The company is seeking ways to monetize these and other patents, whether through licensing or outright sales. It is very difficult to quantify any potential outcome and I will not venture a guess as to if, when, or how much gain the company could ultimately achieve. Nonetheless,  the company’s intellectual property is both a competitive advantage and a potential source of cash.

Company Background and Strategy

One reason the market has been slow to recognize the value of Advanced Emissions Solutions is the company’s tumultuous past. Under the previous management team, the company suffered from very poor capital allocation: a high research & development spend with little to show for it and under-utilization of Tinuum’s assets. Operating costs ballooned, and the company even got into trouble with its financial filings, becoming delinquent and being delisted. New management came in in 2015 and quickly set about reducing costs, restating the financials and focusing on efficiency. The result is greatly reduced costs and a new focus on getting the most out of the company’s best assets. The company also settled some lingering litigation and returned to the NASDAQ.

Advanced Emissions Solutions’ operating costs have been slashed in half, from over $40 million in 2015 to a $20 million annual run rate for the most recent quarter. In previous presentations, management guided for ultimate annual corporate costs of $12-14 million. That seems optimistic to me, but I think $15-16 million is very much achievable.

Capital allocation policy has been revamped. The company just completed a tender offer for 6.2% of its shares, paying $9.40 for a total of $12.9 million. Advanced Emissions Solutions also initiated a dividend and now pays a generous 25 cents per quarter. This dividend is very well supported by Tinuum’s regular distributions. Going forward, the company will focus on returning capital to shareholders, investing in the growing chemical segment, and potentially on acquisition opportunities if they can find compelling deals.

Just recently, the company implemented a tax asset protection plan. Advanced Emissions Solutions has over $100 million in net operating loss carryforwards, which will shield the company from taxation for some time.

Valuation

Evaluating Advanced Emissions Solutions’ worth in full is a challenging process. However, I believe the value of Tinuum in its current state alone, less corporate costs, equals the company’s enterprise value. Any potential value from additional facility leases by Tinuum, growth in the chemical business, or monetization of the company’s intellectual property would only increase value.

My very conservative short-hand valuation incorporates $275 million in distributions received from Tinuum between now and 2021, less $16 million in annual corporate costs over the same period. Discounted at 10%, the present value of the Tinuum distributions less corporate costs equals $158 million. To this figure I would add the $10 million in cash the company holds following their tender offer and dividend payment. Finally, I would credit the company for its NOLs at 10 cents on the dollar. (Normally, I am very skeptical of the value of NOLs. However, given that Advanced Emissions Solutions is already producing substantial profits, I think it is very likely the NOLs are fully utilized.) That adds another $10 million, for a very rough valuation of $178 million.

As I write, the company’s enterprise value is $181 million. So all of the company’s positive optionality is valued by the market at $3 million. Again, the company possess multiple levers for achieving a much higher value, the easiest of which seems to be the potential for additional facility leases by Tinuum. It should be clear that I believe Advanced Emissions Solutions is worth substantially more. However, I think that highlighting the company’s very limited downside is most appropriate in this scenario where the timing and amount of additional value from unproven assets is uncertain.

Alluvial Capital Management, LLC holds shares of Advanced Emissions Solutions for clients. Alluvial Capital Management, LLC may hold any securities mentioned on this blog and may buy or sell these securities at any time. 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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Ocean Yield ASA – OCY:Oslo / OYIEF:OTC

Just a quick post today to talk about what I think is a very interesting company – Ocean Yield ASA. The company was created in 2012 from assets owned by the Norwegian industrial giant Aker ASA, which remains the majority shareholder. Ocean Yield’s business model is very simple: it purchases ships, then leases them to high-quality global shipping companies under long-term charters. In order to deploy more earning assets and produce a more attractive return on equity, Ocean Yield employs meaningful leverage. Ocean Yield pays out the majority of its earnings in dividends (hence the business name) and strives to increase the dividend as its fleet grows.

This is the business model employed by nearly all leasing companies, as well as banks. Borrow short, lend long, and earn the spread. There are risks to this business model, but first let’s take a look at the types of ships that Ocean Yield currently owns. The company’s fleet is modern and fuel-efficient, crucial to ensure the vessels will have strong residual values once their leases are concluded.

