Thursday, October 11, 2012

Schuff, a potential 10 bagger, or bankrupt?

One great thing about recessions and downturns is they clear out a lot of marginal businesses.  The marginal companies either die at the hands of their bankers, liquidate, or manage to get bought out by a competitor in a stronger financial position.  The strong companies not only survive, but thrive.   From the bottom of the recession many companies that taunted death and survived returned 2x,5x,10x for shareholders with guts, and confidence enough to buy at the bottom.  The common consensus is that those opportunities are gone from the current market.  While there might not be as many as there once were, these sorts of opportunities do still exist, one example is Schuff International (SHFK).

Schuff International is a steel fabrication company.  According to their website they're the largest steel fabricator in the US.  When I first heard of Schuff over at OTCAdventures, I thought they were a smallish regional fabrication company.  After visiting their website I learned I was wrong, the company employs 1600 people and has completed many impressive projects like the Cardinals Stadium, the Bronco's Stadium, Bank One Ballpark, Sprint Arena, the Sacramento Airport, and other large projects such as hospitals, shopping centers, and casinos.  If a building requires structural steel, and is located in the Southwest, there's a good chance Schuff is supplying beams or joists.

The bull case for Schuff is very simple.  The company current trades for around $9 a share with a market cap of $36,314k.  Back in 2009 the company's net income was $18m, and in 2007 it was $59m.  The thesis is simple, Schuff is cyclical, and if their earnings can even come within 50% of peak earnings this stock has the potential to be a 10 bagger.  If they fall short maybe it's only a 5 bagger, or a measly three bagger.  For context here are the results over the last nine years:



Schuff isn't attractive just on peak earning power alone, management is shareholder friendly as well.  Last year they went on a binge and purchased back more than 50% of the outstanding shares at once.  The shares were purchased from two large holders, D.E. Shaw and Plainfield Direct LLC at $13.25 a share.  D.E. Shaw and Plainfield owned 58% of the company before the repurchase with the Schuff family owning 25%.  After the purchase the Schuff family now owns 60% of the company with outside shareholder interest increasing from 15% to 36%.  The repurchase was clearly a way for the Schuff family to regain control of the namesake company, but it also created value for outside shareholders.  Management stated they believe they are at the bottom of the cycle and they wanted to take advantage of the opportunity.

The big effect the buyback had was changing the bogie for earnings.  When the company earns $10m instead of that being $1.02 a share it now results in EPS of $2.41 per share.  I think it's useful to consider what past earnings looked like with the new share count:


If earnings recovered to the 2009 level with a market multiple of 10x, Schuff could be worth $45 per share.  If earnings recovered to the 2007/2008 level, which I feel is unlikely at a 10x multiple, shares could be worth $130.  I don't think Schuff will ever recover to the $13-14 per share level, because at that point in time a lot of their projects were coming through from the housing boom in the Southwest. With that said I don't think it's unreasonable to think that Schuff could earn anywhere between $4 and $8 per share in the next few years as the economy recovers.

Margin of Safety

The bull case is simple, but that doesn't mean this is a simple stock to look at.  If this was a sure fire ten bagger I wouldn't be writing it up, I'd be out mortgaging my house to buy Schuff stock, and telling everyone else to do the same.  When I look at Schuff the question I ask is "can this company survive long enough for the market to turn?"  My biggest question with Schuff is how can they survive, and at this level is there enough protection for me an outside investor against losing my money?

Unlike a lot of companies I look at, Schuff isn't debt free, they're actually the opposite of debt free, they recently accumulated a lot more debt.  The company has ~$30m in long term debt, and an additional $26m of long term debt coming due in 2012.  The buyback was financed by cash on hand, an unsecured loan by Mr. Schuff, and a hit to the Wells Fargo credit line.  The result of this is that Schuff has some incredibly high borrowing costs, almost at credit card levels.  The company has $30m of debt due in 2015 with a rate of 14%.  They have an additional $24m at LIBOR plus 4.25%, and the loan from Mr. Schuff is at 13% a year.  Typically rates at the level Schuff is paying are an indication by the lender that they're concerned about the possibility of getting their money back.

