Mestek, Inc.

Mestek, Inc. is a Massachusetts-based manufacturer and distributor of heating, ventilation and air conditioning (HVAC) equipment, as well as metal forming equipment. The company owns a variety of subsidiaries, some founded over 100 years ago. Formerly traded on the NYSE, Mestek conducted a reverse split and de-registered in 2005, spinning off its Omegaflex subsidiary to shareholders. Mestek is controlled by father and son team John E. Reed and Stewart B Reed, who together own a majority of shares outstanding.

Mestek has a long history of profitability, showing a profit in every year since 1990 except for 2002 and 2003, when the company was walloped with environmental charges. The HVAC business is not a growth industry, but should grow at similar rate as the economy in the long run. In the short run, the industry is heavily dependent on the construction and housing industries. It should be no surprise that Mestek’s revenues have trended downward since 2006. The most recent twelve month period (through September 30, 2011) shows an increase in revenues of 7.00% over 2010, appearing to indicate that the HVAC industry has bottomed and is beginning a new growth cycle. In its most recent quarterly report, Mestek notes that its new, energy-efficient products have seen rapidly increasing sales.

Unfortunately, Mestek once was tempted into a line of business beyond its traditional HVAC focus. Beginning in 1999, the company (and the Reeds, personally) began investing in a healthcare IT company, Carecentric. Several years, subsequent investments and write-downs later, Mestek sold Carecentric at a loss in April, 2011. On a positive note, Mestek will no longer be burdened with Carecentric’s operating losses. Mestek is once again looking for acquisitions, but this time notes that any acquisition target must offer “substantial sales & marketing and operational synergies.”

Here is a look at Mestek’s actual historical results, including the loss-making Carecentric. Figures for years 2005 and earlier have been excluded, since they include Omegaflex revenues and earnings.

Beyond generating strong earnings, Mestek has been an outstanding generator of free cash flow. In the five previous full fiscal years, Mestek earned $26.16 million, but generated $57.64 million in free cash. Some of this excess was the natural result of disinvestment in working capital as revenues fell, as well as from non-cash restructuring and impairment charges, but the company is to be credited for judicious capital management and spending discipline.

Mestek dedicated most of its free cash flow to reducing debt and repurchasing stock below tangible book value, resulting in the strongest and most liquid balance sheet in years and value created for shareholders. Mestek’s unadjusted balance sheet does not account for the company’s material LIFO reserve, so I have adjusted assets and equity, net of tax. I assumed the LIFO reserve was constant since fiscal 2010, though it likely grew along with inventories.

While strong in their own right, Mestek’s official results understate the company’s true earnings power. The company recently completed a years-long process of facility consolidation and closing. According to the company, all of its manufacturing facilities are now running profitably. The charges from these closings and consolidations took a significant bite out of earnings in recent years, but are now a thing of the past.

Similarly, losses from Carecentric are still reflected in the twelve trailing months earnings. The company’s share of Carecentric’s losses was $1.38 million in 2009, growing to $4.78 million in 2010. Carecentric was sold at the end of the first quarter, 2011, so two quarters worth of losses remain in the twelve trailing months’ earnings. Assuming losses continued at a similar rate in Q1 2011, trailing operating earnings reflect a $2.39 million loss from Carecentric that will not repeat.

The display below contrasts Mestek’s actual trailing twelve months earnings with earnings of the same time period adjusted for one-time items. A consistent tax rate is assumed.

One time charges have significantly depressed Mestek’s earnings. As these charges moderate or cease in coming quarters, the company’s true earnings power will become apparent.

Mestek’s valuation on unadjusted earnings is modest. On an adjusted earnings basis, the company’s trailing earnings yield is 13.11%, very generous for a conservatively-financed company that has likely passed the nadir of its revenue cycle.

Potential investors in Mestek should be aware of certain issues. First, liquidity in the company’s stock is very poor. Trades occur infrequently and the bid/ask spread is quite wide. A large block of shares would be difficult to dispose of in a rush. Any investment in the company should be considered very long-term in nature. The terms of the company’s going-private transaction required it to conduct a tender offer for $2.5 million worth of stock each year for five years following the transaction. The last of these tenders was completed in November, 2011. The share count reduction from this last tender offer is not yet reflected in the company’s financial statements.

I should mention that Mestek has some ongoing environmental liabilities related to former manufacturing sites. The company has reserved generously for these liabilities. The company is also party to a number of asbestos-related lawsuits, but doesn’t believe any of these will result in material losses.