Chemical tankers make up roughly one third of the fleet. Chemical tankers are specialized ships that tend to see more stability in dayrates, making them an attractive sector for Ocean Yield. Since its founding, Ocean Yield has growth its fleet at a steady pace. The company intends to grow its fleet by $350 million annually. Fleet expansion is funded operating cash flow as well as debt issuance.

Just like a bank making loans, Ocean Yield seeks to lease its ships to highly creditworthy shippers. Below is the breakdown of Ocean Yield’s counterparties. The list is rather concentrated, but these shippers do represent some of the largest and best-capitalized around. Ocean Yield’s average charter term is quite long at 11.4 years at quarter’s end. Some of the leases include purchase options or other customizations that make the lease more attractive for the ship’s operator.

The credit performance of Ocean Yield’s lessees has been generally good. But being that shipping is a highly cyclical industry and shippers tend to carry high leverage, Ocean Yield has had to restructure leases on more than one occasion. Restructuring tends to involve accepting lower lease payments, and may result in receiving one-time cash payments or securities from the distressed shipper. Thus far, Ocean Yield has managed these disruptions without serious losses.

Counter-party risk is one major risk that Ocean Yield faces. Another is residual value risk. The annual earnings of each of Ocean Yield’s ships is essentially its lease revenue less depreciation. But what happens if at the end of the lease, the ship turns out to be worth far less than its book value? That means that economic deprecation was higher than accounting depreciation, and accounting earnings exceeded economic earnings. That’s a bad scenario. Ocean Yield must be careful to invest in ships that will maintain their value at least as well as their accounting depreciation schedule would success, in order to be sure that reported profits are not illusory. Ocean Yield must also take care to invest in ships that are not in danger of obsolescence due to changes in technology or regulations. A large write-down in a ship’s value could wipe out a huge amount of reported profit.

The third major risk to Ocean Yield’s business model is financing risk. Ocean Yield carries about $1.36 billion in net debt versus $2.32 billion in tangible assets. The company’s equity ratio is 35.2%. Liquidity is good, as the company has $264 million of available liquidity. Still, the company would be negatively affected by rising interest rates or a disruption in credit markets.

Ocean Yield has a solid history of increasing revenues and profits since its inception. The fourth quarter of 2016 was a notable exception with a writedown on a vessel extinguishing nearly all profits. EBITDA declined from Q4 2016 to Q1 2017 because for one of the company’s ships, Lewek Connector, the associated lease went into default and the vessel was re-leased at a lower rate while restructuring talks take place.

Nonetheless, profits excluding one-time items have continued to rise. The company has increased its dividend apace, and now pays $0.74 annually. Quarterly dividends have grown at an annualized pace of 14% since the first quarter of 2014.

On an annualized basis, Ocean Yield is currently producing earnings of 89 cents per share. Shares are quoted in Norwegian Krone, but the company operates in US dollars. The current share price of NOK 65 is equivalent to USD 7.70, for a P/E ratio of 8.7 and a dividend yield of 9.6%. Both Ocean Yield’s earnings and dividend could rise as the year progresses once the company’s newbuild containerships and gas carrier begin contributing. In addition to the already announced fleet additions, the company maintains its $350 million fleet growth target.

So, what’s it worth? I never like to pay too much for leasing companies. They don’t typically enjoy significant operating leverage as they grow, and like other leveraged business models, there is always the risk of a blowup if they get too aggressive on the lending/leasing side or if credit markets lock up. Ocean Yield does have the benefit of a deep-pocketed backer in Aker ASA, but the risk is never entirely mitigated. A lot depends on the company’s efforts to grow its fleet responsibly and avoid over-paying for ships. Still, I do think the company’s good track record deserves a valuation higher than 8.7x trailing annualized earnings. I would be happy to buy shares up to 10x trailing earnings, which works out to 1.6x book value. Some might ask why a business made up of nothing but ships which anyone can buy should be worth more than book value, but I would counter that expertise in leasing and navigating the complex world of global shipping is worth quite a premium. Ocean Yield and other lessors seem to be providing a valuable service where traditional banks have withdrawn. At least for now, Ocean Yield is capable of earning a high return on equity, and that merits a premium to book value.

Alluvial Capital Management, LLC does not hold shares of Ocean Yield ASA. Alluvial may buy or sell shares of Ocean Yield ASA at any time. 

