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.



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.

Stock Quote

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.

Alaska Power & Telephone

Alaska Power & Telephone Company (APTL) has been scratching out an existence in the Frozen North since 1957. The company’s business model is simple: generating electrical power and providing telecommunications services to many small communities on the Pacific coast of Southeast Alaska and the interior. The company is largely employee-owned and has deep ties with the communities it serves.

Though electric generation and telecom services are hardly growth business, APTL has been aggressive in driving change and improving service. APTL’s power generation assets are nearly all hydroelectric, a big change from just a decade ago. While the traditional wireline business is eroding, the company has added broadband services and is continually upgrading its network to add to the non-regulated broadband business.

In order to understand APTL’s structure and behavior in recent years, a quick history lesson is in order. In the years prior to 2001, APTL had been a frequent acquirer of small communications and energy companies in Alaska. These acquisitions were funded mainly by debt, eventually leading the company to be 78% liability-financed at the end of fiscal 2000. At that point, attractive acquisitions were nearly exhausted and the company’s large dividend put pressure on the company to find new and diversified revenue sources. Rather than exercising discipline by slowing growth, cutting the dividend and devoting cash flow to debt reduction, the company spent millions to purchase a firm with hydroelectric operating in South America and purchased a minority stake in Summit Alaska, a civil construction firm.

In nearly no time at all, Summit Alaska went bankrupt. This caused APTL to violate its debt covenants with its primary lender, sending APTL itself into Chapter 11. Amazingly, the company exited bankruptcy proceedings a short while later with the equity completely intact. APTL’s profitable electric and telecom subsidiaries were its saving grace. The company agreed to make periodic payments to its bankruptcy claimants from available cash flow until 2013. APTL recently paid off the last of these claims two years earlier than planned.

In the wake of the bankruptcy, the company undertook positive corporate governance changes, separating the CEO and chairman roles and installing a new board. Since then, the company has focused on streamlining operations and deleveraging, with an ultimate equity target of 40% of capital.

Here’s a look at Alaska Power & Telephone’s historical results:

Growth has been slow but steady at around 4.4% annually. Annual net income has roughly doubled in the last decade, but is hardly consistent. The harsh climate and unforgiving environment in which APTL operates makes maintenance expenses highly unpredictable. The company explains that the Alaskan economic environment has been poor which makes it all the more impressive that the company has managed to grow. Any turnaround could improve the company’s operating results.

Consistent profitability has resulted in an improving balance sheet:

Since bottoming in 2002 in the wake of bankruptcy, the company has more than doubled book value per share to $22.93 at quarter’s end, an annual growth rate of 9.1%. Unspectacular, to be sure, but it should be remembered that the company has been burdened by its unprofitable HydroWest subsidiary (South American hydroelectricity, now spun off to investors) and its broadband segment has only recently approached profitability after years of capital investment. The company has more than doubled the equity proportion of its capital and is well on the way to achieving its deleveraging goal.

One interesting balance sheet component to note is the company’s investment in its primary lender, CoBank. CoBank is a private, cooperative bank that is part of the Farm Credit system, created by the government to encourage lending to farms and rural infrastructure projects. CoBank’s earnings are distributed to its borrowers, based on their loan balances. In the past twelve months, APTL earned $529,000 in dividend income from CoBank. Part of this is paid in cash and part shows up as ownership in CoBank. I have no idea what would happen to this ownership in a sale or liquidation of APTL, but this income from CoBank is real and material to APTL’s earnings, providing a nice offset to interest paid on borrowings.

Another important consideration is APTL’s recent spin-off of HydroWest. Due to a disagreement with CoBank, APTL was forced to divest HydroWest. The company did so by distributing common stock to investors, while retaining HydroWest’s newly-created preferred stock. Frankly, the divestiture should have happened long earlier. HydroWest never produced a dime of operating profit for APTL, and offered no synergies at all. Its existence was a legacy from APTL’s ill-fated diversification efforts of a decade ago. APTL’s profits and and leverage will improve going forward in HydroWest’s absence.

APTL stock’s current bid/ask midpoint is $17.55.

