Despite its outstanding record of growth and value creation (a 40% annualized return for investors since 2003, excluding irregular dividends) the company trades at only 8 times earnings and an EV/EBITDA multiple of 4.4.

Brazil is one of the world’s largest democracies, with a population of nearly 195 million. For many decades, Brazil’s story mirrored many other South American countries, complete with military coups, rampant corruption and runaway inflation. The worst of this period ended in 1985 with the first free elections since the 1960s. But transitioning to a democratic system did not bring a resolution to Brazil’s economic woes, and the country was plagued by inflation until the execution of the “Plano Real” in 1994. The plan instituted a new currency and gradually succeeded in bringing inflation down to First World levels in the single digits. Not to say there weren’t hiccups along the way, but the plan was a rousing success on the whole. Over the next two decades, the resulting stabilization helped foster a great increase in Brazil’s wealth and ranks of its middle class. Brazil’s growth rate has slowed in response to challenging world economic conditions and weakness in commodities prices, but the country’s young demographics and increasing per capita income still make it a promising market for investment. Brazil’s economic history and the genius of the “Plano Real” are topics worth studying in their own right. NPR’s Planet Money has an intriguing broadcast on the plan that can be found here.

Company Profile

As of March 31, Brazil Fast Foods owns or franchises a whopping 1,049 restaurants in Brazil, Chile and Angola. (The Chilean and Angolan restaurants account for only twelve of these units and their value is immaterial, per the company.) Of these 1,049 points of sale, roughly 42% are kiosks or express concepts offering a limited menu. These units are located inside convenience stores or similar locations. The other 58% of the company’s restaurants are traditional units.

Franchisees operate 972 of the company’s restaurants, while the company operates 77 locations. For several years, the company has been making efforts to reduce the number of company-operated restaurants and increase its ranks of franchisees. Brazil Fast Foods manages five different brands,  some of which are Brazilian brands and others are well-known American restaurant concepts.

Brazil Fast Food’s main line of business is Bob’s. The company operates 39 locations and an additional 922 are operated by franchisees. Bob’s serves a classic fast food lineup centered on hamburgers and milkshakes. Bob’s was founded in the 1950s by an American-Brazilian tennis player named Robert Falkenburg as the first Brazilian fast food chain. A typical Bob’s looks much any ordinary American fast food establishment.

Bob’s franchisees pay Brazil Fast Foods 4% of monthly gross receipts.

In 2007 and 2008, Brazil Fast Foods expanded its operations by opening KFC and Pizza Hut franchises. The company operates 14 KFC restaurants in Rio de Janeiro and 22 Pizza Hut units in Sao Paulo. Revenues from these American brands are growing rapidly and making up more and more of Brazil Fast Foods’ turnover.

In 2008, Brazil Fast Foods obtained the right to operate the Doggis brand in Rio de Janeiro from a Chilean company.

As the picture suggests, Doggis is a fairly traditional hot dog restaurant. The company once operated these restaurants itself, but has since converted all 11 of the units into franchised restaurants.

Finally, Brazil Fast Foods owns Yoggi, a frozen yogurt concept. The company acquired Yoggi in May, 2012, and has 39 franchisees.

Brazil Fast Foods notes that all of its Brazilian restaurants are located in Southeastern Brazil, the country’s richest and most populated region.

Operating Results

Trailing twelve months and five fiscal year results are presented below, converted into USD at today’s exchange rate of $0.493 USD per Brazilian Real. Operating income is more indicative of profitability, as net income figures include the effects of selling off company-owned restaurants.

Despite a rocky world economy, Brazil Fast Foods has thrived. While revenue growth has been impressive, the company has compounded the effect by converting an ever higher proportion of revenues into operating income. Part of this success is due to the company’s franchising efforts. Franchising is a high-margin business that requires little marginal investment.  The company’s main expenses in its franchising business are advertising campaigns, quality assurance and supply chain management for its franchisees. By contrast, the company-operated restaurant segment must pay for service employee salaries, food costs, occupancy costs and many more costs that the franchising business escapes.

The company provides very helpful financial comparisons between its franchising and company-operated restaurant segments. Again, I have converted all figures to USD at the current exchange rate.

Though revenues from its company-operated stores make up 79% of total revenues, franchising operations contribute 62% of total operating income. Its easy to see why the company is eager to grow its franchising arm. At the same, the company-operated segment is putting up better numbers than ever. Operating profit is over seven times what it was only five years ago, largely on great results at the company’s KFC and Pizza Hut restaurants.

The long-term revenue decline at the company’s flagship Bob’s locations may seem troubling, but the decline is due to a gradual reduction the number of company-operated Bob’s restaurants. On a same-store basis, revenues actually increased 27.3% from 2007 to 2012.

Brazil Fast Food’s consistent profits have allowed the company to repair its balance sheet, which was in sad shape a decade ago. As successful as the 2000s were for the company, the 1990s were the polar opposite. At that time, the company’s sole line of business was operating Bob’s restaurants. The company’s franchising business was in its infancy. In 1997, for example, the company had only 56 contracted to franchisees, compared to over 900 now. Operating costs were out of control and the company was repeatedly forced to offer shares and obtain additional capital. Despite its troubles, the company finally hit on a good business plan and has been thriving since. Book value per share in USD has grown from -$0.33 in 2003 to $4.41 at March 31, 2013.

Brazil Fast Food’s cash on hand is over twice its debt. Most of the company-operated restaurants are subject to leases with terms of up to five years, and these lease obligations do not appear on the balance sheet. These could present a risk if sales were to decline significantly. However, the company’s operating margin on these restaurants is healthy, which reduces the risk of these lease payments becoming an issue. At year end, these lease obligations total $22.9 million.