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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Value Investors, Value Collectors

I’ll be in Omaha May 5-7 for the Berkshire Hathaway shareholders’ meeting and the Markel brunch. I have a busy schedule, but it would be great to meet up with any readers who will be in attendance. E-mail me at dave.waters@alluvialcapital.com.

In my five years of writing on OTCAdventures, I have had the pleasure of interacting with hundreds of investors in micro-cap stocks and other market niches. I have found that people have different motivations for investing in these companies. Some simply want to make a lot of money. Others get a measure of pride and satisfaction out of owning things that few others do and discovering new treasures to add to their hoard. These I’ll dub “Collectors.” Collectors desire a good return, but delight in businesses that are unique in some way, or have some historical cachet.

I am one of these. I derive a great deal of satisfaction from owning the truly rare and unusual. Century-old community banks, the leftover husks of former corporate dynasties, industry pioneers now occupying some sleepy niche. Problem is, many of these “Collector Edition” securities are simply not good investments. Either the economics of the business are too challenging or management is out-matched or self-serving. Consequently, these are not often securities I buy for Alluvial’s clients and partners. But personally, I really enjoy owning stocks  like Ohio Art Company, which until recently was the owner of Etch-a-Sketch. Or St. John Knits, the venerable designer of  apparel for wealthy and powerful women.

One of these unusual companies I have never seen being discussed anywhere is Massachusetts Business Development Corp. I have been a shareholder for several years. “MBDC” is a strange quasi-governmental organization dedicated to providing business financing and venture capital in the New England region. MBDC is not government-owned, but it is very much government-supported via various lending and tax incentive programs. Founded in 1953, the company is the nation’s oldest Business Development Company. Over the course of its existence, MBDC has invested over $1 billion in small companies and startups, creating untold wealth for the economies of Massachusetts and the neighboring states. MBDC invests directly in companies, providing the full spectrum of financing from senior and mezzanine debt to working capital factoring or equity. MBDC also manages a handful of investment funds and invests in these funds.

MBDC operates as a sort of co-op. While shareholders are the nominal owners of the company, the true power rests with the company’s members, a large group of New England banks and insurers who provide the company with capital to deploy. There are 165,382 MBDC common shares outstanding, each with one vote. But, members receive 1 vote for every $1,000 of capital loaned to MBDC. There is presently $56 million in capital loaned to MBDC by members, resulting in 56,000 votes for those members. Shareholders are simply along for the ride.

The company is consistently profitable and does pay a small dividend. But one might expect that with the company’s economic growth mandate, it is not a profit maximizer. One would be correct. MBDC’s three year average return on equity is around 6%. At year-end, Massachusetts Business Development Corp.’s balance sheet reached $77 million, up from $67 million in 2014. The company has been focused on deploying more capital in support of economic growth in its service region. Book equity is currently $10.3 million, which makes the company appear highly leveraged. But remember that nearly all of MBDC’s financing is provided by member banks and insurers, at a very low cost. At year-end, the company’s cost of debt was just 1.4%, and the company had borrowing capacity of an additional $163 million. MBDC does experience loan losses typical for an investor in venture-stage and small enterprises, but these losses are easily surpassed by the loan fee income and investment management income the company generates.

Liquidity is extremely poor for MBDC shares, and the bid/ask spread frequently suggests no reasonable two-way market exists. At the most recent trade of $28, MBDC trades at a price to book ratio of 45% and a P/E of 8.2. I am not suggesting this is cheap. Remember that shareholders have effectively zero control over the company and should not expect any sort of meaningful dividend, share repurchases, a buyout or other value catalyzing event. I expect that MBDC will go about executing its mandate, not seeking to enrich a tiny number of voiceless shareholders. The only way I can foresee shareholders doing very well is if the business is for some reason placed into run-off and eventually liquidated. How could that happen? I suppose that like the controversy over the federally-chartered Export-Import Bank, conservative politicians could seek to nix MBDC in the name of opposing “crony capitalism.” But frankly, that’s pretty unlikely in New England. It’s much more likely that MBDC continues to operate for decades, and remains nothing more than a little oddity in my portfolio. And that is fine with me.

I personally own shares of Massachusetts Business Development Corp. I may buy or sell shares of MBDC at any time.

