The Year in Review and a Thank You to All!

With 2012 drawing to a close and some travel for me in the near future, I’d like to take a moment to thank you and all the other readers of my humble blog before signing off for the year.

When I started this blog way back in January 2012, I never expected it to find more than the tiniest audience. After all, US unlisted stocks are an obscure, often ignored segment of the global securities market. Imagine my surprise to see this blog’s readership gradually grow to thousands each month! Through the course of the year, I have greatly enjoyed your comments and emails, whether you have offered words of encouragement or of criticism. I welcome it all.

I’ll be back in the new year with plenty more investing ideas and updates on situations I have previously covered. Some ideas in the queue include a manufacturing company with 28% operating margins and a 14% free cash flow yield, a fascinating little bank with a consistent earnings history trading at 6x earnings and 50% of tangible book value, and a profitable leveraged pharmaceuticals company that is rapidly paying down debt and equitizing its capital structure.

If you’d like to know when a new blog post is up, I encourage you to sign up for email updates or follow @otcadventures on Twitter.

Performance

With that said, let’s take a look at how my investing ideas have performed so far. In 2012 I wrote about 31 different companies I viewed as worthy investments. Of these, 30 ideas are active and one, Abatix Corp., is inactive due to its going-private reverse split.

(Please note, the fact that I view a stock as having good investment potential DOES NOT MEAN I think anyone else should buy it! Unless I know you and your financial situation and goals quite well, I am in no way qualified to recommend the purchase or sale of anya security or investment strategy to you. Please see my Disclaimer page.)

The performance of these ideas was, on the whole, quite good! These 31 stocks produced an average total return of 13.48% and exceeded the S&P 500 Total Return benchmark by an average of 8.99% from the time of each write-up. Of course, the performance of these ideas varied widely, from QEP Company returning -16.00% to Mexican Restaurants returning 117.14%. I must caution all that the long-term performance of these stocks is highly uncertain and short-term gains or losses do not guarantee longer-term results.

The Winners

Mexican Restaurants – CASA: Mexican Restaurants was a pure valuation story. Trading at an EV/EBITDA multiple of just 1.46 at the time of posting, the company now trades at a still-modest EV/EBITDA of 2.83. Future results will depend largely on the company succeeding in turning around operations and refinancing its debt.

ALJ Regional Holdings – ALJJ: When ALJ announced agreement to sell its Kentucky Electric Steel operations to Optima, shares leaped to $0.75 and higher. Optima has had trouble lining up financing for the deal, which has sent shares slumping back to $0.66. If the deal does go through, expect to see shares reach $0.80 or thereabouts. If not, things could get ugly. If the deal fails, I am confident that ALJ can continue its successful deleveraging process under CEO Jess Ravich’s leadership and create returns for shareholders.

McRae Industries – MRINA: McRae Industries is a classic value investing story of a sleepy, over-capitalized company trading at a single-digit P/E ratio. Since my write-up, McRae has churned out profits, bought back stock and declared regular and special dividends. The market rewarded the stock with a 46.37% total return. McRae still trades at a very reasonable valuation and could have more upside potential.

And….The Losers

QEP Company – QEPC: QEP Company is a great lesson in the danger of customer concentration. Since my write-up, QEP has faced gross margin pressure as its largest customers demand price concessions. The company has tried to make up lost ground with acquisitions, but now faces the threat of product discontinuation from a major customer in 2014. Profits remain excellent for now, but can they be maintained? The company’s choice to reverse course on its deleveraging process worries me and I am considering removing the company from the “active ideas” list and cementing the loss. I sold all the shares I owned personally last week for a better opportunity.

Schuff International – SHFK: Silence makes investors nervous, and silent is what Schuff has been. The company decided to stop releasing quarterly reports, meaning no one knows how business has been since the 2011 annual report. I have great confidence in Schuff for the long run. Nate Tobik has some thoughts on Schuff here.

