Detrex Corp.

Dextrex manufactures lubricant additives and hydrochloric acid at two plants in the Midwest. After the recent sale of its plastics subsidiary, Detrex is extraordinarily overcapitalized and ripe for a takeover or other strategic transaction.

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Detrex sells its specialized additives and highly purified acid command a healthy margin, making the company strongly profitable. Unfortunately, the company has been afflicted by ongoing environmental charges related to past activities at the company’s former manufacturing sights. There is not telling how long these charges will continue, but they have not stopped the company from putting up strong profits. Here’s a look at Detrex’s 2011 results, with and without the environmental charges.

While strongly profitable in 2011, Detrex has the potential to be nearly twice as profitable in the future if environmental charges abate.

Detrex has an impressive balance sheet to go along with its strong operating results. The company received after-tax proceeds of $30 million from the sale of its plastics unit in January 2012, which it used to pay off bank debt and pay a special dividend. Most of the cash remains on the balance sheet as the company considers its alternatives.

At an enterprise value of $15.26 million, Detrex trades at 2.79 times EBITDA and 3.44 times operating income. By comparison, other specialty chemical companies with similar margins trade at much higher multiples.

On average, similarly profitable specialty chemical companies trade at significantly higher EV/EBITDA and EV/Operating Income multiples. Detrex’s tiny size and poor liquidity merit a discount from competitor averages, but not of this magnitude.

The chart below summarizes Detrex’s value per share under a number of different EBITDA and valuation scenarios.

Even assuming that future environmental charges go up by 50%, any reasonable valuation multiple gives a share value for Detrex well above the current $16.14 bid/ask mid-point. Assuming a constant EBITDA and a 6.0x EV/EBITDA multiple (76.5% of peer average) gives a share value of $26.51, a 64.3% advance from current levels. Any future reduction in annual environmental charges would only increase the company’s fair value.

While investors wait for Detrex’s value to revert to the mean, they will be rewarded with a 25 cent per quarter dividend that Detrex initiated this month. This 6.2% yield will add meaningfully to Detrex’s total return.

Risks to investors include the possibility that Detrex will be found liable for hugely costly additional environmental cleanups, or that management will squander excess cash on a poor acquisition.

Disclosure: Detrex Corp. is one of my portfolio’s largest positions and I plan to buy more share in the near future.

Empire Resources

Empire Resources acts as a broker of semi-finished aluminum products for companies in the United States, Canada, Australia and New Zealand. The company sources aluminum products from a diverse base of suppliers and from its own inventory. Empire Resources also provides logistical coordination and market intelligence for its clients. The gross margin on these aluminum sales has ranged from 4.78% to 7.78% over the past decade. This margin can be thought of as the “commission” the company charges its clients.

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Company Website

Here are the company’s fiscal results for the last ten years:

On the whole, the 2000s were an extraordinarily successful decade for Empire Resources. The company grew revenues at an annualized rate of 13.3% and was profitable in every year except for fiscal 2009 when the financial crisis cratered aluminum demand. The company responded by cutting costs, shrinking the balance sheet and de-registering from the NASDAQ. Since then, the company bounced back strongly and just achieved record revenues in the twelve trailing months.

Now for a glance at the balance sheet and some ratios:

Empire Resources rewarded shareholders richly over the past decade, growing book value per share rapidly. Over the last decade, Empire Resources compounded book value per share at 13.1% annually. Remarkably, this figure after paying a generous dividend each year since fiscal 2003. When dividends are factored in, management achieved an IRR on equity (internal rate of return) of an astounding 28.5% annually.

So far, everything is great. However, a careful reader might notice a couple troubling data points above.

1. Net income in the twelve trailing months is down 40.7 from fiscal 2010! The reason for the large decline in profits is the expiration of the “Generalized System of Preferences” (GSP) on December 31, 2010. The GSP is a government program that reduces duties and tariffs paid on imports of certain goods from many nations, including many of the products Empire Resources imports from around the world. The expiration of the GSP had a large effect on the gross margin the company realizes on its sales to customers. Fortunately, Congress has reauthorized the GSP retroactive to January 1, 2011. President Obama signed the bill into law on October 21, 2011. Empire Resources is entitled to a large refund of tariffs paid while the GSP was not in effect.

