An Australian Achiever on the Cheap

The other day I decided to take a look at some Australian stocks. As luck would have it, I had only flipped through a few before landing on a company with an interesting name and line of business. A little more research revealed some eye-popping statistics.

How many companies anywhere in the world have managed this kind of performance?

5 Year Average Revenue Growth: 25.3%

5 Year Average Net Income Growth: 28.30%

5 Year Average EBIT Margin: 23.4%

5 Year Average ROE: 20.5%

5 Year Average ROIC: 16.6%

And all while paying a dividend and using modest debt.

What industry would you guess this company belongs to? Consumer electronics? Maybe a pricy teen retailer or trendy restaurant chain? Your guesses probably wouldn’t include a provider of marine services to the oil & gas industry.

But that’s what Mermaid Marine Australia (Australian Exchange ticker: MRM) is, and it is the largest provider in Australia. Mermaid Marine operates a fleet of 41 service vessels that support the offshore petroleum industry in Northwest Australia and Southeast Asia, as well as Africa and the Gulf of Mexico. These 41 vessels include tugboats, supply vessels, barges, accommodation ships and more. Basically, all the various vessels that keep massive offshore drilling rigs staffed, supplied and in good repair.

Mermaid also owns and operates two supply bases in Northwestern Australia. These are the wholly-owned Dampier Supply Base and the Broome Supply Base, a joint venture. These bases are strategically located next to the North West Shelf, a major oil and gas-producing  region. These bases provide logistical support to ships that service the oil & gas industry, including maintenance and repairs.

Finally, Mermaid owns a slipway at its Dampier base, a facility used for docking ships for repair. The company notes that its slipway is the only such facility located in close proximity to the North West Shelf.

I’ve mentioned the North West Shelf a few times without explaining its significance. The NWS is Australia’s most important and developed petroleum-producing region. Production has been ongoing since the 1980s, with the involvement of many of the world’s foremost extraction companies.

3Activity in the NWS and surrouding areas is strong and is expected to remain so. Tony Howarth, chairman of Mermaid, made these comments in the 2013 annual report.

“Activity in the Australian oil and gas sector remains strong with four major LNG projects currently under construction in the North West of Western Australia with a combined capital cost of $125 billion. Exploration activity is also buoyant with nine oil and gas companies currently undertaking drilling programs in the region and significant gas discoveries announced by Santos and Chevron during the year.”

The four LNG (“Liquefied Natural Gas”) projects under construction are extremely significant for Mermaid. Due to high regulatory burdens and construction costs for land-based LNG facilities, some extractors are turning to “Floating LNG” technology. Shell is in the process of building the world’s first FLNG vessel, with BHP Billiton and Exxon Mobil to follow. These offshore LNG facilities will require the support services that Mermaid offers, and should provide revenues for decades to come. Exploration and production are also important opportunities for Mermaid. The company recently won its first drilling support contract, serving Santos’s Ensco 109 rig.

Let’s take a look at Mermaid’s historical performance and see what insights arise. All figures are presented in millions USD, converted at $1.00 AUD: $0.94 USD.

Historal resultsRevenue, EBIT and net income growth are all strong since 2008. Margins have varied a few hundred basis points in either direction, but are consistently high. Free cash flow is negative on average, but that’s not a bad thing. When a company has as many great investment opportunities as Mermaid does, I don’t want it to produce free cash flow. I want it to use every dollar of operating cash flow and more to capture those opportunities. The success of these capex expenditures can be seen in the revenue, EBIT and net income lines. Spending far beyond annual depreciation on capital assets has clearly been a great use of shareholder capital.

While Mermaid’s consolidated results have been extremely strong, these results have been generated by a changing mix of revenues. Slowing growth in the vessels division has been offset by rapid increases in supply base revenues.

by sectorMost of the revenue growth in Mermaid’s vessel division was realized between 2008 and 2011. High utilization rates during those years pushed up EBIT margins, which have since declined. Additionally, vessels segment revenues and earnings growth have not kept up with asset growth, reducing profit per dollar of assets employed. The vessels segment is still a strong contributor, but is no longer the company’s crown jewel.

That mantle has passed to the supply base segment. Though its 2013 revenues were only just over half those of the vessels segment, its EBIT was 18% greater. The company credits strong growth at the Broome Supply Base with the segment’s remarkable 2013 performance. In 2013, the segment produced nearly 30 cents in EBIT for every dollar of assets employed, an impressive figure that has only grown over time.

The Dampier Slipway accounts for only a small sliver of revenue, but is a solid contributor in terms of EBIT and EBIT per asset employed.

So what must an investor pay for a such a high-achieving company with great prospects for continued growth? Answer: surprisingly little.

ValuatoinMermaid Marine’s trailing P/E is only 14.36, less than one must pay for the broad US and Australian indexes. I find it very hard to believe that Mermaid’s future growth will trail the average company in either of these economies.