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First National of Nebraska – FINN

I have long held that a prime hunting ground for value is in very high-priced stocks, especially those that are unlisted or trade in foreign markets. For whatever reason, investor appetite for shares really falls off once the price eclipses $1,000, especially for illiquid stocks. I suspect the wide bid/ask that often accompanies these shares is also a contributor. Those willing and able to purchase these high-priced shares may walk away with a bargain.

A textbook example of this phenomenon is First National of Nebraska, a large and well-run bank that nonetheless trades at a deep discount to the valuations its peers command.

Since this blog focuses on micro-cap stocks, one might assume that I mean “large” in a relative sense, as in a balance sheet of one billion dollars or so. But First National is a truly large bank holding company, with a balance sheet of $19 billion. Fewer than 50 other public US banks are larger. But you’ll never hear about First National of Nebraska’s shares on CNBC, because they have an eye-popping price tag of $7,500. A typical day’s trading volume is in the single digits, so it’s not exactly easy to acquire a huge position.

First National is well-run in the sense that it consistently generates a return on assets in excess of 1.0%, and a return on equity of 10-11%. The company maintains a strong capital position with common equity to total assets of >10%, a much lower leverage ratio than the company employed before the crisis. Speaking of the crisis, First National never had one. Profits suffered in 2008 and 2009, but the bank never recorded an annual loss. The recession was only a temporary setback in the bank’s continued expansion.

First National has 101 branches in seven states. Please excuse the poor image quality of the graphic I borrowed from the company’s annual report I received last week.

According to Northpoint mortgage lenders, some banks focus on residential mortgages, others on commercial real estate, others on agricultural or development loans. First National of Nebraska has carved out a very profitable niche in credit card lending. Thousands of different businesses and non-profits offer their own branded credit cards to customers and members. First National is the entity actually making these revolving unsecured consumer loans. First National counts Best Western and Ducks Unlimited among its customers, and has a nearly $6 billion portfolio of credit card loans. Credit card loans are riskier than other types of lending, but the bank has large reserves against expected loan losses and has proven itself a responsible lender in the sector. Credit card loans make up 43% of First National’s loan book. Commercial loans, real estate and otherwise, make up 29%. Agricultural loans are 11%, residential real estate 10%, and “other” 7%.

First National has a long history of steady if not spectacular growth. Since 1997, the bank’s balance sheet expanded at an annual rate of 4.3%. Loans grew at the same pace, while deposits expanded at 4.7% annually. Profits grew at a 5.4% rate. Profit growth on a per share basis has been higher recently, growing at 8% since 2012.

Despite its healthy balance sheet, good profitability and attractive niche business, First National of Nebraska trades at a large discount to other banks of similar size and quality. I generated a list of publicly-traded banks with $10-30 billion balance sheets and a five year average return on equity of at least 8%. I may have missed a few peers, but this exercise is to prove a point, not create academic-quality data.

The entire peer group trades at an average price-to-book ratio of 1.8 and a P/E ratio of 19.8. First National’s closest competitors in terms of average historical ROE trade slightly higher, at a P/BV of 1.9 and a P/E of 20.5. Whichever set of banks we look at, First National of Nebraska is far cheaper at just 1.1x book value and a P/E of 10.4.

Perhaps some of this discount is justifiable. First National may carry more risk than other banks in its size range because of its exposure to credit card and agricultural loans. Credit card loans are uncollateralized and agricultural is highly cyclical. And yet, First National of Nebraska remained profitable in the crisis when many traditional residential real estate lenders failed. Or, perhaps the market is concerned that First National may lose some of its credit card relationships. They did lose a large relationship in 2016. Maybe the market doesn’t believe that First National will benefit from rising rates the way its peers will.

However, I believe that nearly all of the valuation discount is due to First National of Nebraska’s lofty share price and minimal trading volume. This presents opportunity for long-term investors who care little about the day to day fluctuations and much about the long-term performance of the underlying business. Naively assuming the bank can earn its long-term return on equity of 11.0%, First National could earn almost $790 per share in 2017, for a forward P/E of 9.6. Of course, who knows what this year holds. A recession could arrive, or expected higher interests rates could fail to materialize. But I am sure that long-term holders of First National of Nebraska will be richly rewarded.

Alluvial Capital Management, LLC holds shares of First National of Nebraska, Inc. Alluvial may buy or sell shares of First National of Nebraska, Inc. at any time. 

