One heck of a hidden asset

Central Natural Resources (CTNR.OTC)

Price: $27 (2/7/2012)

Market Cap: $13,000,000

Often I will read an investment thesis that hinges on some sort of hidden asset.  A hidden asset is something a company might own that is either under monetized or maybe held on the books at an exceptionally low cost.  In theory most investors somehow skip over these hidden assets when doing their research leaving them as a pot of gold for enterprising or inquiring investors.

I have my doubts about how many hidden assets are truly actually hidden and missed by investors.  I own one company that could possibly qualify, Bowl America.  They own 17 bowling alleys in the DC area and Florida, the real estate is held on the books at cost.  The key is these centers were purchased in the 1950s, so presumably DC real estate is worth much more now than in 1950.  Even though the real estate would qualify as a hidden asset I'm not sure how hidden it is.  Most of the investment writeups on Bowl America all discuss the hidden value of the real estate.  If all investors are looking at the mis-priced real estate it's not all that hidden.

One example of a asset being truly hidden is the case of EDCI.  EDCI was a company that entered liquidation a while back that I owned and followed.  At one point in their liquidation process they announced they sold some patents they regarded as worthless for a few million dollars.

Readers might have noticed that recently I'm highlighting a lot of un-followed and mostly unknown companies.  For some background I've been working my way through a book the Walkers Manual of Unlisted stocks.  I started with the A's and have been steadily moving towards Z.  Some of the companies have gone private, for others there is no information available at all.  Some like Central Natural Resources don't file with the SEC but do put their financials out on their website.  The exercise has been fun, most of these companies are simple to research and it's fun to hunt down hard to find information.

For a quick background Central Natural Resources is a resource company based out of Kansas City.  They own some coal properties along with some gas wells.  Most of their income comes from mineral leases on the land they own.  The company is pretty simple and straight forward, price of gas/coal * amount extracted minus extraction costs and salary equals profit for investors.  The company has been pretty good about paying out a good chunk of profits to investors as dividends.

The hidden asset at Central Natural Resources is a bit more hidden than usual, it only appears in the annual reports as a single sentence.


This is curious, the company has a large coal deposit which hasn't been mined yet being carried for $700,000.  When I read about this I wondered what 92m tons of coal would go for on the spot market.  Using a NYMEX quote of $57.87 per ton that coal has a gross value of $5 billion dollars!  Sure there are mining costs, and transport costs and all sorts of other things but remember that Central Natural Resources's market cap is $13,000,000, there is a lot of wiggle room there.  The value of the coal alone is 400x the trading price of this company.

The problem I have with hidden assets is that while they're supposedly unknown to investors they are well known to the people running the company.  And it's not a far stretch to say insiders probably know the true value of the asset.  Sometimes an insider will be buying back stock trying to capitalize on this discrepancy.  But mostly insiders don't seem to care much, and are content to let a supposedly valuable asset lie idle or dormant.

As I was thinking about Central Natural I kept thinking that management knew they had a $13 million dollar company with a $5 billion dollar asset, so why didn't they get moving on mining it?  I skimmed a few of their annual reports and found some vague references answering my question.  It seems those 92m tons of coal aren't exactly easy to extract, the company has looked into mining it but there have been no mine operators who are interested in digging it out.

Maybe after all the $700k carrying value is overstated?  If there's a pot of gold in the ground that's impossible to extract does it have a value?  Maybe this coal will be like the shale gas, in a few years someone will discover a way to extract hard to reach coal cheaply and Central Natural Resources will make a lot of investors rich.

My conclusion is that relying on a hidden asset to make an investment thesis seems fraught with problems, most where were highlighted above.  This doesn't mean an investor should ignore an asset like the 92m tons of coal, but rather they should view it as an option on their investment.  If something lucky happens and the coal is dug out everyone wins. On the other hand if the investment thesis is based on the value of the coal there's the potential and likely outcome of disappointment when the coal remains in the ground forever.

At this point I should mention that Central Natural Resources actually looks attractive on a stand alone basis, they're overcapitalized with $4.6m in cash and a small amount of debt.  They're trading at a EV/FCF multiple of 6x.  If natural gas prices or coal prices rise again they should do very well.