With an earnings yield of 12.2%, even a modest earnings growth assumption of 2.2% (half of historical revenue growth) implies an annual return of 14.4%. APTL’s valuation is very low for a stable regulated utility/telecom company. The company’s gradual deleveraging is wise and will likely continue until the company reaches a stable capital structure. At that point, I expect the company will reinstate its dividend and trade more in line with peers. This process could take several years, but in the meantime I expect the company’s slow but steady growth to continue. The recent completion of the company’s Southeast Alaska Microwave Network (SAMN) broadband data project could provide a kick for telecom growth and profits as well.

At the current valuation, I think Alaska Power & Telephone represents a low-risk opportunity with above-average return potential.

No position.



Webco Industries

And now we go back to steel.

Webco Industries manufactures and distributes carbon steel, stainless steel and other tubular steel products. The company is based in Oklahoma and was founded in 1959.

Quote: WEBC.PK


Webco Industries is, in many ways, your typical pink sheets manufacturer. The company has a long, profitable operating history and lots of tangible assets to back up the share price.

At present, the company trades (infrequently) at a sharp discount to book value and at severely depressed multiples compared to competitors.

Webco’s track record of growing sales and profits is solid. Since 2002, revenues have grown at 13.2% annually. Even in the worst 0f the economic crisis, the company remained EBITDA positive. Revenues for the twelve trailing months sit at an all-time high for the company. Still, the economics of the steel industry are not stellar. The manufacturing process is capital-intensive and foreign competition is a real threat. Even in strong years, Webco has struggled to achieve NOPAT/Invested Capital of much over 10%.

Webco has increased book value significantly through the last decade. The company does employ a significant amount of debt, but not materially more than its competitors.


With a P/E of 3.63 and an EV/EBITDA of 4.00, Webco looks cheap on an absolute basis. The company also looks cheap when compared to a group of steel manufacturers with enterprise values under $1 billion. Webco has a superior gross margin, EBITDA margin and net margin to most others, yet trades at less than half the valuation.

The average EV/EBITDA for these competitors is 8.59. It’s unlikely that Webco will ever trade at that level, due to its small size and obscurity. However, if Webco would trade up to just 80% of its competitors’ valuation (EV/EBITDA of 6.87) then equity value would rise by 150%!

The biggest mark against Webco Industries is its lack of free cash flow. The steel industry is mature and true growth opportunities are scarce, yet the company directs all of its operating cash flow year after year to capital expenditures. The company itself is confident in its ability to create growth through capital spending, with the CEO saying “We are progressing with the development of additional facilities and new product offerings. It is our intention to continuously deploy capital in pursuit of organic growth opportunities that are consistent with our long-term niche strategy” in the most recent quarterly report.

Time will tell.

At 68% of book value and 3.63 times trailing earnings, Webco Industries looks like a great value for patient investors. If management can grow the company in a disciplined manner, acquirers may come calling.

Disclosure: An account I manage holds Webco Industries.




McRae Industries

McRae Industries manufactures boots. Combats boots, work boots and Western boots. The company has been in business since 1959 and is still run (and controlled) by the McRae family.



McRae Industries is a stable, profitable manufacturer of necessary goods with a significantly overcapitalized balance sheet, trading at a very modest valuation. The company has had operating losses in only two of the past 25 years. Within the past several years, the company exited an unprofitable bar code reading business and now concentrates  solely on boots. The company pays a dividend and consistently repurchases stock. First, a look at recent operating results.

Revenues and income have been relatively flat over the last five years, which in itself can be considered an accomplishment. In 2009, the company’s sales of its higher margin Western fashion boots faltered, leading the company to a modest loss. However, the company’s fortunes have recovered and the twelve trailing months period shows the highest revenues and income since fiscal 2008.

On the negative side, return on capital continually comes in at an anemic 8% or so. A large part of the reason for this is the company’s extremely conservative balance sheet.

To say McRae has excess capital is an understatement. The company has no debt and minimal liabilities, yet it continues to hold 1.4 times its total liabilities in cash alone. If the company were willing to reduce net working capital or take on modest debt and return the excess to shareholders through a special dividend or share tender offer, the value for shareholders could be substantial.