With Schuff facing a debt bill of $26m in 2012 it's worth considering how they're going to pay the bill. This is even more concerning after realizing the company had a negative $3.7m cash from operations in 2011.  In the sheet above I pulled out cash from operations over multiple years, and you can see it's lumpy, very lumpy.  This is because Schuff isn't paid by clients in a straight line basis, they're paid a portion of the cost (sometimes just materials) at different checkpoints of a project, with a final payment coming once the project is complete.  In 2009 the company had $91m in cash from operations, $18m in capex and $73m in FCF.  That's something to consider for a moment, two years ago Schuff generated enough free cash to take their company private..twice.

If one were to only look at the latest annual report and speculate on the debt repayment the obvious conclusion would be that Schuff is bankrupt, unless they can either roll or extend their loan.  This was my initial reaction when reading the latest annual report.  But then I sat and thought about Schuff a bit more and came to a different conclusion eventually.  As outside investors we can only see what the company gives us, yet management can see everything, projected cash flow schedules, project completions etc.  Why would the company management take on onerous short term debt that might imperil the company to buy back shares if they had no way to pay back the debt?  I think Schuff management knew that there would be some projects completing in 2012 with associated cash flows.  The cash flow would provide way to pay back some or most of the short term debt related to the share buyback.  After 2012 the company will owe $4m in 2013, $5m in 2014, $19m in 2015 and $1.4m in 2016.  The payback schedule seems odd, but it also seems to line up with the volatile nature of cash payments the company receives.  It wouldn't surprise me if the loans were tailored to have balloon payments that coincide with the completion of some of the company's larger projects.

Although we can't be quantitatively confident that the debt will be paid off, there is a strong inference that this won't be a major problem in 2012.  While we expect the company to make their payments this year it's always helpful to look at what might happen if the company doesn't pay and ends up in bankruptcy.

Schuff has $258m in assets against $164m in liabilities, for a book value of $92m, or $22.43 per share.  Book value consists of mainly of current assets and PP&E.  The company does have $10m in Goodwill, but even if we remove that from book value the investment is pretty well protected.  Most of the company's assets consist of inventory and receivables, two items that could take a haircut in a bankruptcy situation.

Maybe book value is overstated, or receivables or inventory aren't worth stated book value.  The good news is if any of those things, or something else is the case a buyer at today's price is protected by buying at 40% of book value.  There's room for a lot of error before an investment is at risk.

Conclusion

While I have been looking at Schuff the biggest question has been "can they survive?"  I don't have solid evidence that they can survive until the construction market turns around, and the results are reflected in the financial statements.  But I do have signs, management is bullish on the company, both with buying back shares, and reopening an idled plant in Florida.  I take comfort in the fact that project billings are lumpy, and associated cash flows are irregular as well.  Maybe this year's cash flow will pay the debt and then some.

The bottom line is I really don't know, but I'm not sure how much I need to quantify to invest in Schuff.  At 40% of book value, and at a very low multiple of mid-cycle earnings it's worth taking the speculation.

Talk to Nate about Schuff International

Disclosure: I have an order placed for shares.  I could be long when you read this, or have no position.

40 comments:

  1. Nate:

    A very interesting speculation for sure.

    HOWEVER, one concern I would have is thus:

    The Schuff family LOADED the company down with debt, a tremendous burden, with a great deal of risk as evidenced by the high interest rates...

    Could it be that the Schuff family views buying back all those shares as a NO LOSE situation?

    If the company survives in it's current form, all well & good.

    If the company has to enter bankruptcy, oh well...They've got a stake higher up in the equity chain as evidenced by their loan.

    If the Schuff family has LOTS of liquid assets, they could come in and try an take the company out of bankruptcy by buying claims at $.30 on the dollar. All the common equity would be wiped out...or very nearly so...

    I'm not saying this would happen, but things like this always make me nervous.

    In no way do I mean to imply that the Schuff family would OR could do this.

    Just me looking for a way that things could go wrong. This deal almost seems too good to be true...

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    1. Thanks for the comment, it's interesting and thought provoking, but I think some of the fears are unfounded.

      If Schuff were to go bankrupt the family's 60% interest would be standing in line behind the debt with their interests grouped with the rest of the equity holders. I believe if they did purposefully put the company in BK, then attempted to buy out their claims cheap they could be sued by the creditor.