Given the controlled nature of the company, it is critical that investors be able to rely on the Reeds to be honest and prudent. The company is party to a few related-party transactions commonly seen in pink sheets companies, including leasing facilities from insiders and extending loans to officers. The scale and terms of these agreements do not seem untoward. One item that may raise eyebrows is the company’s partial ownership of a corporate airplane, used by management for transportation between manufacturing sites. On the other hand, Wikipedia informs me that the aircraft (a 1990 Beechcraft King Air 200) is worth less than 10% of a Gulfstream G650.

Because of their significant majority shareholdings in Mestek, the Reeds have significant incentive to increase the company’s value. Management’s own language on their commitment to the company’s shareholders is encouraging. Stewart B Reed is Vice Chairman and Chief Operating Officer and had this to say in the Q1 2011 report:

“Mestek management will always regard your investment in our company as if it were our own money, carefully evaluating the risk/reward equation of every capital commitment. We have no desire for glory; rather we strive for healthy moderate growth combined with prudent financial management.”

Music to my ears.

 

No position.

 

Quarter in Review

And, we’re back. I’ve been on vacation. It’s good to be home and I will have more stock ideas coming your way soon. Thanks for your patience!

I’ve been blogging for three months now, and I think this is as good a time as any to review the ideas I’ve presented so far and remark on any developments at the companies.

QEP Co.

All quiet for QEP. The company won’t be releasing its annual report until late May, but I expect big numbers when it does. The stock price has meandered higher, but the bid/ask spread has blown out and liquidity has been nearly non-existant.

Schuff International

Schuff released its annual report on March 14, 2012. Adjusting for the one-time goodwill writedown, the company would have earned approximately $2.5 million for the year. The company’s backlog is $258.83 million, compared to $244.97 million at previous quarter’s end and $173.37 million at the previous fiscal year’s end. If business continues to pick up, Schuff’s earnings per share will increase dramatically, particularly with fewer than half as many shares outstanding as in the last upcycle.

McRae Industries

McRae continues to tick along as usual, profitably and conservatively. Investors have taken notice of the strength of earnings and the quality balance sheet and bid the shares up  to a 33% total return since I wrote on the company. Revenues dipped slightly in the most recent quarter, but earnings increased 33.9% compared to the same quarter in 2012. Earnings for the six month period were up 19.3% over the same period last year, though revenues slipped by 3.1%. The company’s trailing P/E ratio is now 9.5. The company continues to maintain significant excess cash balances.

Webco Industries

Webco’s second quarter revenues climbed 13.4% over the same quarter in 2011, while earnings slipped. The company’s capital spending program is on track with the new facility scheduled to open in 4th quarter 2012. Most encouragingly, the company’s operating cash flow has been healthy, totaling $30.80 million thus far in 2012.

Alaska Power and Telephone

AP&T released its annual report on April 19, followed immediately by a first quarter report on the 20th. Revenues climbed by 6.0% in fiscal 2011 compared to fiscal 2010, with earnings climbing 17.3%. As of the end of the first quarter, the company earned $3.33 million dollars in the twelve trailing months, or $2.21 per share. at the current bid/ask midpoint of $16.61, AP&T’s trailing P/E ratio is only 7.5. The company continues to deleverage its balance sheet, raising its equity-to-assets ratio from 27.3% when I posted to 28.4% at present.

Steel Partners Holdings

Steel Partners Holdings successfully uplisted to the NYSE and now trades under the symbol SPLP. After trading down into the low $11’s, the unit price has rebounded to $12.70, outpacing the S&P 500 Total Return Index. The large discount to net asset value persists.

Advant-e Corp.

Advant-e reported annual figures on March 22. Revenues increased 3.1% over 2010, with earnings increasing 7.9%. The stock has performed well, providing a total return of 14.3% since the date of my post. The trailing P/E ratio stands at 10.1. Adjusted for cash, the trailing P/E ratio is 8.1.

Empire Resources

Empire’s annual report revealed revenue growth of 10.7% year-over-year. However, earnings decreased by 45.8% as the company felt the sting of losing the Generalized Systems of Preferences. Disappointingly, the company did not make any reference to any tax refund associated with the re-enactment of the GSP. Ideally, the company’s profitability will still be enhanced with the law’s return. The company’s current trailing P/E ratio of 6.3 reflects a good deal of pessimism and neglect already discounted into the stock price.

Detrex Corp.

Detrex has been on quite a tear, rising 42.4% since the time of posting. Investors finally got around to recognizing the company’s newly reinvigorated balance sheet and growing specialty chemical business. The company’s first quarter report was all good news, showing strong growth in operating profits. The company’s excess cash balances are less robust than what I had used in my initial calculations, but the company still possesses significant excess liquidity and plans on paying a 25 cent dividend in the quarter. In my opinion, Detrex is approaching fair value and I may sell it from my portfolio if fair value is attained.