Valuation

Brazil Fast Food’s last trade price was $11.60 for a market capitalization of $94.3 million. Trailing P?E is 8.0, though this includes one-time gains from converting company-operated units into franchised restaurants. The more useful EV/EBITDA metric stands at 4.4.

It’s tough to find a direct competitor for comparison purposes, but Arcos Dorados’ business model is similar enough to facilitate a comparison. Arcos Dorados is the largest franchiser of  McDonald’s restaurant in South America and Latin America, and has a substantial presence in Brazil. Brazil Fast Foods and Arcos Dorados have similar opportunities in emerging markets and operate similar restaurants, but their valuations could hardly be more different. While Brazil Fast Foods trades at 8x earnings, Arcos Dorados trades at 28x. Arcos Dorados’ EV/EBITDA is 10.2, more than twice Brazil Fast Foods’ valuation. 10.2x EBITDA for a high-growth emerging markets company may or may not be a good value, but 4.4x very likely is.

If Brazil Fast Foods Corp. traded up to 7.1x EBITDA, just 70% of Arcos Dorados’ valuation, shares would rise to $17.93, a gain of 55%.

Risks

Like any other emerging markets country, Brazil Fast Foods faces special political risks. Brazil has enjoyed a multi-decade period of stability, but that doesn’t mean the country is out of the woods entirely. Problems of corruption, income inequality and inflation remain. On the other hand, the country’s recent oil discoveries and significant foreign currency reserves will provide surer economic footing. Brazil’s dollar-denominated debt rating was raised to BBB by Standard & Poor’s in 2012.

Part of Brazil’s legacy of instability is a frequently-changing and often arbitrary tax system. Brazil Fast Foods has a long-term disagreement with the Brazilian government over taxes owed by the company’s Venbo subsidiary. Though the company disputes these tax assessments, claiming they were calculated incorrectly, the company lists a potential liability for the disputed amount of $3.2 million on its balance sheet.

The company is also embroiled in a dispute over taxes on the royalty payments it receives from franchisees. The company believes these payments are not subject to the municipal tax on services received, but the city of Rio de Janeiro believes otherwise. The matter is in court, but the company lists a possible liability of $4.3 million.

Investors in Brazil Fast Foods Corp. must be comfortable buying into an insider-controlled company. Mr. Rômulo B. Fonseca and Mr. José Ricardo B. Bomeny together own 57.7% of shares outstanding, and other insiders own an additional 3%. In 2010, the company executed an agreement to sell all eight of its owned real estate properties to these investors. The company states these sales were done at fair market value and the company realized a gain on the sales. 64 of the company’s restaurants are franchised to Mr. Fonseca and Mr. Bomeny. These units pay the same royalties as all other franchisees. No other related-party transactions were disclosed in the 2012 annual report.

In Summary

Brazil Fast Foods represents an opportunity to invest in a fast-growing company that operates in an attractive industry and economy. Upcoming events like the 2014 World Cup in Brazil and the 2016 Olympics in Rio de Janeiro will put Brazil in the spotlight and could drive sales. Until then, continued improvement in operating margins and growth at the company’s operated restaurants and franchisee roster could further increase revenues and profits, making Brazil Fast Foods’ valuation look better and better.

I have a position in Brazil Fast Foods Corp.

Amidst all the bluster, Awilco released stellar first quarter earnings.

• Revenue of $53.4 million, up 1.1% from the previous quarter.
• EBITDA of $33.9 million, up 4.0%.
• Net income of $24.7 million, up 7.9%. EPS was $0.82.
• Revenue efficiency (revenue achieved vs. maximum revenue potential) was 91.2%, down slightly due to poor weather and a stoppage for minor repairs on WilHunter.
• Net debt of $66.4 million, down substantially from last quarter’s $97.7 million.

Even better, Awilco’s management followed through on its intentions and declared a $1.00 quarterly dividend! If this quarterly dividend can be maintained (and perhaps it can, given rate increases on the horizon) then investors are looking at an incredible yield. Shares are up 10% since my original write up, but the potential yield is still in excess of 20%.

This might be the shortest post in my blog’s history, but it’s also probably the shortest I’ve ever had to wait to see an investment thesis confirmed. That’s not to say Awilco’s current successes will continue forever, but for now favorable economic conditions, the company’s great execution and the generous dividend could continue to drive shares higher.

I have a position in Awilco Drilling.

The first of Awilco’s rigs is the WilHunter, pictured below.

The WilHunter was built in 1983 and upgraded in 1999 and 2011. The ship is capable of operating in water depths of 1,500 feet and can drill 25,000 feet. WilHunter is contracted to Hess until November 2015, with options to extend the contract another 275 days. The dayrate is $360,000, increasing to $385,000 in May 2014.

Awilco’s second rig is the WilPhoenix.

The WilPhoenix was built in 1982 and upgraded in 2011. It can operate in water depths 1,200 feet and drill 25,000 feet. WilPhoenix is contracted to Premier Oil until May 2014, with options to extend the contract another 180 days. The day rate is $315,000, increasing to $351,000 in October 2013, then returning to $315,000 in March 2014.

Awilco is highly profitable at current dayrates, but tight rig supply and persistently high oil prices may bring even higher rates in years to come. When WilPhoenix’s contract ends in mid or late 2014, it will be one of the few rigs available. In its April 2013 presentation to shareholders, Awilco included a chart illustrating the supply situation.

The company also provided a helpful chart showing historical dayrates and supply trends.

If these images are difficult to read, simply click for the full-sized versions.

Awilco’s performance in the fourth quarter of 2012 was its best yet, based on higher dayrates and full utilization of its fleet. For the quarter, the company earned $0.76 per share on revenue of $52.8 million and produced $32.6 million of EBITDA. This EBITDA figure included $3.56 million in provisions for doubtful debt, which will presumably not be a repeating expense. EBITDA excluding the charge was $36.2 million.