IEHC Corporation – IEHC: I wrote about IEH Corporation less than a month ago, but the stock is down 7.25% since. No specific bad news appears to be affecting the share price, just a continued lack of interest. IEH Corporation trades at 4.76 times trailing earnings and an EV/EBITDA of 2.04. Price to book value is 0.59.

Once again, thanks for reading! Happy holidays to all and I look forward to providing more research and analysis for you all next year.

Until Then,

OTC Adventures

Calloway’s Nursery – CLWY

Calloway’s Nursery operates 18 garden center stores in the Dallas-Fort Worth and Houston, Texas areas. The company has been in operation since 1987. I ran across Calloway’s on Nate Tobik of Oddballstocks.com’s excellent site unlistedstocks.net, a great resource for financial information on these overlooked companies. Calloway’s is tiny, with a market capitalization of $6 million or so and $45 million in sales last year. The company is also heavily indebted, carrying net debt of 2.3 times trailing adjusted EBITDA. However, the company is profitable, produces free cash flow and trades at a modest multiple of each.

Calloway’s operates in a highly competitive market. The company lists its top competitors as Lowe’s, Wal-Mart and Home Depot, all heavy hitters in the garden department. The company also competes with hundreds of small private nurseries in its geographic region. I was able to do a little research on Calloway’s competitive strategy through Yelp. While Yelp reviews are a highly non-scientific source, the company’s reviews are positive. My sense is Calloway’s charges a little more than its competitors and focuses on pleasing its customers through excellent customer service, free education and guarantees on plants sold.

Yelp Reviews:

Denton, TX Location

Richardson, TX Location

Plano, TX Location

The big issue facing retail chains in the US is the encroaching “show room effect,” or “Amazonification” as I prefer, where customers go to physical stores to appraise merchandise, then buy it online for cheaper. I don’t think garden centers will be significantly affected by this trend. Plants are not fungible. While one iPhone or DVD or vacuum cleaner is the same as another of its kind, plants vary in size, visual appeal and health. When I go to buy a houseplant I need to see it, pick it up and turn it around and compare it to its neighbors. I would be very hesitant to buy a plant sight-unseen. For this reason, I think physical garden centers will be around for as long as gardening is popular.

Despite this advantage, top-line growth has been difficult to come by for Calloway’s. Revenues peaked at $47.35 million in 2003 and have remained largely steady since, aside from a sharp downturn in 2009. However, looking at sales per store shows a rosier trend. Since peaking at 26 stores in 2003, Calloway’s has gradually closed down marginal locations and now operates 18 garden centers. While each store generated $1.84 million in sales in 2003, sales per location hit $2.54 million in trailing twelve months, a 38% increase over the time period.

The company has been successful in increasing its gross margins, which rose to a new high of 48.43% over last four quarters. Operating margins have followed suit, climbing to 6.05%. Operating income in the chart below is adjusted to exclude one-time items like the impairment charge the company took in the most recent quarter. Net income is not adjusted.

CLWY results

Calloway’s turns in an annual profit fairly consistently, but the amounts of these profits are regrettably inconsistent. For the twelve trailing months, Calloway’s adjusted EBITDA and operating profits hit new highs. Free cash flow followed suite, coming in at the highest levels since 2008.

Calloway’s balance sheet is another matter. While the company’s finances are stronger now than they once were, the company carries significant debt.

CLWY bs

At $11.26 million, Calloway’s debt is 4.06 times its trailing operating income. Total debt is down $2.35 million since 2008, but the company does not seem overly serious about shaping up its balance sheet. Total debt is still 1.5 times equity and interest payments used up 32.3% of operating income in 2011. If the company would dedicate just a little of its excess cash and a year or two of its free cash flow to reducing debt, it could greatly improve its financial metrics and perhaps even qualify for a lower interest rate refinancing on existing debt. As is, the company’s significant debt load reduces the company’s flexibility.