Mermaid’s valuation may be weighed down by fears of a slowdown in the Chinese economy, and by fears that Australia’s currency will continue its recent decline. I view both of these factors as short-term in nature and unlikely to interfere with Mermaid’s long-term success. The most important factor in long-term equity returns is a company’s ability to reinvest earnings at consistently high rates, and Mermaid has demonstrated its aptitude.

Finally, for income-oriented investors, Mermaid Marine Australia pays an annual dividend of 12.5 Australian cents, an increase of 13.6% over 2013. At current prices, this dividend is good for a 3.3% yield.

No position.

Harry & David is an Attractive, Little-Known Post-Bankruptcy Opportunity – HARR

Harry & David Holdings is an attractive post-bankruptcy situation. The company has successfully shed its bad assets and is now poised for continued margin expansion and possibly, a recapitalization.

Harry & David is a brand name that will be familiar to many readers. Founded in Oregon in 1910, the company sells its gift baskets and other edible gifts through its catalogs and company-owned stores. The company’s products are somewhat pricy and are targeted toward middle and upper middle class consumers.

1430_6-applegate-gift-basket-deluxe

A typical Harry & David gift basket.

Harry & David was passed among multiple owners for 20 years before being bought by private equity firm Wasserstein & Co. in 2004. Wasserstein proceeded to pile on debt by the hundreds of millions, and expanded the company’s product lineup and the number of company-operated stores.

Trouble started in 2008. The weakening economy took a bite out of revenues, as customers cut back on discretionary purchases. (Expensive fruit and cheese baskets may be the very definition of “discretionary purchases.”) In 2010, Wasserstein replaced Harry & David’s long-time CEO with its own choice, Steve Heyer. Heyer instituted many changes, the results of which only served to alienate customers, discourage employees and increase costs without building revenue.

From a Bloomberg.com article:

“Heyer hit Harry & David like a hurricane, according to former executives there. He fired many of Bill Williams’s managers and brought in his own. He often called Harry & David workers ‘idiots,’ two former employees say.”

“One of Heyer’s biggest blunders, former employees say, was rearranging the contents of Harry & David gift baskets. He had workers lay out samples of all the baskets in a warehouse, and he went down the line, adding and removing items, one former worker says. The changes made it impossible for returning customers to easily repeat an order from the year before on forms that the company sent out, former employees say, and many customers didn’t buy.”

By late 2010, Harry & David was in deep trouble, and the company defaulted on its interest payments in mid-2011.

In the course of the bankruptcy process, Harry & David shed its debt load and offloaded its pension obligation in return for payments of cash and newly-issued shares to the PBGC. The company also reduced its cost structure, shuttering unprofitable company stores and simplifying its product line-up. Wasserstein lead a group of bondholders in backstopping the bankruptcy process, agreeing to lend $55 million to the restructured company. Harry & David exited bankruptcy in September, 2011.

Harry & David recently reported its fiscal 2013 results, and things are looking up.

Results

Revenues are up modestly over 2012, despite the fiscal 2013 having 52 weeks and fiscal 2012 having 53. Additionally, the number of company-owned stores declined from 56 to 49 in the course of the year. The company’s gross and operating margins rose significantly, evidence that cost-reducing initiatives have been effective. Adjusted EBITDA rose 17.41% year over year and adjusted operating income rose 61.10%.

Note that the adjusted EBITDA and adjusted operating income figures above are not GAAP numbers and are based on adjustments provided by the company. Normally, I am extremely skeptical of adjusted figures, since they tend to exclude only “bad stuff” that represent very real economic expenses. My personal income statement would look much better if I could exclude “one-time items” like that brake caliper that froze on my car last spring and the 45 Euro I lost to the shady hotel clerk who short-changed me in Rome last week.

However, in Harry & David’s case, these one-time items are largely associated with the lingering expenses of bankruptcy, such as shutting down unprofitable stores and compensating turnaround consultants. Not adjusting for these temporary expenses would disguise the company’s earning power, which is increasing rapidly.

Harry & David’s stock is illiquid and the company does not publicize its earnings reports, which contributes to a very modest valuation. The company has fewer than one million shares outstanding, and the large majority of these are held by the company’s former bondholders, including Wasserstein.

ValuationThe “Debt/Re-Org Liabilities” figure requires some explanation. As part of its bankruptcy agreement, Harry & David was required to make periodic cash payments to the PBGC and other claimants. As of June 30, 2013, the remaining claims are $7.86 million, which will be settled almost entirely in fiscal 2014.

Harry & David’s balance sheet shows no debt at fiscal year end, but that will change dramatically as the holiday season approaches. Because its business is so seasonal, working capital needs swing widely throughout the year. Harry & David uses a line of credit to finance inventory purchases prior to its busiest sales period, then pays down the line of credit as inventory is sold and receivables are collected. The current net cash figure of $7.73 million is conservative, as net cash actually averaged $15.57 million in fiscal 2013.