Assuming current revenues and costs are maintained, any recapitalization strategy would lead to improved returns on capital, which could lead the market to assign a higher multiple to McRae’s earnings.

Unfortunately, none of these events are likely. The McRaes are firmly in control (owning over 40% of class A shares and over 60% of the super-voting class Bs) and have held excess cash for many, many years. On the plus side, holding this excess capital provides an additional buffer against economic downturns.

Investors shouldn’t expect massive returns from McRae, but a 12.3% earnings yield, significantly overcapitalized balance sheet and ongoing dividend and share buybacks make McRae Industries a very strong candidate for conservative equity investors.

No position.

Schuff International Inc

Schuff International fabricates and installs steel structures. The company operates mainly in the American South and Southwestern regions and has been run by the Schuff family since its founding in 1976.

Quote: SHFK.PK


First, a look at the company’s historical performance.

Steel construction is a tremendously cyclical industry. Schuff rode the great housing boom of the early and mid 2000s, more than quadrupling revenues from fiscal 2003 to fiscal 2007. From there, revenues fell off quickly, bottoming in 2010. Since then, revenues have rebounded 16.7% in the twelve trailing month period.

At cycle peaks, Schuff records massive profits and impressive returns on assets and equity. At troughs, the company operates at roughly breakeven. For cyclical companies, any particular year’s earnings may not be representative of long-term earnings power, so it helps to normalize earnings by averaging the results of several years, including at least one full economic cycle. Over the last ten full fiscal years, the company has produced an after-tax return on invested capital averaging an impressive 14.5%. (I calculate this as operating profit less 35% tax, divided by the sum of book equity and interest-bearing obligations. Note, I am excluding a one-time accounting charge that reduced net income in 2002.)

The company used its last decade’s profits to fund expansion and to deleverage the balance sheet. As of the last quarter’s end, the company had zero net debt and strong liquidity.

Schuff took on a large amount of debt in the late 90s. This debt was nearly extinguished at the end of September, 2011. The company was successful in creating value for shareholders, compounding book value per share at 10.7% annually over the period. This figure does not include the $56 million dollar dividend the company paid to shareholders in 2009. If the dividend had been retained, annual book value growth would have been over 30%.

With 9.76 million shares outstanding as of quarter’s end and a bid/ask mid-point of $10.86, the company’s market cap would be $106 million. (It isn’t, but I’ll explain why in just a bit.) Short of another historically unprecedented housing and construction boom, I don’t expect the company to repeat its 14.5% after-tax ROIC decade. I think a handicap of 30% is reasonable, down to 10.13%. Pre-tax, that is 15.58%. Given the quarter’s end capital structure, here’s how that looks:

That is not to say that Schuff will earn $17.54 million this year, or probably even next. They will likely earn far less until the cycle turns, then far more. 6.0 times normalized earnings is a reasonable price for a strongly-capitalized company with a history of success. However, the story doesn’t end there.

Schuff recently announced the repurchase of 5.6 million shares from majority shareholders D. E. Shaw and Plainfield Direct LLC. The repurchase leaves 4.1 million shares outstanding, a reduction of an astounding 57.7%. Schuff is serious. President and CEO Scott A. Schuff had this to say:

“By completing this transaction, we are taking advantage of a unique opportunity to enhance stockholder value while demonstrating confidence in the long-term outlook for our business…Every Schuff International stockholder now owns a greater percentage of the company by a factor of nearly 2.5. The reduction of the total outstanding shares as a result of this repurchase implies a greater share value for the holdings of our stockholders. We believe that the commercial construction market is at or near the bottom, and we are confident that our strategic vision and the disciplined cost controls we instituted nearly two years ago are allowing us to capitalize more quickly on new projects we see in the pipeline.”

To finance the repurchase, Schuff used cash on hand, a $30 million mezzanine financing from GB Merchant parters, its Wells Fargo line of credit and an unsecured loan from Mr. Scott A. Schuff in the amount of $1.4 million.