All the same, it’s hard to argue with success. After sustaining years of losses leading to its reverse split and de-registration in 2004, Calloway’s has built book value per share from $0.41 per share in 2003 to $0.92 at quarter’s end, an annualized rate of 12.7%. Maybe not world-beating, but certainly respectable.

The past is informative, but what is Calloway’s Nursery worth today? Adjusted for non-recurring items and assuming a 35% tax rate, Calloway’s would have earned $1.27 million in net income in the twelve trailing months, and $3.31 in EBITDA. Actual free cash flow was $1.64 million, but the company made nearly no capital investments. Assuming depreciation and maintenance capital expenditures are roughly equal, free cash flow would have been $1.30 million.

With a market capitalization of $6.00 million, Calloway’s looks cheap.

CLWY valuation

Investors will have to weigh the company’s recent successes, P/E of 4.7 and free cash flow yield of 21.7% against net debt to adjusted EBITDA of 2.3. It’s also worth mentioning that Calloway’s trades at 80% of book value despite recording an ROE of 27.2% in 2011. Nearly all of this book value is tangible, and it’s quite possible that some of the company’s landholdings have appreciated since purchase. The company lists property with a book value of $1.508 million as held for sale. A successful sale would provide a nice opportunity to reduce debt or make a productive investment.

To close with a bit of triva, Calloway’s Nursery boasts a famous shareholder in Peter Lynch, acclaimed former manager of the Fidelity Magellan Fund. Mr. Lynch wrote briefly about Calloway’s in his book One Up On Wall Street and disclosed an 11% interest in the company in 2001. (I can’t guarantee that Mr. Lynch still holds these shares, but his original filing is here.)

Disclosure: No position.

 

 

 

 

 

Advant-e Cancels Reverse Split, Declares Special Dividend – ADVC

Canceled Reverse Split

In a surprising turn of events, Advant-e has announced it will not proceed with its planned 1 for 10,000 reverse stock split. This is excellent news for small shareholders, who will no longer be forcibly cashed out at a large discount to fair value. Advant-e cited delays in regulatory review and approval, the timing of its special dividend (more on that down the page) and “other factors” as the reasons for the cancellation. The company still intends to discontinue as an SEC reporting company as soon as possible.

The rationale for the reverse stock split was dubious from the beginning. In its 14C filing on November 30, the company described the reverse stock split as intended to “ensure that the number of record holders of [Advant-e’s] Common Stock…remains below 500 so that [Advant-e] will remain eligible to terminate the public registration of our Common Stock under the Securities Exchange Act of 1934, as amended (the “Exchange Act”).”

Thing is, in the same filing Advant-e professed to have only 289 holders of record, a far cry from 500. The company is already eligible to cease filing.

Special Dividend and Share Repurchases

Advant-e has declared a special dividend of 2 cents per share to be paid  on December 28 to shareholders of record on December 18. This dividend is likely motivated by the same tax considerations that have lead so many other companies to move up distributions. CEO Jason Wadzinski will receive about $730,000 from the dividend, and paying 15% in tax sure beats paying upwards of 40%!

The company has also updated investors on its share repurchase plan, saying it has repurchased 4.3 million shares at a cost of $1.1 million as of December 11. These 4.3 million shares represent 6.4% of shares outstanding prior to the repurchase. Though the company still has a $900,000 repurchase authorization, the company will forgo additional purchases in favor of the special dividend.

Valuation and the Future

Advant-e’s dividend and share repurchases only stand to make the company more attractive from an investment standpoint. Here are actual and pro forma valuations for the trailing twelve months.

advc valuation

 

Through the special dividend and share repurchases, the company will return about $2.4 million in excess cash to shareholders. Advant-e will remain strongly capitalized, as $2.4 million represents less than half of the cash on its balance sheet. Disregarding any interest forgone on that cash, the company’s trailing P/E ratio will decline to 8.18 after the share price is adjusted downward for the dividend.