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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Parks! America – PRKA

As someone who traffics in the obscure and the unusual, I am always particularly interested when I happen across a company with a unique business model. Often, the company is the only publicly-traded entity in its line of business. As far as I can tell, this is the case with Parks! America Inc. Parks! America operates wildlife parks in Pine Mountain, Georgia and Stafford, Missouri under the “Wild Animal Safari” brand. These are exactly as they sound, enclosed areas where exciting non-native wildlife roams for visitors to observe. At both locations, visitors can observe dozens of species in a natural(ish) setting. Visitors can feed some of the more amiable species. I would imagine this does not include the wolves and tigers.

Now, I know what you might be thinking, and it’s the same thing that occurred to me when I first ran across the company. How do I know this isn’t some shifty carnival-type operation where sad-eyed, underfed wild creatures  pace in circles in tumbledown enclosures? While I have not visited either of Parks! America’s properties in person, visitor reviews tell a different story. Tripadvisor reviews for both the Georgia and Missouri properties are overwhelmingly positive, with hundreds of reviewers speaking of their good experiences, especially families with young children.

Financially speaking, running a wildlife park appears to be a surprisingly good business. In 2016, Parks! America reported an operating margin of 28% and a return on tangible equity of 20%, adjusted for a one-time tax benefit. But these figures don’t tell the whole story. For several years now, Parks! America’s Georgia property has been a standout, strongly profitable and with growing revenues. However, the company’s Missouri property has struggled. Wild Animal Safari in Missouri has only recently achieved an operating profit for the first time since 2012. Below is a breakdown of yearly results at each property.

So what we really have in Parks! America is a company with one astonishingly profitable and successful property, and one struggling property. To me, that spells upside potential. If Parks! America is able to build on the small amount of positive momentum their Missouri property has generated, a sharp increase in profits could result. Alternatively, it the company chose to pack it in and sell the property, significant capital could be released.

For the trailing twelve months, Parks! America’s wildlife parks produced $2.29 million in operating income. Corporate expenses were $0.66 million, leaving company EBIT of $1.63 million. Annualized interest expense in the most recent quarter was $0.20 million, leaving pre-tax income of $1.43 million. Parks! America is not a taxpayer for the moment as it works off its $1.9 million federal NOL. Georgia state corporate income tax is 6%, giving pro forma trailing net income of $1.34 million, or 1.8 cents per share on a market cap of $9.7 million. Oh, did I forget to mention that Parks! America is tiny? Indeed, it’s one of the smallest public companies I have run across that actually generates attractive margins and cash flow.

At a market cap of $9.7 million, Parks! America trades at 7.2x trailing earnings. These earnings will likely rise substantially in fiscal 2017 if the company can again increase visitor numbers at its Georgia property and increase margins at its Missouri property.

Parks! America does carry debt, but the terms are generous compared to the usurious rates that most other companies this size must pay. In 2013, the company secured a 20-year loan from a local Georgia bank, secured by substantially all the company’s assets. The loan bears interest at prime plus 2.50%, currently 5.75%. Principal amortization requirements are minimal, so the company enjoys a lot of freedom to deploy its cash flows as it sees fit.

For the trailing twelve months, Parks! produced operating cash flow of $1.34 million. After capex of $0.43 million and principal repayments on debt of $0.12 million, the company produced $0.79 million in true free cash flow. For now, that cash sits on the balance sheet. Assuming the company’s profitability remains strong, the biggest question for me is what the company will ultimately decide to do with all the cash they will generate. Will they build another park? This could be lucrative, but also potentially risky if the park runs into the same troubles the Missouri property has faced. Perhaps they’ll begin paying dividends. A management buyout is also a possibility. Insiders control about 55% of the company’s shares, and it wouldn’t take a lot of capital to make an offer to the minority shareholders. Including other major holders, only about 31% of the company’s shares are freely floating.

Readers looking to do further research on Parks! America should be aware that this company is extremely small and its shares are very illiquid. I own a very small stake, which took me months to accumulate. And as usual, it’s far easier to buy into these tiny companies than it is to sell out of them. Shares of Parks! America should be considered a very long term investment.

Alluvial Capital Management, LLC holds shares of Parks! America. Alluvial may buy or sell shares of Parks! America at any time. 