This large upcoming refund is not reflected in the company’s current financial statements,  which end before the GSP was reinstated. In my opinion, the market doesn’t see it coming either. The company will be able to revise profits in the past three quarters upward significantly, which will take care of that alarming earnings decline.

2. Book value per share declined by 15% since the end of fiscal 2010 as diluted shares outstanding rose by 27.9%! The reason for the seeming loss of value is a large, forward-looking transaction the company has undertaken. By Empire Resources’ own admission, the company sometimes finds itself at a cost disadvantage in acquiring aluminum relative to its larger competitors. The company’s response to this issue was to raise $12 million in convertible debt and then loan the money at zero interest to PT Alumindo Light Metal Industry Tbk, an Indonesian aluminum producer. PT Alumindo is using the cash to expand its facilities and increase production capacity. (I cannot claim any special expertise in evaluating Indonesian aluminum foundries, but the company seems legitimate. The website is here.) In return for the loan, Empire Resources received a long-term contract for a supply of attractively-priced aluminum products from PT Alumindo. When construction is complete, Empire Resources should be able to realize a larger gross margin on its sales, greatly helping profitability.

That the transaction results in dilution is unfortunate, but company insiders put up some of their own money to purchase the company’s subordinated debt. Combined with insiders’ 42.6% ownership of the company, I think shareholders can feel confident that management sits on the same side of the table and they are doing as they see fit to increase the value of the business in the long run.

Empire Resources has a market cap of about $37.6 million. The company’s P/E ratio based on trailing earnings is 6.9. Once again, those earnings are without the benefit of the reinstatement of the GSP. If adjusted earnings for 2011 turn out equal to 2010’s profits, the company’s actual P/E ratio is just 4.1. Empire Resources trades at 87% of book value and a dividend yield of 3.2%.

Empire Resources goes unnoticed and unloved by the market, but that may be changing. Management plans to re-list the stock on a national exchange, which should bring a lot more attention to the company’s strong profits and growth.

Things could go wrong. The company’s clients could choose to disintermediate and purchase directly from producers. An aluminum glut could reduce gross margin to almost nothing. The partnership with PT Alumindo could go badly, leaving the company without its dedicated supply and with increased debt. However, management run the company well for many years and I expect they will continue to do so.

 

No position, though I may purchase shares with 24 of this posting.

 

Advant-e Corp.

Advant-e (ticker:ADVC.OB) designs software for document capture and transfer-those unsung applications that keep companies organized and efficient. It is not a sexy industry. But it is a profitable and necessary one. In addition, corporations are loathe to change software providers as long as the software works well enough, which provides an economic moat. Ever worked for a company that has decided to change software systems on the fly? It’s painful and irritating.

Advant-e has two operating divisions, Edict Systems and Merkur Group. Edict Systems creates web-based applications, while Merkur Group’s products are software-based. It should be not a surprise that Edict Systems’ revenues have been rising healthily while Merkur Group’s sales have been only modest increases in recent years. Overall, the company has a very strong record of growth and profitability. Here’s a look at Advant-e’s historical results:

Over the past decade, Advant-e’s sales grew by an amazing 23.8% annually. However, annual sales growth slowed to 12.6% annually over the last five years and just 4.9% year over year. A lot of the slowdown can be attributed to the economic crisis, but it’s unlikely that sales growth will rebound to previous levels.

Advant-e’s growth did not come at the expense of margins. The company was successful in increasing margins all the while, hitting all-time highs in the last twelve months. Free cash flow has tracked higher right along with net income, effectively equaling or exceeding net income in each of the last four years.

The company’s balance sheet is as strong as ever with no debt and significant cash reserves:

Advant-e has responded to its slowing growth and continually increasing cash reserves by initiating an annual dividend of 1 cent per share, as well as a special additional 1 cent dividend in 2011.