Despite my pleasure in hearing the company has decided to abandon the reverse split, the entire episode leaves a bad taste in my mouth. I prefer to invest alongside management, not against. Fair treatment of all shareholders, no matter how large or small, is a hallmark of good corporate governance. I will not be selling out, but I will be keeping a close eye on management to see if they will try to pull another trick.

Disclosure: An account I manage holds Advant-e shares.

ACME Communications Completes Station Sale, Announces Distribution – ACME

Today ACME Communications announced the closing of its New Mexico TV stations to Tamer Media and Lin Media. The company announced a $0.93 distribution to shareholders of record as of December 14 to be paid on December 21. The distribution will be treated entirely as a return of capital.

After the distribution, ACME Communications will still own its TV show “The Daily Buzz,” which the company is trying to sell. ACME also has $1.0 million in cash in escrow with Lin Media for a period of one year and $290,000 in escrow with the FCC for a period of two years.

The swift closing of the sale and the announced distribution are good news, but the amount of the distribution is somewhat disappointing. In my original post I projected a distribution as high as $1.078 per share, based on the company’s stated intentions of distributing the entire proceeds of its sales to shareholders. The significant gap between the maximum distribution and the actual distribution is explainable in part by cash in escrow of 8 cents per share. The company will eventually receive this cash, provided unexpected occurs. For the other 6.8 cents per share, I don’t know. Was it paid to Tamer Media or Lin Media as part of a working capital adjustment? Was it paid to a broker or advisor on the deals? Perhaps it is being retained by the company? Until the company’s next quarterly report is released (some time before December 21, per the company) the fate of that cash is a matter of conjecture.

The question now is how the market will value ACME’s remaining cash and operating asset, The Daily Buzz. I am not optimistic about the company receiving a significant sum for The Daily Buzz, so I am going to disregard its potential value. The show does generate an operating profit, so I expect the company will be able to operate without significant cash burn until such time that it succeeds in selling the show. The value of the cash in escrow should obviously receive a discount. I think 50% is appropriate. 50% of the $1.29 million cash in escrow is 4 cents per share, a conservative estimate of the company’s remaining value. (The market also judges it to be conservative. As I write, ACME’s share price bid/ask is $0.96/$1.06, indicating a mid-point price of 8 cents per share after the distribution.)

If my conservative estimates hold true, investors will be left with a stock worth $0.04 per share when the $0.93 distribution is paid out on December 21 for a total value of $0.97 per share. This represents a return of 12.8% on ACME Communication’s $0.86 share price when I originally wrote about the company on October 4, 2012. Annualized, the figure is 75.7%. Even though the company failed to meet my expectations for the distribution, investors may still be left with a satisfactory outcome, as well as some optionality upside from the company’s remaining operating asset.

Disclosure: No position.

 

Unlisted Companies Join the Special Dividend Parade

The past several weeks have seen a flood of companies announce special dividends in advance of almost certainly higher tax rates to come in 2013. While perhaps less noticed by the financial community, unlisted companies have been active participants in the trend.

I compiled a short list of non-financial companies that have declared special dividends and the details of each. Some of these dividends have already been paid, while others are upcoming. This list is by no means complete. If you know of other unlisted stocks issuing special dividends, feel free to comment.

[table id=1 /]

Mestek and TNR Technical’s dividends are notable because they both represent a significant portion of each company’s market capitalization.

TNR Technical is a modestly profitable battery seller with tons of excess cash on the balance sheet. The company trades at a P/E of 8.7, EV/EBITDA of 2.4 and 78% of book value. After paying out the $2.75 special dividend, the P/E falls to 6.6 and price-to-book value falls to 73%. It should be noted that TNR Technical has a market capitalization of only $3.46 million before considering the special dividend and just 307,119 shares outstanding. Not investable for many.

Mestek (which I wrote about here) manufactures and distributes HVAC and metal forming equipment. The company termed its special dividend a “loyalty dividend,” writing:

“John E. Reed, Chairman and CEO of Mestek, remarked that he is pleased to reward shareholders who have exhibited loyalty and belief in Mestek, especially during the past four years given the depressed conditions in the construction and machinery markets which Mestek serves.”