With its rigs fully contracted for the next year, its not stretch to assume Awilco can produce earnings of at least $3.04 per share and EBITDA of at least $144.8 million. I say “at least” because these figures exclude the increased dayrate WilPhoenix will earn beginning in October 2013. These projected earnings also exclude benefits from debt reduction and the absence of future doubtful debt charges. Earnings in future years could be even higher if rig supply remains constrained or if oil prices rise.

In the face of these projections, Awilco’s valuation is extremely low. (Again I’ll emphasize these projections are not pie in the sky figures based on breathlessly optimistic assumptions, they are based on Awilco’s actual signed contracts with oil majors.) Awilco has 30,031,500 shares outstanding. The recent trade price of $14.10 yields a market capitalization of $423.4 million. Net debt is $97.7 million. P/E based on conservatively estimated $3.04 per share earnings is 4.6 and EV/EBITDA based on EBITDA of $144.8 is 3.6.

Using these projections and assuming free cash flow approximates net income, Awilco’s annual dividend will be $3.04 per share for a yield of 21.6% on the current share price. Now, the dividend may not reach these heights immediately. Awilco has said it will retain a $35 million cash buffer for operational and capex needs, and it may take time to build this reserve. The company also indicated it will not allow the dividend policy to keep it from pursuing worthy growth opportunities, but said it will continue to pay a healthy dividend even if it engages in an acquisition or another initiative.

Cheap stocks are great, but cheap stocks with a catalyst are better. In a yield-starved world, a 20%+ yielder that is not an MREIT or a wasting asset like a royalty trust will turn some heads. Awilco will pay its first dividend in the first half of 2013. At that time, the company will no longer fly under the radar.

Awilco Drilling does bear substantial risks. Chief among them is the company’s concentration. Because it has only two drill ships, the company is vulnerable to a host of potential issues like operational problems, damage or disputes with the contracting oil companies. With only two revenue streams, a disruption in either would affect earnings severely. Awilco is also exposed to mid-water dayrates, over which it has absolutely no control. Rates have been very strong, but high rates may eventually attract competitors. Alternatively, oil prices could crash and dayrates could tank.

Another issue Awilco faces is the age of its ships. Though they were upgraded in 2011, each ship is three decades old and won’t last forever. In its 2011 annual report, Awilco lists the expected life of each ship as 20 years. As they age, these ships may command lower dayrates or require expensive upgrades.

Awilco’s illiquidity should also be considered. Though it has a market capitalization of $423.4 million, only just over $50 million worth of shares are available for trading. The remainder are held by a variety of banks and pension funds. A related company, Awilco Drilling AS, holds 48.73% of Awilco Drilling. Awilco’s US ADR is traded on the grey market, with a few thousand shares trading hands on a typical day. The company’s primary listing is the Oslo Exchange, where it is slightly more liquid.

I have a position in Awilco Drilling.

One, I like the thrill of the hunt. Finding these tiny but successful companies is a blast and a great antidote to the boredom that comes of hearing the same ten large cap company names over and over again every trading day. Is anyone else already tired of reading about Apple’s bond issuance or JC Penney’s dire straights?

Two, I like being a little different. It’s a wild world out there! The S&P 500 constituents are dull! Why not buy some shares in your local community bank instead? Or in a tiny widget manufacturer and then call up the CFO and shoot the breeze?

Third, the returns! Nowhere else have I found such abundant opportunities to buy companies at a fraction of their listed competitors’ valuations. On average, the investor who pays $1 for an asset will fair much better than the investor who pays $2 for a substantially similar asset.

To illustrate my point, let’s look at a company I own and have written about before, Alaska Power & Telephone. APT shot the lights out in 2012. Here are just a few of the company’s accomplishments.

• Achieved record net income of $2.55 per share.

• Achieved record free cash flow of $5.61 per share.

• Repurchased 10.4% of shares outstanding, reinstated a dividend and grew book value per share by 7.3%.

• Reduced net debt 8.2% to $59.4 million. Net debt/EBITDA and debt/equity are at their lowest in the past decade.

The first quarter of 2012 saw further increases to net income and book value and another $1.3 million shaved from net debt.

Despite this laundry list of accomplishments, APT’s stock price has not so much as budged. Net income continues to rise and net debt continues to fall and the market takes no notice. The result is a company that trades at barely half the valuation of comparable listed competitors.

APT’s revenues are roughly 60% electrical power generation and transmission and 40% telecommunications services. Generating a comparison to peers is as simple as pulling up valuation statistics for utilities and telecom providers and weighting them appropriately.

The chart below compares valuations, yields and leverage for these industries, based on the trailing twelve months. The average telecom services EV/EBITDA multiple is actually 8.32. Since the index includes firms with wireless assets and APT has none, I reduced the  the multiple by 2.00 to 6.32. This aligns fairly well with reality. Even troubled traditional telco Cincinnati Bell trades higher at at 6.86 times trailing EBITDA.

On average, a business that is 60% electrical utility and 40% traditional telco would trade at 8.35 times EBITDA and carry net debt of 3.29 times EBITDA. APT is much, much cheaper.

Despite being only slightly more leveraged than our hypothetical competitor, APT’s valuation on an EV/EBITDA basis is 40.5% lower. To trade at the industry average valuation, APT stock would have to rise to $62.29, more than triple its current price.

All right, so APT does have a few weaknesses. It is geographically confined to an area of low population density and a harsh climate. The stock is illiquid. On the other hand, how many other utilities and telco firms are gobbling up their own shares while also reducing debt and earning record income and free cash flow? Moreover, APT’s power generation facilities are mostly hydro-electric, leaving them immune to the threat of input cost inflation or the environmental issues of coal plants.

