ALJ Regional Holdings Makes Progress – ALJJ

Back in August I wrote about ALJ Regional Holdings, a leveraged equity situation with high return potential. Shortly after I wrote the post, ALJ released its June 30 quarterly report which once again showed the company turning a healthy profit and reducing its debt load.

For the quarter ended June 30, 2012, ALJ made $2.52 million in net income and produced EBITDA of $4.07 million. Operating cash flow for the quarter was $6.74 million, driven by strong operating results and decreased net working capital.

ALJ used this cash flow to make further reductions to its subordinated debt, cutting it by 17.8% from last quarter. The result is a continued strengthening of the company’s balance sheet and a reduction in net debt to trailing EBITDA.

Total interest-bearing liabilities were reduced by 13.33% from a quarter ago. At 2.38 times trailing EBITDA, the company’s net debt load is the lowest it has been since beginning operations in 2006.

Despite this progress, the market has not rewarded ALJJ. Since my post, shares are down 12.1%.

ALJ Regional Holdings now has an enterprise value of 3.69 times trailing EBITDA, compared to 4.16 times when I originally wrote about the company. If the company continues to operate profitably and work off its debt, sooner or later the market will wake up and give the company some credit for the path it’s on.

For now, I view the dip in the share price as an opportunity to get in on a rapidly transforming company at an even higher expected return than when I first wrote about it.

 

Disclosure:  No position.

 

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10 Responses to ALJ Regional Holdings Makes Progress – ALJJ

  1. bear says:

    Hi there, thanks for the informative article on McRea incidentally I just wrote my own article after I opened a position. Your comments about ROIC gave me an additional point of view.

    thanks and I look forward to scouring your site for more ideas
    ps. my article is http://bovinebear.blogspot.com/2012/09/why-i-own-mcrae-industries.html

  2. clownbucks says:

    The stock looks certainly cheap. However, I noticed that KES has not spent a single $ on Capex for quite a few years now. The mill itself appears to be on the books for almost nothing 2.2M$, probably because it’s value was written down in the bankruptcy, but I wonder how they can stay competitive, without investing anything.

    There is significant dilution going on, as evident in the high single digit % increase in share count. Last year, the sharecount increased from ~53M to 57M shares. it creates headwind for the intrinsic equity value increase.

    They wrote down an investment in Bellator a early stage martial art company. While the writedown is only 150k, i wonder if somebody uses ALJJ as a piggy bank for personal ventures. Certainly a steel mill like ALJJ/KES should not be involved any ” early stage martial art development enterprise”.

    • otcadventures says:

      A few points in response to your comment.

      1. The lack of capital expenditure concerned me too. Obviously, an un-maintained mill will eventually cease operating and lose all economic value. Fortunately, this is not the case. The company explains in its annual report that regular maintenance on its plant is treated as part of general expenses, not capital expenditures. The reason for this is that the company is not attempting to expand its capacity, only maintain current operations. So even though capital expenditures do not appear on the statement of cash flows, the company is certainly spending the funds necessary to keep things running smoothly.

      2. As far as the dilution goes, in multiple instances shares have been issued in return for cancellations of debt and preferred stock and accrued interest. Reductions to these liabilities are a source of real value for shareholders. The dilution seems to have ceased and in fact diluted shares outstanding fell quarter-over-quarter as the company’s stock repurchase plan went into effect.

      3. Bellator was obviously a poor investment. I would imagine the investment was at the direction of Jess Ravich. Given Mr. Ravich’s success in turning the company around, I am inclined to forgive him the mistake. The company has not made further un-related investments since.

      • clownbucks says:

        >>The company explains in its annual report that regular maintenance on its plant is treated as part of general expenses, not capital<<

        Capex and maintenance is somewhat different. If you buy a let's say 1M$ price piece of equipment with a service life of 10 years, I don't accounting rules even allow to expense it directly, it has to be capitalized. So it seem that ALJJ does not make large capex investments. it does not seem plausible, to me that you can run something like a steel mill without a large Capex item here and there. Even in a steel mill, some large equipment will have to be completely replaced at some point, or new equipment purchased to improve operations. The fact that they are nit doing this means, that they are effectively liquidating their mill, or deferring pot. Huge Capex investments to a later date.
        If you see any other steel company that can stay competitive without capex, let me know. It's not plausible that ALJJ can continue what they are doing for a long time.

        • otcadventures says:

          While I doubt the company’s facilities are on the verge of breaking down, I do agree with you that capital expenditures will be needed to maintain operations. Average depreciation over the last three years was $574,000. If that’s a reasonable assumption of needed capital expenditures, the present value of these costs at a 12% cost of equity and 3% annual growth is $6.57 million. That’s a material figure, but it only knocks a little over 10% off what I think the company’s intrinsic value is, which is more than twice the current market capitalization.

          If ALJJ were more richly valued, I would be more concerned. I do appreciate the contrary voice.

          • clownbucks says:

            My google search indicates that a Minimill cost about 300$/ton capacity to build. That would mean a 60M$ replacement cost for ALJJ 200,000 ton capacity mill. If I assume straight 30 year depreciation, this would be. 2M$/year depreciation or maintenance capex. the above are all my estimates and I don’t claim to be an expert, but 600k in maintenenace Capex sounds way too low.

  3. bear says:

    Do you ever cover microcaps traded on Nasdaq?

    • otcadventures says:

      At the moment the OTCBB and pink sheets have more than enough opportunities to keep me busy. However, I can’t rule out expanding my universe of coverage to micro-cap and illiquid securities that are exchange-traded in the future.

  4. DTEJD1997 says:

    Any thoughts on ALJJ releasing revenue figures earlier today?

    It appears this latest quarter revenue was down to $33.5MM vs. $45.9MM in the year ago period.

    According to John Scheel, ALJ’s Chief Executive Officer, “The slight revenue drop for the fiscal year was solely due to the last quarter in which we saw sizable declines in scrap and product pricing as well as in demand, particularly for SBQ and service center products.”

    With as large a revenue drop as this, I’m going to guess that they would be booking a loss for this latest quarter…

    That’s a big let down. I was hoping to possibly invest in this, now I’m not so sure…

    • otcadventures says:

      It’s certainly not a good report, but I don’t think it’s as bad as it appears at first glance.

      Back in the Q4 2010, the company managed just $32.67mm in revenue with a gross margin of 11.73%. If we assume a 12% gross margin in the most recent $33.5mm quarter (which I think is reasonable given that recent quarters have managed a 15% gross margin) then that leaves gross income of $4.02 million. Selling expenses were $0.53mm last quarter, which I can’t see rising on lower gross sales. SG&A expenses were $1.83mm, which I’ll pump up to $1.9mm to be conservative. That leaves operating income of $1.59mm. Net interest expense was $0.79mm, which will decline this quarter. I think $0.75 is a reasonable estimate. So there we have pre-tax income of $0.84mm. Minority interest and taxes will be lower based on these lower profits. Last quarter these amounted to 21% of pre-tax income. Even if these rise to 40% of pre-tax income this quarter, that would still leave net income of just over a half million dollars, or nearly 1 cent per share.

      Of course, that’s not a good result. But it’s still a profit. The company has weathered tough operating conditions before and still succeeded in deleveraging the balance sheet. I added shares yesterday on the decline and I’ll add more if the stock moves down again.

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