I used a few assumptions to make the projection below. I assumed that Schuff spent its cash down to $20 million and drew $30. 34 million from its line of credit. For the mezzanine debt, I used the same interest rate as the existing long-term debt, 10.5%. The interest on Schuff’s line of credit is prime minus 1 percent, so I assumed a long-term average of 5%. For the unsecured loan, I used an interest rate of 15%.

Based on my projections, Schuff’s debt-financed recapitalization adds tons of value for shareholders. Previously trading at 6.0 times normalized earnings, the company now trades for only 3.4x. Projected interest expense is much higher, of course, but income per share increases dramatically. The debt is easily serviceable, given the company’s liquidity and recent cash flow.

Of course, Mr. Schuff could be wrong and the commercial construction industry could remain sluggish for years to come. In that case, Schuff would be dead in the water, operating at near break-even for a long period to come. However, I am inclined to trust management’s judgement, especially considering how much of the Schuffs’ own money is at stake. After the repurchase, the Schuff family owns 60.8% of shares outstanding. That in itself introduces the risk that minority shareholders will not be treated fairly. Shareholders should keep both eyes open.

I will be adding Schuff International Inc. to the Idea Tracker page soon.

No position.



QEP Company

QEP Company manufactures and distributes flooring products such as hardwood floor materials and installation tools.

Quote: QEPC.PK


Despite operating in an absolutely horrid housing market, the company is firing on all cylinders. Revenues, earnings and EBITDA are all at record highs. The balance sheet is solid and improving. Even with all of these positive factors, the company trades at a depressed multiple and could reward investors handsomely once the market eventually recognizes the company’s success.

First, a look at the company’s recent income and cash flow trends:

Beginning in 2007, the company was hit hard by declining sales, resulting in losses and goodwill writedowns. The company responded with vigorous efforts to cut costs and reduce debt, resulting in greatly improved margins and profits. Net income and revenue over the trailing four quarters are the highest in company history! Free cash flow has soared as well.

Improving profitability and cash flow has gone hand in hand with a strengthening balance sheet:

QEP Company’s share price was hammered during the financial crisis as investors fretted over the company’s excessive leverage and poor liquidity. Since then, the company has succeeded in nearly doubling its current ratio and has cut total liabilities by 37.1%. By gradually paying down liabilities and retaining earnings, the company has increased equity to greater than 50% of assets, more than double 2007’s figure. By any measure, the company’s present balance sheet is less levered and more flexible than at any time in recent history.

At a recent bid/ask midpoint of $17.73, the company’s market cap is $60.18 million. Enterprise value is $65.76 million. Trailing earnings of $11.57 million give a P/E of just 5.20, while EV/EBITDA comes in at only 3.14. Trailing free cash flow yield is 17.02%.

QEP’s process of deleveraging by using free cash flow to reduce debt is coming to an end. Future free cash flows can be used to make acquisitions, reinvest in the existing business or distribute to shareholders via dividends or repurchases. At some point, the market will recognize QEP company’s earnings power, growth potential and balance sheet strength and reward it with a higher earnings multiple. A normalized housing market would only provide an additional tailwind for the company.

QEP does face risks. A stronger US dollar would reduce the value of the earnings of the company’s foreign operations. Another US recession could cause decreased revenue and pinch margins. Most significantly, Home Depot accounted for 63% of sales in fiscal 2011. The impact of losing Home Depot’s business would be devastating. However, the company’s relationship with Home Depot goes back to 1983 and QEP works very hard to maintain the partnership, even offering support to the Home Depot customers who buy QEP Company products.

I’ll be adding QEP Company to the Idea Tracker page tomorrow. In my view, QEP offers a chance to buy a good business with improving finances at a large discount to earnings power.

No position.


And welcome! Somehow, amidst the endless chaos that comprises the internet, you’ve found yourself here. My task on OTC Adventures is to find and profile the most intriguing investment opportunities I can find among the ranks of the market’s most neglected and suspected companies: OTCBB and pink sheets stocks.

Most of the companies trading in these markets are worthless, or even fraudulent. However, the patient and diligent investor can still find hundreds of profitable, reputable companies worth examining.

Please check back soon for commentary and investment ideas.