Even at just 80% of the valuation of its competitors, APT would be worth $41.18, 111% higher than today’s price mid-point of $19.50.

Many investors view the unlisted markets as the exclusive domain of fraudsters and stock manipulators. And there are those. But there are also scores of profitable, well-run companies waiting to be discovered.

I have a position in Alaska Power & Telephone.

For years, Paul Mueller earned steady profits and paid generous dividends. From 1997 to the end of 2008, the company paid annual dividends of $2.40, totaling an astonishing $28.80 per share. The company’s shares rose precipitously, peaking at nearly $70 in August, 2007. However, all was not well. The company’s tradition of paying out nearly all earnings as dividends had left the company dangerously leveraged. In 2007, as profits peaked, the company’s balance sheet showed assets of nearly four times equity. In 2008, Paul Mueller Company purchased its Netherlands-based licensee, taking on significant debt to do so.

When the financial crisis struck, Paul Mueller’s suffered the same fate as other over-leveraged, cyclical companies. From the 2007 peak at $241 million, revenues plunged 46% to $130 million in 2010. Earnings per share took an extraordinary dive from $7.74 per share in 2007 to negative $7.50 per share in 2010. Simultaneously, the company’s pension liability blew up. Investment losses lead the net pension liability to increase by nearly $10 million in 2008 alone.

With its solvency in doubt, Paul Mueller Company responded by eliminating its dividend and laying off workers. The company also took a serious approach to debt reduction, paying down over $20 million in principal between 2008 and 2011. These steps combined with a recovering economy helped the company back to profitability in 2011.

Apparently unsatisfied with the pace of the company’s recovery, the board of directors parted ways with CEO Matthew T. Detelich in early 2011, eventually replacing him with Mr. David T. Moore. Mr. Moore has proceeded to sell non-core assets, such as the company’s restaurant and brewery in Springfield, Missouri. For 2012, the company’s revenues rose 16.5% to nearly $180 million, while profits held steady at near $2 million, or $1.59 per share.

That’s the story to this point. At a share price of $18, Paul Mueller Company has a trailing P/E of 11.3. However, this ratio is extremely misleading. In 2012, the company was affected by a number of unusual items that depressed earnings. On a normalized basis, the company’s earnings were much higher.

Three major items affected Paul Mueller’s earnings in 2012. First, a decrease in inventory caused a decrease in the LIFO reserved, benefiting gross profit by $227,000. Second, the company settled a compensation with former CEO Matthew T. Detelich for $2.042 million. Lastly, a reduction in a valuation allowance on tax assets of $880,000 helped earnings.

Reversing these unusual items and adjusting for the tax effects of each, Paul Mueller’s normalized earnings are 38% higher than reported, and trailing P/E falls to 8.2.

The story doesn’t end there. A closer look at Paul Mueller Company’s operating segments and the relative prominence and profitability of each reveals a very interesting trend. Paul Mueller has four operating segments: dairy farm equipment, industrial equipment, field fabrication and transportation. The dairy and industrial segments accounted for 86% of total revenues in 2012, and their results could hardly be more different. (Note: the figures for each year in the segment charts below are as reported in that year’s annual report. The company later re-stated some figures, reallocating income and costs. The changes do not materially change the relative profitability of each segment.)

The dairy equipment segment’s revenues and pre-tax profits are up 4.3x and 2.4x since 2002, respectively.  A large part of this growth is the result of the acquisition of the company’s European licensee in 2008, but revenues have grown 49.8% since then. Revenue growth has dropped off in recent years, but pre-tax profits have continued to rise. The division was profitable in every year from 2002 to present. Paul Mueller’s dairy division is a gem.

The industrial equipment division, on the other hand, is a total disaster. From 2002 to 2012, the segment managed only three profitable years. The profits from these three lonely years were not nearly sufficient to make up for the losses of the many losing years. This is not a cyclical business, it is a bad one.

What we have here is consistent losses from a bad business obscuring consistent and growing earnings from a very good business. The good news is Paul Mueller Company has been gradually shifting its focus from its industrial segment to its dairy segment. In 2002, revenues from the dairy segment accounted for 17.8% of total revenues while industrial equipment made up 68.5%. By 2012, dairy equipment had grown to 48.2% of revenues while industrial equipment declined to 37.9%.

While the the losses from the industrial segment have lessened in significance, they are still taking a real toll on the company’s profits. Assuming a 35% tax rate, the industrial equipment segment cost shareholders $1.81 per share in 2012, equal to 10% of the company’s share price. Clearly, solving the issues with the industrial segment could deliver a lot of value. In the 2012 annual report, company President David Moore expressed optimism for the industrial equipment division’s largest product line, noting pre-tax losses were reduced by almost $2 million compared to 2011. Perhaps Mr. Moore’s leadership will allow the company to solve its longstanding problems in the industrial equipment division.

Excluding losses from the industrial equipment division, adjusted for 35% tax, the company would have earned $4.01 per share for a trailing P/E of only 4.5. That’s quite reasonable for a growing manufacturer with a “crown jewel” division.

Backing out one time items and the loss-making division reveals huge earnings potential for Paul Mueller Company. However, this analysis would not be complete without a look at the company’s balance sheet. And unfortunately, it’s not a pretty sight. At year-end, Paul Mueller had shareholders’ equity of negative $1.47 million, net debt of $33.7 million and pension liability of $34.4 million. Ouch! Fortunately, the company also has a hidden asset in the form of a LIFO reserve of $10.7 million.

Even with this reserve factored in, the company’s current ratio is only 1.1. The company’s current ratio has historically hovered around 1.0 without any issue, but the ratio still suggests the company’s liquidity is low. Poor liquidity could make both customers and suppliers nervous in an economic down-turn. The company’s debt is quite high at slightly over three times adjusted EBITDA.