Despite these depressed conditions, Mestek continues to profit. After the payment of the special dividend, Mestek will have a P/E ratio of 8.3 and an EV/EBITDA ratio of 4.1. If the company’s end market rebound, that P/E could drop rapidly as profits rise. Mestek’s stock is very illiquid and any interested investors should proceed with caution.

 

 

Repro-Med Systems: Growth and More Growth – REPR

Repro-Med Systems sells the FREEDOM60® Syringe Infusion System as well as other medical devices. The company is profitable and has grown revenues at 29.6% annually since 2006. Repro-Med was co-founded in 1980 by CEO Andrew I. Sealfon, who owns 21% of shares outstanding.

Repro-Med’s flagship product is the FREEDOM60® Syringe Infusion System. This device allows patients to receive constant drug infusion therapy without being tied to an IV stand, allowing them to go about their lives. It looks like this.

The device can be used to administer several different drugs, and the company continues to search for new applications.  FREEDOM60® is approved for use in the US as well as many European and Asian nations. Very importantly, Repro-Med’s product is the only Medicare-approved product for subcutaneous administration of immune globulin. I am not extremely familiar with medical terminology, but a little googling informs me that immune globulin treatment is given to patients with compromised immune systems and autoimmune disorders. Elements of FREEDOM60®’s design are patent-protected.

The company also sells the RES-Q-VAC® Suction Unit. In 2012, sales of the FREEDOM60® accounted for 86.4% of Repro-Med’s total revenue, while RES-Q-VAC® accounted for 12.3%. Other legacy products made up the other 1.3% of sales.

The success of the FREEDOM60® has resulted in record revenues and operating income for the company over the last twelve months. In the quarter ended August 31,2012, revenues rose 43.3% over the same quarter a year earlier and operating profit leaped 203%.

Net income was artificially inflated in 2008 and 2009 as the company wrote up the value of net operating loss carryforwards that had previously been written off. A better gauge of true profitability is operating income, which reached a new high last quarter.

The company’s gross margins are a thing of beauty, coming in around 65% for the last few years. These margins have remained steady as revenues increase, indicating the company has not had to reduce prices to stoke demand. Operating cash flow has lagged net income, but Repro-Med’s rapid growth makes this only a minor concern. Growing companies must invest in working capital assets like inventories and accounts receivables, which depresses operating cash flow. (By contrast, poor operating cash flow in a company that is not growing is very worrisome.)

Repro-Med’s balance sheet is extremely healthy, showing $1.94 million in cash and equivalents against total liabilities of just $1.22 million. The company also makes extremely good use of its assets, recording a return on equity of 32.9% in 2011 with minimal leverage.

Despite its track record of nearly 30% annual growth, positive free cash flow and robust profit margins, Repro-Med’s valuation is modest.

On a twelve trailing months basis, Repro-Med has a P/E ratio of 9.00 and an Enterprise Value/EBITDA ratio of 4.35. Since, Repro-Med is growing so quickly, twelve trailing months data understates the company’s earnings power. Annualizing results from the quarter ended August 31, 2012 gives a P/E and EV/EBITDA of only 6.03 and 2.98, respectively. Regardless of how it is calculated, numbers like these are more typically seen in low-growth or highly cyclical companies, and Repro-Med is neither.

Of course, the fact remains that Repro-Med is a tiny company competing in an industry dominated by gigantic international companies with deep pockets and huge R&D budgets. It’s possible that new drug therapy regimes could render Repro-Med’s products obsolete or changes to Medicare could reduce reimbursements for the FREEDOM60®.

Despite these risks, the company has been extremely successful in increasing revenues and profits. As Western societies (and eventually the rest of the world) grow older and require more frequent and more intensive medical care, medical device manufacturers like Repro-Med stand to benefit from ever-increasing demand.

Disclosure: No position.