Blog and Business Updates

Today’s post is a brief departure from my usual discussion of micro-caps and illiquid stocks, and instead contains some updates and news on the blog and on my RIA firm. Regular posting will resume later this week with a profile of a true rarity in today’s market: a profitable net-net, this one in Australia.

The Business

It’s been nearly six months since I started my RIA firm, and I’ve never had so much fun at work! It’s been a great pleasure to manage portfolios for many readers. Being a one-man shop is a lot of work, but finally being able to buy promising securities for clients rather than merely writing about them online is such a great feeling. Assets under management is growing quickly, but there’s still plenty of room for new clients! Drop me a line if you’re interested.

That brings me to an important announcement: the name of my RIA firm is changing from Catalpa Capital Management, LLC to Alluvial Capital Management, LLC. Nothing else about the business is changing except for the name. The change should show up on FINRA soon, and the new website is alluvialcapital.com.

The Blog

Long-time readers may have noticed a decline in the frequency of new posts on OTC Adventures. The main reason for the decline is my RIA duties. Writing new blog posts necessarily falls lower on the list of priorities than performing research and managing client accounts. Besides that, it’s simply more difficult to locate clearly cheap stocks. It’s not impossible, in fact I think anyone who claims all the good values have been eliminated by the rising market is just not searching very hard. However, the days when I could browse through filings for an hour and come up with a list of a dozen dirt cheap American OTC stocks are over for now. That’s the reason that more than half of the new posts I do are on exchange-traded companies outside the US. Many international markets still abound with tiny, cheap companies waiting to be discovered by investors. Here are a few of the areas where I am finding a good number of promising stocks:

  • Western Europe, particularly France, Germany and Switzerland – These nations abound with family-controlled micro-caps and larger companies with low floats due to the presence of controlling shareholders. So long as the owning families or controlling shareholders have a history of stewarding their companies well and treating outside shareholders fairly, I’m happy to buy in at valuations and ratios that are a distant memory in US markets. So far, I’ve found bargains in real estate and manufacturing, though nearly every sector offers value.
  • Australia – The perception of Australia that many investors have is of an economy dominated by raw materials and energy and beholden to China’s appetite for coal and iron ore. There’s a grain of truth to that, but it obscures the hundreds of small Australian companies that have nothing to do with the resource economy. For example, I’ve found bargains in agriculture, consumer goods and logistics, and I’ve only just begun my search. Another nice feature of Australian companies is the dividend culture that exists there. Australian companies normally pay out high portions of their earnings in dividends, which I find tends to discourage management from frittering away earnings on dubious investments.
  • Mexico – Mexico suffers from a reputation for shaky creditworthiness, high inflation and social issues. Investors who focus on these perceptions may miss that fact that Mexico’s per capita GDP rose 27% from 2009 to 2012, and will likely keep growing following the liberalization of the nation’s energy sector. I’ve found bargains in consumer staples and auto suppliers.
  • “Exotic” Exchanges – Lately, I’ve been spending time seeking out local exchanges in developed nations that for whatever reason aren’t widely available to Western investors. I’ve not yet found ways of accessing many of these exchanges, but several offer incredible value, if the stocks can be bought. In the interest of keeping it that way, I won’t be talking about them here…..

Thank you, as always, for reading OTC Adventures. I’ve benefited immeasurably as a writer, analyst and investor from your comments and e-mails. Nearly without fail, each time I write up a company I get several e-mails from company or industry experts offering insights and perspectives that I would struggle to arrive at myself. Please feel free to contact me at any time.