The company’s pension plan is an even more serious issue. Relative to the size of the company, the plan is huge with $66 million in assets versus a calculated liability of just over $100 million. The plan is frozen for domestic workers, but declining interest rates and falling return expectations have caused the pension deficit to balloon into a serious liability. In 2012 alone, the size of the net liability increased by $7.9 million. At present, the pension plan is allocated 55% to equities and 45% to fixed income and other securities, so the stock market’s performance will have a great impact on the size of the pension liability going forward. Bad stock market performance would greatly increase the size of the liability. Higher interest rates would depress fixed income returns in the short run, but would greatly reduce the long-term pension liability through increased discount rates.

Investors must assess whether Paul Mueller Company’s earnings potential outweighs its balance sheet woes. If Paul Mueller Company can reduce its indebtedness, get its pension under control and make progress in the industrial equipment division, its stock could be a spectacular investment. For example, if the company can grow its dairy division at 5% annually and reach break-even in industrial equipment in three years, 2015 earnings per share would be approximately $4.72, assuming all other divisions and corporate costs remain exactly the same. An 8x multiple on these earnings would yield a stock price of $37.77, 110% higher than today. These ifs are big ifs. Another recession could send the pension deficit soaring and stress the company’s ability to service its debt.

While I am enticed by Paul Mueller Company’s hidden earnings and successful dairy division, I am staying out until I see evidence of a balance sheet transformation. This company is one to watch from the sidelines, at least for now.

No position.

Trans World has a consistent history of profits, but earnings declined 39% in 2012 to 18 cents per share. The decline was largely the result of the Czech Republic’s new taxes on gambling revenue and profits. Beginning in 2012, taxes were changed from a graduated scale to a flat 20% of company gambling winnings and 19% of adjusted net income. The company also blamed the 2012 Euro Cup for temporarily depressing revenues.

At a share price mid-point of $2.55, Trans World has a market capitalization of $23.0 million versus book value of $41.2 million. Price-to-book ratio is 0.56. Price-to-trailing earnings is 14.2. Trailing return on equity was an anemic 4.8%.

Against this backdrop, two micro-cap investors see significant opportunity. These investors are Lloyd I. Miller, III and Wynnefield Capital. Mr. Miller has a long history of investing in micro-cap and unlisted stocks, including Great American Group, Emerson Radio Corp and Capstone Therapeutics. Wynnefield Capital has a similar focus.

As of April 18, Wynnefield and Miller have succeeded in buying up 50.7% of shares outstanding, giving them effective control of the company. Funds managed by Wynnefield own 26.6% and Miller owns 24.1%. Both investors are active, having filed schedule 13Ds. In its 13D filing dated November 14, 2012, Wynnefield explains its rationale:

The Wynnefield Reporting Persons believe that while the Issuer possesses a superior management team, it is apparent to the Wynnefield Reporting Persons that the Issuer lacks the critical mass required to allow the Issuer’s shares of Common Stock to trade meaningfully above its current depressed market price. In light of the Issuer’s past unsuccessful efforts to raise capital through the issuance of debt securities, the Wynnefield Reporting Persons have urged the Issuer’s Board of Directors (the “Board) to continue to seek alternative ways for enhancing stockholder value without diluting existing stockholders or otherwise consider selling the Issuer.

Wynnefield’s contention is straightforward: Though its management is capable, Trans World’s small size makes its existence as an independent entity sub-optimal for shareholders. If Wynnefield is correct, Trans World’s value could be much higher if sold to a larger competitor rather than run as an independent company.

Wynnefield’s claims can be tested by comparing Trans World’s revenue growth and operating margins with its larger competitors. If Trans World’s small size truly is holding it back, the handicap could manifest as below-average revenue growth, poor operating margins or both. The chart below compares Trans World’s results with casino companies with over $1 billion in revenues. Revenue growth is presented on a per share basis to correct for large mergers (and businesses that choose to return capital to shareholders versus reinvest it for growth.) Operating income is adjusted for one-time gains or losses and pre-opening/development costs.

This brief look suggests Wynnefield’s argument may have merit. Trans World’s revenue growth has lagged competitors, and its operating margins are below average. Of course, these figures do not take into account geographic differences. Las Vegas Sands and Wynn each operate in the booming China/Macau markets. Economic conditions on the ground in the Czech Republic may be very different. The Eurozone’s economic troubles are well-known. Perhaps Trans World’s lackluster growth couldn’t be helped.

Regardless, Wynnefield and Lloyd Miller clearly have plans for Trans World. Probably the simplest means of realizing value would be to shop Trans World and sell to a strategic or financial buyer interested in the European casino market. Taking over existing facilities would almost certainly be more cost-effective than lobbying governments for new licenses, and would avoid years of expenses while new construction was completed. If these activists were to succeed in selling Trans World at book value, investors at current prices would reap a gain of 79%. On the other hand, investors should be aware that Europe’s economic woes and the new Czech taxes could lessen Trans World’s attractiveness to competitors and result in a lower deal price, or a lengthier sales process.

No position.

Decker Manufacturing is a true dark unlisted company. Decker does not file SEC reports or even provide quarterly or annual results on its own website. Investors in Decker must wait for the company’s physical annual report to show up in the mail. (The company might be willing to send information in response to requests, but I did not attempt this.) My annual report arrived on Monday. In addition to being one of the most informative and well-organized reports I have ever seen, it revealed a banner year for Decker. Revenues and earnings hit new highs, and the balance sheet grew stronger than ever.

Revenues for 2012 rose to $34.17 million, up 9.6% from 2011. Earnings leaped to $2.28 million, up 56.1%. The company provides a five year income statement history in the annual report, which I have reproduced.