Talk to Nate about Central Natural Resources

Disclosure: No position

10 comments:

  1. Interesting case, it reminded me of what is going on right now with a proposed quarry in Ontario. If you are unfamiliar you should read this article (plus the related ones): http://www.valuewalk.com/2012/01/baupost-might-lose-money-on-mega-quarry-investment/#.TzLbYeRfRC8

    It caught my eye because I consider Baupost/Seth Klarman to be the greatest value investor of our time. Take a look and see what you think.

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  2. What edition of Walkers Manual do you use, and do you have any tips on where to actually get a copy? Thanks! I'd also be careful valuing resource companies on current cash-flow since it is a depleting resource.

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  3. Anon 1 - I'm familiar with what Baupost is doing, I never made the connection though with Central Natural Resources. It is very similar, I think what Baupost shows is that there are other factors at play besides just straight math, and those factors (human factors) can really lower the rate of return.

    Anon 2 - I have the last edition published the 2003 edition. I purchased it used on Amazon a while back. There are a few copies from year 2000 floating out there on Amazon at reasonable prices. If you can't get the 03 edition the 2000 edition will probably be fine, maybe a few more companies that went private but not much difference. The financials are old anyways.

    I think you'll probably do well with any copy, there are some like minded investors who I email with about some of these pink stocks as we've all been going through the Walkers on our own. Here's the strange thing, our list of "interesting" companies is all very similar, we all used our own criteria, did our own research. So I think the types of companies you'd want to own stand out a bit.

    I'd also recommend looking at a library, I know a library near me had a few copies. You can see if it's useful, if you can't get a copy you can always bring the laptop and research there. My copy is a old library discard so maybe it's worth seeing if they're going to pitch it soon.

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  4. I have a question, when looking at small/unlisted stocks. If the financial statements are unaduited, do you still bother to look into the company? If so what degree of trust do you put in unauditied statements?

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  5. Anon,

    I don't worry much about audits/auditors for a few reasons.

    1) Quarterly statements by most companies in the US are unaudited and no one seems to have a problem using them.
    2) Auditors are notoriously bad at detecting fraud, usually auditors find out about fraud at the same time as the public.
    3) Auditors can sign off all clear (think China RTO) when in fact that's not the case.

    I do my own checks for earnings quality and signs of fraud. Simple things like checking accruals, quality of cash flow, revenue per employee, cash paid for taxes etc.

    My question would be what are your specific concerns? A lot of investors seem to put a ton of faith in auditors. I would recommend every investor sit down with an actual auditor and ask them about the process, how they conduct it, what they look for etc.

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    1. Thanks for your reply. I guess i just read somewhere that if the company doesn't produce audited financial statements, it shouldn't be trusted. And of course a blanket statement like that is bound to have exceptions but I thought you might be using as a criterion to sort through the massive amount of companies listed in one of those manuals or as described on the Valueuncovered blog going through the pink-sheets.

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    2. Pcook,

      The question I would ask a company is why aren't they auditing their financials?

      I haven't run into a company yet that doesn't have their annual report audited, in all cases the audit letter is attached to the annual report. In most cases the accounting firm actually prepares the annual report for the company if the company is small enough.

      For most of the companies that Adam (ValueUncovered) and I look at are not the typical penny stock/pink sheet fraud types. I want to see companies heavy with assets, earnings or cash flow which excludes 99.9% of pink sheet bio stocks, and 99.9% of pink sheet tech stocks.

      Most of these companies are stable boring companies that will never have explosive earnings. Often I hope that management will just go private at a fair valuation which would give me a nice return.

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    3. That makes sense. Thanks for your response.

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  6. On the 2010 annual report for CTNR they actually omit the 92 million tons

    "Coal deposits, mineral rights, and surface land are stated at cost and are classified as mineral interest properties on the
    consolidated balance sheet. Coal deposits with a net carrying value of approximately $700,000 at December 31, 2010 are not
    presently leased or producing coal in commercial quantities."

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  7. I have been reading Walker's Manual of unlisted stocks.It is a great book.

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