Teak Holz International AG – Vienna Exchange: TEAK

THI-AG_Teak_sustainable_growing_investment_en

Now and then I run across a company with a truly unusual business model. So far as I know, Teak Holz International AG is the only pure-play publicly-traded producer of teak wood in the world. (If I’m mistaken, I welcome corrections.) Teak Holz is established in Austria and traded in Austria and Germany, but owns nearly 4,800 acres of teak producing land in Costa Rica. Teak is a tropical wood that has long been prized for use in furniture, boatbuilding and construction due to its excellent durability and water resistance. The tree is native to Asia, but is now cultivated in Central and South America as well. The teak industry increasingly uses sustainable forestry methods and complies with fair labor practices, and Teak Holz emphasizes its leadership in these areas. The company’s teak plantings are not yet mature, and many years will pass before Teak Holz realizes meaningful cash flows from harvesting timber. Teak Holz’s unusual cash flow profile complicates the valuation, which makes the company all the more interesting to me. Even more interesting is the company’s 79% discount to tangible book value.

Most of the companies I evaluate and invest in are dependable cash generators. Valuing these companies is a process of normalizing this cash flow and applying the appropriate multiple based on industry prospects, capital structure and management quality, among other factors. Businesses like Teak Holz present a different challenge because their cash flows are far off and highly uncertain. The present value of the future cash flows generated by Teak Holz’s timber harvest is highly sensitive to factors like discount rates, harvest timing and teak prices, all of which are impossible to predict with any degree of accuracy.

According to the company, the growth period for Central American teak crops is 15 to 20 years. The majority of Teak Holz’s trees are 5 to 6 years old. Not saplings, but also not ready for harvest. Between now and then, these plantings will be thinned multiple times, allowing the remaining trees to increase in diameter and become much more valuable. These thinnings will generate a small amount of positive cash flow, but the big payday will not arrive for another 10 to 15 years. Teak Holz provides an estimate of the present value of its teak crop. Discounted at 12.75%, Teak Holz’s own estimate of its cost of capital, the company values its teak assets at €97.65 million at the end of fiscal 2013. This figure is net of all costs to plant, manage and harvest the teak crop.

As of fiscal 2013, Teak Holz’s balance sheet looked like this, in millions of Euros.

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Teak Holz has EUR 77.24 million in balance sheet equity value, yet its market capitalization is only EUR 14.97 million. That’s among the largest discount to book value I’ve seen, especially for a company not in dire financial straights. Teak’s 79% discount to tangible value is just as stark.

That leaves us with a question: why? Why does the market assign such a massive discount to the stated value of Teak Holz’s assets? Turns out, there may be some solid reasons.

Possibility #1Overstated Assets

Perhaps Teak Holz is simply wildly over-estimating the value of its teak plantations. It’s a reasonable hypothesis because Teak Holz recently took a huge writedown, reducing the estimated value of its teak assets from over EUR 135 million to the current figure of nearly EUR 98 million, a reduction of 28%. Ouch. The writedown was done in response to a new valuation survey commissioned by the company after a significant leadership change. For the first time, the company contracted an outside expert, Legacy Appraisal Services of Gainesville, Florida, to provide a new estimate of the teak crop’s value. Legacy Appraisal Services’ valuation process incorporated much less optimistic inputs for teak prices and harvest yield than the company’s own process, resulting in a substantially decreased balance sheet value. The new balance sheet value is likely closer to the actual present value of the company’s teak harvest, but investors may remain suspicious of the company’s published figures. Nobody wants to invest in Teak Holz, only to suffer through another 10% of 20% writedown.