At an enterprise value of just under $114 million, Harry & David trades at 4.2x EBITDA and 7.2x operating income.These are attractive multiples, and investors purchasing at this valuation will likely do well simply through the earnings yield and eventual appreciation to more reasonable multiples. However, that scenario does not account for the possibility of value creation through a modest recapitalization of the company.

At present, Harry & David’s balance sheet is “lazy,” carrying no debt beyond its re-org obligations and its periodic inventory financing. Shareholder returns could be improved significantly through a modest debt issuance and a special dividend.

From 2006 to 2009, Harry & David’s debt load was in excess of 4x EBITDA. Obviously that level of leverage was unsustainable and ultimately wrecked the company. However, a smaller debt issuance would reduce the company’s cost of capital and could fund a sizable special dividend.

Harry & David’s owners are private equity veterans and are undoubtedly aware of Harry & David’s capacity to support debt. In my view, they are waiting to pursue a recapitalization until the re-org liabilities have been completely discharged and the company has shown a sustained period of profitability and margin expansion. At that point, the company could likely issue debt on attractive terms.

Ultimate exits for Harry & David’s owners include an uplisting/IPO or a sale to another entity such as a retailer or retail-focused fund. Any such transaction would likely take place at a valuation well above today’s depressed multiples. At 6x trailing EBITDA, a sale would yield $183 per share. At 7x, it would yield $212 per share.

It could pay to wait on Harry & David.

No position.

 

CIBL’s Asset Sale Widens Gap Between Price and Value – CIBY

It’s good to be back! I spent a few weeks in Europe, centered around my brother’s wedding in England. The celebration and the sightseeing were great, but I really missed scouring the daily flow of filings and news items from obscure companies for opportunities. As luck would have it, a news item revealed an attractive opportunity just an hour after my return to the States yesterday.

CIBL, Inc. is selling its interests in two Iowa TV stations. The company has signed a definitive contract with Nexstar Broadcasting, Inc. to sell its stake in WOI-TV and WHBF-TV for proceeds in excess of $21 million, pre-tax. The transaction requires FCC approval and is expected to close in the first quarter of 2014. Details are available here.

Note: Subsequent to the posting of this article, CIBL updated its press release, changing the pre-tax gross sales figure from $21 million to $24 million, but noting this figure is before recalculation of alternative allocation of proceeds, working capital adjustments, and payment of debt. 

This transaction is so significant because the sale price is much higher than the market was expecting. Prior to the announcement, CIBL’s market capitalization was $22.59 million, with $17.44 million in cash and short-term investments. The whole of CIBL’s investments (the two TV stations and some shareholdings) were being valued at $5.15 million. Clearly, the sale price of $21 million is materially higher!

Let me back up for a minute and provide some general information on the company, its history and what it has accomplished so far. CIBL was spun off from LICT Corp. (another favorite of mine) in 2008. At the time of the spin-off, CIBL held a collection of broadcast and telecom assets, all in small, mostly rural markets.

Since the spin-off, CIBL has taken steps to monetize most of these assets. Giant Communications, a cable operator, was sold back to LICT in 2010. CIBL’s interests in two New Mexico wireless partnerships were sold to Verizon in 2012. Nate Tobik had a good analysis of the value of the wireless assets over at Oddballstocks.

Once the sale of its TV interests closes, CIBL’s remaining assets will include substantial net cash, a 40% stake in ICTC Group (ticker: ICTG), an interest-bearing note issued by LICT Corp., and a 1.36% stake in a private company, Solix, Inc. The sum of these assets is substantially greater than the current market cap, even after today’s increase.

Cash and short-term investments account for the majority of CIBL’s pro forma value. Assuming a 35% tax rate, CIBL will reap $13.65 million from its TV assets, resulting in liquid assets of $31.09 million. CIBL owns 161,552 shares of ICTC Group, worth $3.65 million at the last trade price of $22.6o. The LICT note is for $600,000, but the balance is used to offset ongoing management fees owed to LICT. For that reason, I ascribe it no value.

The value of CIBL’s investment in Solix, Inc. is more difficult to determine. I was able to find a 2012 revenue figure of $91 million for the company, which seems to be healthy. Depending on Solix’s margins, a value of somewhere between 0.5x and 2x revenues seems warranted, which translates to between $0.62 million and $2.48 million for CIBL.

These assets total to between $35.36 and $37.22 million, or between $1,605 and $1,689 per CIBL share. Today’s closing price of $1,150 represents a discount of 28% to the low end of the valuation.

Question is, what will CIBL do with all its excess cash and its ICTC Group stake? Through a voting agreement, CIBL controls ICTC and is free to direct its operations. ICTC owns rural wireless assets much like CIBL did that could be hiding considerable value.

In my view, a large special dividend or tender offer is likely. Even if CIBL were to buy the rest of ICTC Group, it would still have substantial excess capital. The company is not exactly tripping over investment opportunities, and all that capital will eventually have to find a home or be returned to shareholders.

An account I manage owns shares in CIBL, Inc.