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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A Post-Mortem on Armanino Foods – AMNF

A blog reader e-mailed me this weekend, asking if I had ever reflected on why I never bought Armanino Foods of Distinction. This reader (who happens to have a quality blog himself) rightly noted Armanino’s many attractive characteristics. The answer is yes. I have asked myself why I never bought any Armanino. I’ve missed out on a nice return on what should have been a slam dunk investment. I had reasons, some good, some less so, and hopefully examining them publicly will benefit me in my future efforts.

I originally wrote about Armanino way back in 2012. Honestly, I have a tough time making myself read through posts from that far back. I’ve come a long way as an investor in the interim! But even then, I pointed out some qualities that made Armanino shares uniquely attractive. Chiefly, the business was astonishingly profitable. The humble purveyor of frozen pesto was producing nearly one dollar of EBIT for every dollar of capital invested, a feat that vanishingly few companies can match. This excellent capital efficiency enabled the company to grow at a rapid clip without dedicating meaningful additional capital to operations. In fact, the company had paid out more than its net income in dividends for several years running, yet managed to grow its top line at a high single-digits rate. Operating income grew even more quickly as operating leverage kicked in. Companies with excellent returns on capital and good growth rates typically and justifiably trade at lofty multiples, but Armanino traded at just 7x operating income at the time of my writing.

So, what made me hold back? Anchoring bias is probably the number one factor. The first time I ever looked at Armanino, shares were trading at between 50 and 60 cents. They were just under a dollar when I wrote. But even though everything about the company screamed “buy!”, something in my mind told me that since the stock had already nearly doubled, it was no longer cheap. Let that be a reminder to us all. A stock that has doubled is not necessarily expensive. Likewise, a stock that has been cut in half is not necessarily cheap.

A second reason was my concern over the company’s competitive positioning. After all, Armanino was and is extremely tiny, and sells its products into an intensely competitive industry. Hundreds of companies are jockeying constantly for shelf space in supermarkets and bulk stores. Many of these companies have annual marketing budgets that exceed Armanino’s revenues. If only one or two decided to compete in frozen Italian foods and/or pesto, Armanino could see its margins get crushed in short order. However, it appears I under-estimated the reputation and loyalty that Armanino commands with its customers. Combined with the fact that Armanino’s products are relatively niche items, larger operators have decided not to attempt to compete in the space, and Armanino’s sales and revenues have continued their upward trend.

Finally, I was concerned that Armanino’s growth would eventually put a strain on its manufacturing capabilities. Both then and now, Armanino creates its products in a single leased factory in Hayward, California. If Armanino’s growth pushed the limits of that factory’s capacity, I feared the company would be forced to undertake significant capex for expansion or forego pursuing additional growth. The possibility of a large deferred capex liability seemed material for a company that had been distributing over 100% of its earnings to shareholders.

So there it is, one intellectual blind spot and two reasonable concerns that perhaps could have been overcome with some deeper research and better understanding. There’s nothing I can do about the missed opportunity except strive to avoid the same bias going forward, and strengthen my analytical capabilities. That’s what serious investors do, try to end each day a little smarter and wiser than we were that morning.

What about now? Does Armanino offer good value today? Armanino shares trade at 11.0x trailing operating income and roughly 16x earnings net of excess cash. Free cash flow has been compressed by increased capital expenditures (there’s that long-awaited expansion spending!) and an increased working capital need. But revenue growth remains healthy, and operating margins are robust, hovering around 18%. By all indications, Armanino shares are somewhat cheap, assuming that 5-10% annual revenue growth continues. Not the bargain they were in 2012, but still likely to provide nice returns for long-term holders. The company is close to paying off the last of its debt, which will free up more cash flow for investment or for returning to shareholders. And yet, I still see a few issues that I would need to understand better before considering an investment in Armanino.

First, it appears that operating margins have plateaued. Since sitting 18% in 2013, Armanino’s operating margins have meandered between 18% and 19%, this after a long stretch where operating margins increased nearly every year. Has Armanino finally reached the limits of its operating leverage? Many small firms achieve remarkable increases in operating margins as their scale increases, but maturity means that future growth in earnings depends on top-line growth and not on better economizing of fixed costs.