Possibility #2 – Financing Issues and Dilution

While Teak Holz may ultimately realize a handsome profit on its teak harvest, the company will have to fund its ongoing corporate expenses in the interim. These expenses reduce the value that shareholders will ultimately realize from the teak crop, moreso because they are current expenses while the teak harvest cash flows will not be received for several years. In fiscal 2013, Teak Holz spent roughly EUR 3.2 million on operating expenses, compared to EUR 2.6 million in fiscal 2012. Because Teak Holz has minimal cash reserves and nearly no revenues, these operating expenses must be funded by raising capital or selling assets. This is where the company’s depressed stock price becomes a serious issue for the company and for shareholders. Selling equity as a means of funding operations is extremely unattractive, because selling shares at 19% of book value is extraordinarily dilutive. Traditional debt financing is only marginally feasible because the company has little capacity to make periodic interest payments. Payment-in-kind debt would circumvent this issue, but such debt usually comes at a cost of high, high rates. In order to finance its ongoing operations, the company has settled on a mix of bank debt, loans from a related party and convertible debt. Teak Holz’s bank debt of EUR 4.96 million is secured by a mortgage on the personal property of a company insider, who in turn holds a contingent mortgage claim on one of Teak Holz’s plantations. The same insider has also provided Teak Holz with a EUR 3 million loan, again secured by one of the company’s plantations. Finally, the company has EUR 11 million par convertible bonds outstanding, bearing interest at 5%. These bonds come due in 2015 and are convertible at a share price of EUR 5. Since the last annual report was filed, Teak Holz sold an additional EUR 2.35 million in convertible bonds with the same terms. Refinancing the convertible bonds is a looming issue for the company, one that sustains uncertainty and contributes to the depressed valuation.

Simply put, Teak Holz’s small size, ongoing cash needs and depressed valuation leave the company with few good financing options. The market may rightly be pricing in the possibility of significant dilution between now and the eventual teak harvest, an outcome that would reduce investors’ pro rata shares of the eventual harvest proceeds.

Possibility #3 – The Market is Wrong

Questions concerning asset value and financing risks notwithstanding, it’s possible that the market simply has Teak Holz all wrong. Perhaps the teak assets are fairly valued or even under-valued, and perhaps the company manages to fund its operating expenses at a reasonable cost between now and the first big harvest in several years. In that case, investors buying at this price will likely do very well.

Unfortunately, I can’t get comfortable enough with Teak Holz’s financial position to even consider possibility #3. Rather than rely on expensive and short-term convertible debt financing, I’d rather see the company execute some long-term forward timber sales or selectively sell acreage/plantation ownership interests. (A little strategic self-liquidation doesn’t hurt anyone. If Teak Holz’s acreage is really worth what they say it is, they shouldn’t have too much trouble liquidating a little each year at a price sufficient to fund operations.) The company has announced some medium-term forward timber sales, but I’d be happy to see them explore this financing method further. Another factor that gives me pause is Teak Holz’s management team. The corporate officer and director ranks seem to be a revolving door of Austrian businessman who know each other through outside business dealings. I am not suggesting any nefarious activities are in progress, but I’d rather see some consistency in leadership and a few more experts in teak and Costa Rican forestry.

That said, Teak Holz is a fun one to watch and a nice change from the typical industrials, banks and telecoms that are my bread and butter. As a final note, Teak Holz’s convertible bonds may make an interesting speculation. They trade on the Vienna Exchange with the ISIN AT0000A0K1F9. The last trade was at 76.101 for a yield to maturity of 29.1%. More importantly, they have plenty of asset coverage if Teak Holz’s harvest valuation is even remotely realistic. Please note I am not any kind of authority on Austrian fixed income and bankruptcy law, so I have no idea what special risks these bonds would carry.

Alluvial Capital Managment, LLC does not hold shares of Teak Holz International AG  for client accounts.

OTCAdventures.com is an Alluvial Capital Management, LLC publication. For information on Alluvial’s managed accounts, please see alluvialcapital.com.

Alluvial Capital Management, LLC may buy or sell securities mentioned on this blog for client accounts or for the accounts of principals. For a full accounting of Alluvial’s and Alluvial personnel’s holdings in any securities mentioned, contact Alluvial Capital Management, LLC at info@alluvialcapital.com.