Despite hitting record sales and earnings figures and paying a healthy dividend, Advant-e trades at a very modest valuation:

Advant-e has an earnings yield of 11.3% and a free cash flow yield of 12.8% without adjusting for excess cash. If the company can manage even a modest growth rate of 3-5%, investors are looking at the possibility of very attractive returns. In the meantime, investors benefit from a 4.4% dividend yield with a good chance of dividend increases or additional special payouts.

Are there risks? Absolutely. Advant-e is a tiny company in a crowded industry. One botched software edition roll-out or a larger competitor entering the field could have a severe impact on revenues or profitability. Advant-e is also a controlled company with CEO Jason Wadzinski owning a slight majority of shares outstanding. If Mr. Wadzinski wants dividends, that is what you get. If not, tough. The company has disclosed a few related-party transactions, none of which seem inappropriate.

Despite these risks, I view Advant-e as a growth company trading at a value price. Like many of the other stocks profiled on this blog, Advant-e Corp. trades with little volume and a wide bid/ask spread. Anyone attempting to buy in should use limit orders and more than a little patience.

No position.

Steel Partners Holdings, LP

Steel Partners Holdings, LP (“SPH”) offers a rare opportunity to invest in a leading activist investor’s portfolio at a significant discount to net asset value. There’s even a catalyst on the horizon.

Steel Partners Holdings is run by activist investor Warren Lichtenstein. According to the Financial Times, the partnership produced gross annual returns of 22% from its 1990 inception to 2007. SPH typically engaged in different forms of investor activism, pushing companies to improve operations or seek a sale and often taking a seat on company boards. Steel Partners also had a pioneering role in activist investing in Japan, with mixed success.

SPH ran into trouble in 2008, when the financial crisis caused the value of many of its holdings to drop precipitously. Facing huge requests for redemption, but believing many of its holdings to be too under-valued or illiquid to sell without doing harm to continuing investors, Steel Partners Holdings hit upon a novel solution: going public. Many investors objected to this plan and pressed for a full liquidation, but Lichtenstein prevailed in court. Steel Partners executed a reverse merger into WebFinancial, a tiny pink sheets-traded financial concern operating in Utah, and then distributed the newly-created units to investors in the Steel Partners partnership. The LP now trades under the ticker SPNHU on the pinks. Many objecting shareholders opted to receive cash and in-kind securities instead, so the total assets of the partnership are much smaller than in 2007, when the partnership had $1.2 billion in assets.

Since listing publicly, SPH has remained extremely active. The company succeeded in taking control of Adaptec, renaming it “Steel Excel” and seeking acquisition candidates for the shell. The company’s BNS Holding Corp. has expanded into the oil and gas equipment and services market in North Dakota, buying Sun Well Services. The company continues to hold active stakes in many other public companies, including GenCorp, Handy & Harman, SL Industries and others.

As of today, Steel Partners Holdings, LP units are changing hands for around $12.55. However, the partnership held net assets of $18.02 per unit as of January 31, 2012. The S&P 500 Index had a total return of 4.32% in February. If we assume conservatively that the partnership’s holdings advanced half as much,  current net asset value is somewhere around $18.41. The current trading price represents a discount of 31.8% from net asset value.

If Warren Lichtenstein can achieve returns close to the historical performance of Steel Partners Holdings, investors in SPH will experience magnificent returns. If not, investors can still benefit from a narrowing of the market value/net asset value gap over time plus the market return on the fund’s assets.

A narrowing of the large market value/net asset value gap is likely because on December 15, 2011, SPH filed a registration for its units to trade on a major exchange. An uplisting will provide a much greater level of attention and publicity for SPH, as well as enable a much greater cross-section of investors to buy in. Even the worst-performing closed-end funds rarely trade at a 30%+ discount to asset value, much less the investment vehicle of a successful activist manager. Once the market becomes aware of this huge discount, I expect it to evaporate quickly.

Here are a few links with some more information and history:

Steel Partners Holdings, LP website and financial statements

Steel Partners Holdings, LP registration statement

Financial Times story on conversion to publicly-traded entity

No position.