The financial crisis of 2008 and 2009 did a number on the company’s sales and profits, but Decker has bounced back in a big way. From 2003 to 2012, Decker Manufacturing grew its top line at a very respectable 5.9%.

Decker Manufacturing’s balance sheet is extremely strong and liquid. The company owns $10.5 million in cash and marketable securities, nearly half its market capitalization of $22.6 million. Total liabilities are $6.8 million and include notes payable of $4.2 million and a pension liability of $0.44 million. Ordinarily, pension plans at small manufacturing companies make me very nervous. However, Decker’s pension plan is closed to new participants and the return assumption of 7% is much more reasonable than many plans. The net pension liability amounts to  4.0% of shareholders’ equity and does not give me pause.

The company’s marketable securities are worth just over $7 million, and are split roughly equally between fixed income mutual funds and equity mutual funds.

Decker Manufacturing uses its marketable securities as a a sort of “ballast” for rough economic conditions. Even in 2009, when sales declined 32.4% and profits plunged to zero, the company paid a $1.00 per share dividend, funded from its reserves. Dividends seem to be somewhat of an obsession for Decker. Since 2008, the company has paid dividends of $9.20 per share, worth about 25% of the current share price.

Decker earned a return on equity of 12.4% in 2012. Good, but not world-beating. However, Decker’s equity base is inflated by its mutual funds and excess cash. The current ratio is 3.3, indicating more than sufficient liquidity. If Decker returned its entire $7 million investment in marketable securities to shareholders, the current ratio would drop to a still healthy 2.3 and shareholders’ equity would fall to $12.4 million. On a backward-looking basis, return on equity would jump to a much more attractive 18.4%. Decker’s excess capital is hiding a high-quality business. If Decker reduced its dividend payout to 50% of earnings, I am willing to bet it could find some worthwhile projects to invest in.

Decker Manufacturing’s share price mid-point is $37, giving the company a trailing P/E of 9.9. Net of cash and securities, the P/E is much lower.

While it’s no once-in-a-lifetime bargain, Decker looks attractively priced. At the current earnings yield of 10.1%, even modest annual growth could push annual returns well north of what broad market indexes can offer.  The company’s significant excess capital limits the risk of insolvency and provides some optionality, should the company ever decide to use it more productively. Decker Manufacturing’s chief risks are its tiny size and strong ties to the American industrial sector, which will inevitably experience booms and busts.

I own one share of Decker Manufacturing.

Care Investment Trust

In January, 2013, Care Investment Trust entered into an agreement to merge with its parent company, Tiptree Financial Partners, LP. The combined company will not retain Care’s REIT status and will attempt to list on a national exchange. The transaction is somewhat convoluted and it is difficult to assess whether or not it is fair to minority shareholders. One thing is for certain, and that is Tiptree would not be going forward with the transaction if it weren’t advantageous for its own partners.

Care continues to trade at a discount to book value, perhaps because of the company’s difficulty in finding a productive use for its large cash reserves. One attempted purchase of senior housing properties ultimately fell through, sending the company back to square one. On February 8, 2013, the company announced a joint venture created to purchase two senior living properties, but this deal has not yet closed.

Until investors gain better clarity on the company’s financials and prospects post-merger, I can’t see the stock making any significant gains.

Reserve Petroleum Company

Since my writeup in early June, 2012, Reserve has earned $19.94 per share and paid out $10 per share in dividends. Net oil and gas properties rose from $80.26 per share to $89.96. Despite solid performance, Reserve’s share price hasn’t budged. In fact, the company’s total return is -2% since last June, trailing the S&P 500 Index by 21%. Maybe the market is unhappy with Reserve’s $111 per share in uninvested cash and securities, but I suspect the company is simply ignored and forgotten. The broad market’s gains make Reserve’s valuation even more attractive.

Unilens Vision

Unilens is another flatliner, returning 0.13% since last July and trailing the S&P 500 by a wide margin. Unilens’ profits have slipped as royalties from Bausch & Lomb have diminished. The company has cut debt and managed to maintain its lofty dividend, but the market is clearly not confident in the company’s future. However, better times may on the horizon Unilens recently cut a new royalty agreement with Bausch & Lomb that extends its current contract and also adds the company’s new multifocal contact lens, which are being rolled out nationwide for the first time. With the revenue stream looking more secure and a new product in the marketplace, perhaps Unilens can reverse its revenue declines.

Rockford Corp.

Since Peter Kamin’s board shakeup and a tender offer for almost 25% of shares outstanding, Rockford has been as secretive as they come. Beyond a few product-related announcement, the company has not provided any financial information since October, 2012. Last April, the company announced both its annual and first quarter results. Investors should be starting to wonder about the company’s commitment to transparency.

While they may have a legitimate complaint regarding the secrecy, shareholders certainly cannot complain about the returns. Since last September, Rockford is up 37.6%.

Spindletop Oil & Gas

Sometimes all it takes is a little attention from the market for a company’s share price to rocket. Spindletop is a poster child, rising 75% in just under seven months. Earnings have been solid, and the company has repurchased over 700,000 shares. But it seems like a stretch to ascribe Spindletop’s huge gains to these factors alone. The company went from trading at 90% of book value in September, 2012, to trading at 158% today, without significant changes in its business outlook or strategy. Such is life with these unlisted companies. The cheap ones can languish for months or years, only to rocket without notice.

Chesapeake Financial Shares

Chesapeake remains a well-run, highly profitable bank and financial services business that receives far too modest a multiple. 2012′s earnings per share were up 7.6% from 2011 and up 14.9% compounded since 2008, yet Chesapeake trades at 7.5 times earnings and 92% of book value. In November, 2012, the company raised its dividend to 12 cents per quarter. I’m happy to hold onto Chesapeake shares for however long it take for the market to recognize the quality of its operations and its track record of growth and increasing dividends.