Sanluis Corp. SAB de CV: Fast-Growing, Deleveraging Auto Supplier at a Cheap Price

Today’s investing idea takes us to Mexico, where a small company has quietly become the world’s leading producer of light vehicle leaf springs, and the top provider of suspension components for light trucks in the Western hemisphere. Sanluis Rassini made its first sale to Ford’s Mexican operations in 1938 and began exporting to the USA in 1970. Sanluis spent the 80s and 90s adding plants and offices in Mexico and the United States, and expanding into Brazil. From 1988 to 2013, Sanluis grew its revenues at an astounding 19% annually. However, for most of that period, Sanluis was hampered by a crushing debt load. This debt load lead to a default and restructuring in 2010. Sanluis emerged from the restructuring with a strengthened balance sheet and has continued to reduce its net debt, both in absolute terms and relative to EBITDA and cash flows. Results at Sanluis have climbed to record highs, powered by the strong sales of light trucks like the Ford F-150 and the Chevrolet Silverado. Sales growth for light trucks has outpaced the recovery in small automobiles, and the trend seems likely to continue as the US labor market improves. Results at Sanluis’ Brazilian subsidiary have lagged, but could provide an additional tailwind when and if the Brazilian economy recovers. Despite its reduced leverage and bright business outlook, Sanluis trades at very low multiples of EBITDA and EBIT, and offers a double digit free cash flow yield.

Results and Outlook

Since the lows of 2009, Sanluis’ revenues have nearly doubled, topping $900 million USD for the twelve trailing month period. Forward revenues should be considerably higher. According to data provided by the Wall Street Journal, US pickup truck sales volume rose 3.6% year-to-date through May versus 2013, strongly outpacing cars. Sanluis’ components can be found in eight of the top ten selling pickup trucks in the US, so the sales increases are benefiting Sanluis’ results. To wit, revenues for the first quarter of 2014 were up 20% year over year. The chart below summarizes Sanluis’ results from 2009 to present. Amounts are in millions and are translated to USD at $1 USD: 12.91 MXN.

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Sanluis’ margins have cooled off a bit since 2009 and 2010, but have stabilized at levels comparable to US-based auto suppliers. For the first quarter of 2014, Sanluis reported EBITDA of USD $30.8 million. This increase came solely from strong activity in North America, as EBITDA at the company’s Brazilian subsidiary fell 48% year over year as the Brazilian economy slowed. At this pace, Sanluis is on track to produce USD $123 million in 2014 EBITDA. I expect quite a bit more, as the US market for pickups continues to improve. Any improvement in Brazil’s results would simply provide an additional tailwind, though I don’t count on it in the short run.

Improving Balance Sheet

Below is a chart of Sanluis’ net debt in recent years, and multiple of trailing EBITDA that it represents.

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Since peaking in 2010, Sanluis’ net debt has been reduced by 42.2% in absolute terms. More importantly, net debt has fallen from 5.99x EBITDA to only 1.89x on a trailing basis. If we annualize first quarter results, the company’s net debt is only a hair over 1.5x EBITDA, a thoroughly sustainable level. Sanluis has accomplished this improvement in its financial footing mostly via dramatic increases in revenues and earnings, but also by dedicating the majority of its free cash flow to debt reduction. For fiscal 2010 to 2013, Sanluis produced a total of USD $168 million in free cash flow and reduced gross debt by USD $113 million. Slightly over 44% of Sanluis’ gross debt comes due in December, 2014, but I expect the company to have no trouble refinancing the debt on as good or better terms, give then substantially better operating performance the company has produced since the original debt agreement was reached. The company’s next series of debt comes due in 2017.

Now that Sanluis is on sustainable financial footing, it will be free to dedicate its free cash flow to growth investments or payments to shareholders.

 Valuation

Due to the growth of the US market for pickup trucks, Sanluis’ results are highly likely to rise in coming quarters. For the sake of conservatism, let’s annualize Sanluis’ first quarter results to arrive at a yearly estimate of EBITDA and EBIT. Based on the first quarter of 2014, Sanluis is poised to report $123 million in EBITDA and $96.7 million in EBIT for 2014. However, these figures are slightly misleading. Sanluis has a 50.1% stake in its Brazilian subsidiary, which causes those results to be consolidated under standard accounting principles. However, half of the subsidiary’s EBITDA and EBIT doesn’t actually “belong” to the parent company. By the same token, half of the subsidiary’s debt must be taken out of the equation to arrive at a true measure of enterprise value. My calculation of the company’s liabilities included in enterprise value also bears some explanation.