And second, some data suggest that Armanino is finding itself competing more on price than it once did. The company very helpfully discloses both gross sales and the net amount received by the company after discounts, slotting fees, and promotional costs. Between 2006 and 2011, the net amount of sales received by Armanino averaged 87.0% and never dipped below 86.4%. But this figure has been trending downward in recent years. For the trailing twelve months, Armanino received 84.3% of gross sales. This is not necessarily a sign of trouble, though it is worth watching. Armanino could be choosing to implement a different pricing strategy, listing its products at a higher sticker cost but more frequently offering discounts and promotions. Or it could be intentionally chasing market share.

I have yet to reach a final assessment of these factors. I don’t feel comfortable buying Armanino without a better understanding of what is driving each data point. Armanino is no longer trading at a single-digit multiple of earnings or EBIT, so there is less room for error if either of these factors indicates a negative business trend forming. So for now I sit on the sidelines, hoping only to learn.

Alluvial Capital Management, LLC does not hold shares of Armanino Foods of Distinction for client accounts. Alluvial may buy or sell Armanino Foods of Distinction shares at any time. 

OTCAdventures.com is an Alluvial Capital Management, LLC publication. For information on Alluvial, 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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Steel Excel is an Attractive Special Situation – SXCL

Shares of Steel Excel are trading well below the value of the merger consideration they will receive when the company is taken over by its majority owner, Steel Partners LP.

On December 7, Steel Partners announced an agreement to acquire the 36% of Steel Excel that it does not own in return for preferred units of Steel Partners LP. The units would carry a 6.0% coupon and mature in nine years. Steel Excel shareholders would receive $17.80 in Steel Partners LP preferred units per share. Evidently, the deal was not acceptable to one of Steel Excel’s major shareholders, GAMCO. After discussions with GAMCO, Steel Partners unveiled an amended merger agreement on December 23. The preferred units’ distribution would now be cumulative, and Steel Partners agreed to offer to redeem at least 20% of the preferred units on a pro rata basis in cash within three years of issuance. Steel Partners also agreed to seek an NYSE listing for the preferred units.

Following the announcement, shares of Steel Excel scarcely budged, though the amended terms offered much better value for Steel Excel shareholders. Specifically, the fact that 20% of the preferred units will be redeemed within three years reduces both the effective maturity and the credit risk of the preferred units.

Modeling the implied IRR of Steel Excel shares is a simple matter. When converted into Steel Partners preferred units, holders will receive $1.07 in dividends per year and will have the option of redeeming 20% of their preferred units some time in the first three years after the merger closes. Assuming Steel Partners waits the full three years to redeem units for cash, the IRR for purchasers of Steel Excel shares at $14.75 is 9.3%. Earlier redemption would result in a higher IRR.

9.3% is a generous return for these Steel Partners LP obligations. Though the preferred units are junior to all of Steel Partners’ other obligations, the holding company is quite well-capitalized. At September 30, Steel Partners LP held cash and investments of over $97 million against debt of $57 million. Upon taking full ownership of Steel Excel, Steel Partners will assume direct ownership of another $122 million in net cash and securities. The full face value of the Steel Partners LP preferred units in issuance as the result of the merger transaction will be $72 million.

So what are Steel Excel shares/Steel Partners LP preferred units worth? I think it’s worthwhile to break down the cash flows into buckets and value each using a spread over treasury rates. I ran some numbers using current treasury rates and various credit spreads: 200 basis points over treasureies for 0-3 year cash flows, 350 basis points over for 3-6 year flows, and 500 basis points over for cash flows in years 6-9. The resulting calculation values Steel Excel shares at $17.09, 16% higher than the current trading price. At $17.09, Steel Excel shares would provide an IRR of 6.7%, which seems fair to me.

In reality, I don’t expect the gap between the current Steel Excel price and the face value of Steel Partners LP units to close because of the rich interest rate spread, I expect it to close because investors will see a listed preferred unit trading at a 17% discount to face value (at a $14.75 trading price for Steel Excel shares) and bid the price up.

The Steel Excel merger is expected to close in the first half of 2017 and is subject to a shareholder vote. Holders of more than half of the 36% of shares not owned by Steel Partners LP must approve the deal. GAMCO owns one third of those shares and has implicitly blessed the merger, so I don’t expect approval to be a problem.

Alluvial Capital Management, LLC manages a private investment partnership. If you are a qualified client and are interested in learning more, please contact us at info@alluvialcapital.com.

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

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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