Siem Industries

Siem released its annual report on April 20. Siem’s largest holding, Subsea 7, had an excellent year, reporting $434.7 million in net income and over $1 billion in EBITDA. Siem Offshore had a good year by Siem’s reckoning, producing a record $123 million in EBITDA, but not recording an accounting profit. STAR Reefers remained a trouble spot, taking a large impairment loss. Siem’s potash mining operations recorded a third consecutive profitable year. Due to the impairment loss in STAR Reefers, the company recorded a net loss of $1.34 per share in 2011. However, the merger between Subsea 7 and Acergy SA resulted in a gigantic book value writeup. Siem Industries’ book value now stands at $1.776 billion. At current prices, Siem Industries trades at 55.5% of book value and an even greater discount to asset value.

Siem Industries

Siem Industries (SEMUF.PK) is a holding company with interests in shipping, petroleum-related marine construction and support, potash mining and a few other industries. While the company is headquartered in the Cayman Islands, the majority of the company’s holdings are based in Norway. Hat tip to Theodor Tonca for alerting me to this fascinating company.

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Website

Siem Industries trades at a substantial discount to the market value of its publicly-traded holdings, let alone its other substantial holdings. There are multiple reasons why this discount has developed.

1. The well-known market phenomenon known as the conglomerate/holding company discount. Simply put, companies that engage in multiple unrelated lines of business tend to trade at lower valuations than their focused peers.

2. Illiquidity and control. Over 70% of the company’s shares are owned by Kristian Siem and his family. The company estimates that only 5% of shares outstanding are available for trading.

3. And the most important, economics. The shipping industry is suffering from severe over-capacity issues, depressing prices below break-even levels in many cases. Worse, many of the profitable contracts that shippers executed in 2008 and earlier are now rolling off to be replaced at much lower rates.

First, a look at the company’s public holdings and their value to the firm:

Siem Industries also holds a minority stake in a German potash mining company, Deusa International GbmH, and various other interests in insurance and pharmaceuticals. Since the market value of these investments is not ascertainable and they make up only a small part of Siem Industries’ value, I have chosen to ignore their value for the sake of conservatism.

STAR Reefers’ financials are consolidated with the parent company, but the rest of these public and private investments are accounted for on the balance sheet and income statement using the equity method. What this means is that only the firm’s proportional share of net profits or losses shows up on the income statement. On the balance sheet, only the cost basis of these investments appears, adjusted for the firm’s cumulative share of net profits or losses. The actual market value of these investments may be significantly higher or lower than what is reflected on the balance sheet.

Siem Industries also owns 100% of the share capital of Siem Car Carriers Inc. This company operates vessels that carry automobiles and was profitable in 2009 and 2010. The company also possesses assets in the form of loans and lines of credit issued to subsidiaries for capital expenditures. The company has roughly $50 million in unrestricted cash at the parent company level against a little over $100 million in debt outstanding. The company’s current ratio is 1.25, perhaps a little low by the standards of normal companies. Remember, however, that the company possesses billions of dollars in publicly-traded assets that can be sold at any time. Liquidity is really not an issue.

Below is Siem Industries’ adjusted balance sheet, less the balance sheet value of the company’s equity-accounted subsidiaries (Subsea 7, Siem Offshore, and the company’s private investments.) The consolidated portion of STAR Reefers’ assets and liabilities has also been removed. Leaving it in would be double-counting the value of Siem Industries’ stake in the company, since it has already been accounted for in the publicly-traded assets summary.

This $18.77 value for the company’s wholly-owned assets assumes that they are worth exactly book value. The estimated value of Siem Industries’ net assets, public and private, sum up to $161.37 per share, quite a bit above the current trading price of a bit over $64 per share. Put differently, the firm’s assets are worth an estimated $2.474 billion versus a market capitalization of $987 million.

So, the firm’s assets are worth quite a bit more than the firm’s trading price. But how’s management? Has Kristian Siem succeeded in building value for shareholders over time? The answer is yes. Rather than being just a sleepy holding company, Siem Industries has a history of wheeling and dealing and compounding book value per share rapidly along the way. I was only able to obtain annual reports going back to 2001, but from 2001 to the end of fiscal 2010, the company grew book value per share at an impressive 20.3% annually, adjusted for small dividends paid out along the way. At the same time, the diluted share count shrank by 9.8% since 2001. The last decade’s energy boom certainly helped matters, but Siem Industries still managed to outpace the S&P Energy Sector SPDR’s total return over the same time period by 7.7% annually.

Siem Industries faces economic headwinds, but the huge discount to asset value combined with management’s demonstrated skill may make the company an attractive holding for the long run. Shares are difficult to obtain, so any purchaser will want to use limit orders and as always, be patient.

 

No position, but I may purchase shares in the next week.