I’ve written about plenty of other companies, but I want to give them a little longer to see how they fare before revisiting them. Posting has been a little slow lately due to work demands and some travel, but expect new content soon, including a look at an over-capitalized, highly-profitable small manufacturer, and a turnaround story where losses from weak business lines are hiding big profits and growth at the company’s crown jewel operation!

I hold shares of Chesapeake Financial Corp.

Many companies and government agencies still depend on software systems and programs created decades ago, written in programming languages that are no longer used. Enabling newer software and hardware to “talk” to these legacy systems involves additional time and expense for IT staff and developers. At some point these costs become unmanageable and it’s time to replace legacy systems or at least develop workarounds. That’s where companies like Information Analysis, Inc. (or “IAI”) come in. Information Analysis’s staff specializes in modernizing obsolete software systems and transferring processes away from retired software. IAI also creates web-based programs that can replace PC-based software.

IAI’s largest client is the US Government, which accounted for 87% of revenues in 2012. Such a concentrated revenue base is a large risk. The company notes that contracts made with the US Government are generally less profitable than contracts with private industry, and contain many provisions for cancellation or changes.

Information Analysis, Inc. has been profitable in 8 of the last 10 fiscal years, and free cash flow positive in 7 of those years. Revenues have trended downward since 2005, but have been relatively stable since 2008.

Margins analysis is very revealing. From 2008 to 2012, IAI was very successful in signing higher-margin contracts and reducing low-margin business lines like software reselling. Gross margins improved from 25.04% in 2008 to 34.16%. Though 2012 revenues were only $370,000 higher than 2008 revenues, gross profits were higher by $730,000! However, that’s where the good news stops. All of the company’s growth in gross profit has been eaten up by increases in operating expenses. IAI’s operating margin for 2012 was a downright pitiful 1.42%, the lowest of any profitable year in the last decade. IAI has a problem with operating expenses, which rose to 23.9% of revenues in 2012 from 20.0% in 2011. The company explained the increase as the result of non-productive labor expenses in its annual report:

“The increase is primarily due to increases in non-revenue-producing labor costs. These consisted of an increase in overhead labor related to periods of U.S. federal government customer budget uncertainties and to a short-term business development project that did not yield anticipated results.”

The Fiscal Cliff and a failed sales initiative. These may be temporary issues, but Information Analysis, Inc.’s high operating costs still leave it perilously close to break-even.

Declining margins and dependence on government revenues may paint a bleak picture, but IAI’s real value is in its balance sheet. The company is simply loaded with cash. Cash makes up 72.8% of total assets and is 53% greater than the company’s market capitalization. IAI carries very little in the way of fixed assets and has no long-term liabilities.

Information Analysis, Inc. has net current assets per share of 18.7 cents. On a discounted basis, net current assets stand at 17 cents per share. (I used a very low discount for IAI’s receivables because they are nearly all government obligations.) IAI’s current share price mid-point of $0.1525 represents a discount of 10-19% from the value of its net current assets.

IAI’s large cash balance is both an opportunity and a risk. Insiders own 25.7% of shares, so presumably they are interested in using this cash productively and increasing their own wealth. Whether or not they invest this cash wisely will determine the company’s future and the returns investors will experience.

Like most businesses that trade below the value of their current assets, IAI faces its share of obstacles and risks. However, like JLM Couture, Information Analysis could make a solid addition to a diversified basket of stocks trading below their NCAV values.

I own shares in Information Analysis, Inc.

Many of the more communicative companies I have discussed on this blog have already provided their quarterly or annual reports to the public. Now is a good a time as any to take a look at those companies, and to do some housekeeping on the “Idea Tracker” list. Because I’ve written up over thirty companies so far, I am going to break this list into four parts.

QEP Company

QEP Company has been disappointing to say the least. When I originally profiled the company, QEP was experiencing sales and earnings growth and was steadily reducing its debt. Then trouble struck at the company’s largest customer began squeezing QEP’s margins before eventually informing the company it would be ceasing purchases of certain products beginning in fiscal 2014. QEP has responded by acquiring multiple smaller companies in an effort to expand its product lines to recover lost margins, increasing its debt along the way.

QEP continues to profit, but its outlook is murky and will depend on the success of its acquisitions. I will be monitoring the company closely for stabilization in its gross margins and discipline on its levels of debt. If either trend continues to deteriorate, the company will be removed from the ideas tracker, presumably as a failed idea.

McRae Industries

McRae, on the other hand, has been exceptional! Mcrae’s business is robust, chalking up orders from the US and Israeli governments while seeing its Western-style boot lines remain popular. The company has been generous with shareholders, paying regular and special dividends and repurchasing stock. And its share price has been on fire, providing a total return of 92% in just 14 months. McRae’s valuation remains reasonable at 9.4 times trailing earnings and 1.04 times book value. The company has no debt and holds $11.65 million in cash, equal to 21% of its market capitalization.

My only criticism of the company is its recent decision to invest in land. Land investments are highly unlikely to provide a return in excess of the company’s cost of capital. I’d much rather see the company increase its dividend or better yet, buy back stock. However, the company’s land investment is small in comparison to its balance sheet and shareholders certainly cannot complain about recent returns. McRae’s valuation still looks attractive, but the company is no longer as extraordinarily cheap as it was last year.

Webco Industries

Webco has suffered from slowing demand and challenging pricing, resulting in reduced profits. However, free cash flow has been strong and has allowed the company to reduce debt from $103 million in October, 2011 to $76 million in January, 2013 . The company completed its new $55 million plant in Sand Springs, Oklahoma in mid-2012. With this large capital project completed, future cash flows can be devoted to further debt reduction or additional projects.