  • EBITDA and EBIT: Sanluis’ Brazilian subsidiary is called “Autopecas.” This business produced USD $4.0 million in EBITDA in the first quarter. The EBIT figure was not disclosed, but assuming the same margin as the company as a whole, Autopecas would have produced USD $3 million in EBIT. (In reality, it was probably lower as the sting of negative operating leverage was felt.) Annualizing these results reduces Sanluis’ estimated 2014 EBITDA by USD $8.0 million and its EBIT by USD $6.0 million.
  • Net Debt: The Brazilian Autopecas segment has USD $12.8 million in debt. Adjusting this figure for Sanluis’ 50.1% stake in the business results in a USD $6.4 million reduction in net debt. Autopecas likely also has some subsidiary-level cash, but this figure is not disclosed and I’ll ignore it. I’ve been fairly conservative in all my other assumptions.
  • Pension deficit: Sanluis reports a pension deficit of USD $23.2 million, which I add to enterprise value. In most cases where a pension is involved, it is important to look at the assumptions involved. Sanluis uses an expected return of 7.5% on its plan assets. With a high-quality Mexican corporate bond index currently yielding 5.30%, the return figure is in the realm of reasonability. Other important figures like the assumed discount rate and expected salary increases are also reasonable.
  • Special Tax Liability: In late, 2013, Sanluis was hit with a large increase in taxes payable due to a change in the Mexican tax code. These new taxes payable sum to USD $52.8 million and must be paid over the next five years. Using a discount rate of 10%, I’ve included the tax liability in enterprise value at a present value of $41.8 million.

After all those adjustments, Sanluis’ projected 2014 valuation looks like this.

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At 4.8x projected EBITDA and 6.1x projected EBIT based on very conservative assumptions, Sanluis is about the cheapest auto supplier I’ve found. This despite Sanluis’ prime industry positioning in the hot market of pickup trucks. The market seems to be catching on to Sanluis’ progress, and shares have rallied quite a lot over the past few months. However, I think they have quite a way to go before they begin to reflect reasonable valuation multiples.

Risks

Though the company appears very cheap to me, Sanluis is not without its share of risks. The company has been through two separate rounds of restructuring in the past decade. Sanluis is far larger, more profitable and less leveraged than it has been at any point since its troubles, but “this time it’s different” are famous last words in the investing world. Though the company’s finances (and those of its customers) appear strong at present, a return to a deep recession with an accompanying decline in vehicle sales would hurt Sanluis. Currency risk is also a factor. Sanluis earns the majority of its revenues in USD, but its debt is denominated in Mexican Pesos. A strong US dollar is great for Sanluis, while a strong Peso reduces earnings. (Interestingly, this fact also provides somewhat of a natural hedge for US investors in Sanluis. Though a strong Peso would hurt the company, it increases the value of Peso-denominated investments. The opposite is also true. A weak US dollar benefits Sanluis’ earnings and debt position, yet it decreases the value of Peso-denominated investments.)

There’s a lot more to the story with Sanluis, but that’s quite enough verbiage for now. I always welcome discussing any company I write about with readers, so feel free to drop me an e-mail or leave a comment.

Alluvial Capital Managment, LLC holds shares of Sanluis Corp. SAB de CV  for client accounts.

OTCAdventures.com is an Alluvial Capital Management, LLC publication. For information on Alluvial’s managed accounts, please see alluvialcapital.com.

Alluvial Capital Management, LLC may buy or sell securities mentioned on this blog for client accounts or for the accounts of principals. For a full accounting of Alluvial’s and Alluvial personnel’s holdings in any securities mentioned, contact Alluvial Capital Management, LLC at info@alluvialcapital.com.