Webco’s EV/EBITDA of 4.76 and P/E of 6.4 are very reasonable, though they are based on trailing figures. If the steel market does not pick up soon, these ratios will rise. The company now trades at 62% of book value despite a strong record of profitability. Even though the short-term steel market may be challenging, Webco’s discount to its assets strong track record may still appeal to long-term investors.

Alaska Power & Telephone

AP&T continues to hum along, gradually reducing its leverage and churning out profits. Since I originally wrote, AP&T’s equity-to-assets ratio has improved from 27.3% to 28.2%. Modest, but moving in the right direction. Net debt has declined from $61.7 million to $55.9 million. The company quietly re-instated a dividend in October, 2012 and now yields 2.2%. Trailing P/E is 8.4, which is low for a utility company in a low interest rate world. Free cash flow generation for the trailing four quarters was very strong, amounting to 22.9% of market capitalization.

AP&T’s annual report will be out later this month and I expect more of the same. Alaska Power & Telephone is not going to double or triple overnight, but the company makes a good lower-risk holding.

Steel Partners Holdings, LP

Steel Partners uplisted to the NYSE in April, 2010, so I don’t keep up with the company like I used to. Net asset value for the partnership at the time of my writing was $18.02 per unit. Steel Partners no longer reports a monthly NAV, but the company’s 10-K reports partners’ capital per unit of $17.13. Part of the decline is due to a large number of units issued per a management agreement. Warren Lichtenstein has been busy, acquiring Steel Partners’ control of companies including Steel Excel and DGT Holdings.

Units currently trade hands at $13.25, a 22.7% discount to partners’s capital per unit. An investment in Steel Partners Holdings is a “jockey” bet that Mr. Lichtenstein can repeat his historical success, and that he will treat shareholders fairly. Investors must also hope Mr. Lichtenstein’s attention is not diverted by relationship drama, as Google informs me he and reality TV “star” Bethenny Frankel may be an item.

Advant-E Corp.

Speaking of drama, the reverse split debacle with Advant-E Corp. seems to have faded, at least for now. The abusive reverse split scheme concocted by the company’s management was yanked only 13 days after the company’s 13E3 document was filed. Perhaps the company feared a class action by disenfranchised shareholders? I’m not against reverse splits, when the compensation to be received by small shareholders is fair. Advant-E’s proposal was not remotely fair. In its annual report, the company indicates it still plans to go ahead with a plan to reduce its shareholder base and deregister with the SEC. Let’s hope the new plan will adequately compensate all investors.

Corporate actions aside, Advant-E continues to thrive. In 2012, revenues rose 5.4% and profits rose 16.9%. The company repurchased 10% of shares outstanding and paid a 2 cent special dividend. The trailing P/E is now 7.7 and 6.4 net of cash.

Detrex Corp.

Detrex Corp. continues to lavish shareholders with dividends, paying out a total of $4.25 in dividends since the sale of its Harvel Plastics subsidiary. Unfortunately, earnings have been less rosy. Pre-tax income for the quarter ended September 30, 2012 declined 51% from a year earlier and environmental remediation costs rose. The company assured investors its finances are strong and indicated it is “exploring strategic opportunities to enhance shareholder value.” In November, Detrex added John C. Rudolph of Glacier Peak Capital to its board of directors.

The crux of Detrex’s valuation is its environmental liabilities. At present, environmental expenses are holding down operating income to the tune of $3 million per year. Take that away and you have a much, much more profitable enterprise. Detrex’s environmental issues will eventually be resolved, but the question is how much more in earnings will be consumed first? Investors looking forward to the eventual resolution of these environmental issues may find a very cheap, high quality manufacturer in Detrex.

Siem Industries

Siem’s share price has risen with the market, up about 16.5% since my writeup. The company continues to suffer from the conglomerate discount, as well as from its extreme illiquidity. The value of Siem’s publicly-traded holdings has declined modestly to $125.29 per share. A large part of the decline stems from the Norwegian Krone’s decline against the US Dollar. Still, the value of these holdings is 66% higher than Siem’s recent trading price.

In late 2012, Siem took action to monetize a portion of its largest holding, SubSea 7. Siem sold $445 million in 1% senior secured exchangeable bonds. These bonds are exchangeable for SubSea 7 stock at a price 30%+ higher than SubSea 7′s trading price. The bonds are due in 2019. This is essentially a bond issue combined with a covered call, and it seems like a great move for Siem. By issuing the bond, Siem gets to play with $445 million for six years at a cost of only $4.5 million per year. Yes, the company may have to part with shares in SubSea 7, but only at a large premium to current prices. Even if Subsea 7 shares do appreciate enough for bondholders to exchange, Siem will retain 62.3% of its SubSea 7 shares and the $445 million in cash.

Siem Industries shares trade at 56.8% of book value. What is would take to close this gap is unclear. Share repurchases are not an option given Siem’s illiquidity and the fact that Christian Siem already owns more than 90% of shares outstanding. Investors in Siem must be content to let value be its own catalyst.

Mestek, Inc.

Of all the companies that declared special dividends in late 2012, Mestek may be the most generous of all! Mestek bestowed shareholders with a massive $3 per share dividend, thanking them for their loyalty and patience through a difficult period in the machinery and construction markets. Meanwhile, Mestek has delivered solid performance, earning $11.23 million ($1.51 per share) in the four quarters since my post on the company. Mestek’s trailing P/E is 9.4. When the market for Mestek’s products eventually turns around, that ratio could drop quickly as earnings increase. Until then, an investment in Mestek looks quite reasonably priced. Plus, one could hardly ask for a more shareholder-focused management team.

I own shares in Webco Industries, Alaska Power & Telephone, Advant-E Corp., Detrex Corp. and Mestek Inc.