      The CEO also gave an unsecured loan to the company as a sign of his confidence in this deal. While the amount isn't very large (a few million) it does seem significant in the sense that he's putting his money where his mouth is.

      I think the benefit there is with Schuff is this is a family controlled company, with a lot of equity at stake. The Schuff family's portion of book value is roughly $60m, so there's a lot to lose in a BK, and a lot to protect.

      Delete
  2. This is too much of a speculation for my taste. I think this is much more like a call option on the construction market than a solid value investment.

    The odds of losing 100%, or close to it, on this stock aren't in any way negligible.

    One of graham's most known sayings is: "An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return. Operations not meeting these requirements are speculative."

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    1. Do you mind explaining how an investor could lose everything? That was my first reaction, but I can't get it to work out unless we presume the current assets are worthless, and their hard assets are worthless as well.

      That isn't the reality though, those assets have value in the sense that they've been deployed to create acceptable returns in the past. While they're underutilized right now that doesn't mean they will always be, and they should be valued as such.

      I think Graham would actually like this stock, it's selling at a large discount to tangible book value. The risk of a loss is actually much smaller than perceived. A point of contention might be that I estimate (speculate) on the company being able to pay off the debt in the next year. I'd go on a limb and say that my estimation is no more egregious than someone who's speculating on what future earnings or cash flows would be.

      Looking forward to the hearing where you see the gaping holes in this thesis. Thanks!

      Delete
  3. The term loan is secured by the company's real estate which, at cost, is worth $62m.

    Worst case, adjusted book = 288 and liquidation value is (288-164) = 124 = 29.95.

    You'd have to squint real hard not to see a 3-bagger at least.

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    1. Red,

      I saw that, but forgot to call it out in the post. I agree, it's tough to see this not being a multiple from here.

      Nate

      Delete
  4. how do you get to 288 adjusted book?

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  5. "how do you get to 288 adjusted book?"

    add back the depreciation on land & buildings.

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  6. depreciation on land? is goodwill eliminated? what about discounts to other assets, capitalized costs, receivables and inventories in a liquidation scenario?

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  7. I followed this company in the 90s, when it had even more debt on it. At the time, they did a $100mm debt issue and Ebitda was around $20mm-$25mm. Went to visit them and saw one of their plants. At the time, they had a nice contract for some very large diameter pipe (I could stand in the pipe and there would be plenty of headroom). I thought at the time it was a well run company.

    EV was around $100-$125mm for a long time. I don't know if they bought other assets or expanded since then. I see the last couple of years they've had minimal Ebitda (less than $10mm) but they did about $52mm of Ebitda in 2009. They also paid themselves a big $50mm+ dividend a couple of years ago.

    Current EV is $140mm. Unless you know of a couple very big contracts, I would think that the stock could maybe double from here but not much more than that. I would rather pass at this point. It doesn't seem that cheap and I don't see a lot of big commercial construction projects out there.

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  8. Nate, not sure I would use the term shareholder-friendly and Schuff in the same sentence. If it's in their interest, we can tag along for the ride, but they've tried several times in the past to take out minority shareholders with a low ball MBO.

    I actually like the debt for that reason. Job one will be reducing the debt and I think they will be successful, as they've done it before and know how to play these cycles.

    They've added capacity in the past and bought some plants for a song, so when the economy turns they are ready to make some serious money.

    Anonymous stated "current EV is $140mm", not sure where he got that figure (probably using old share count), but I actually think that is a fair valuation. As debt is paid down, the MC in the EV ratio, should move nicely (at least dollar for dollar, but then valued higher as the enterprise is perceived to be more soundly financed).

    LBO's are inherently risky propositions and much more so in a deeply cyclical industry, but when you call the turn correctly, the stock can be fun to watch.

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    1. JJR,

      Good points about management, I like how you say we get to tag along. With the Schuff's owning 60% shareholders really are at the whims of management. That said the family appear to be savvy operators, I don't think it's an accident that they've grown to be the biggest in the industry in the last 20 some years.

      A take under is a big risk here. The company paid a high premium to buy out Shaw and Plainfield, but they might not treat minority shareholder the same.

      I like the LBO dynamic as a shareholder, especially in the case of Schuff where it appears the downside is fairly limited.

      Delete
  9. The $140mm of EV came from a quick look at Bloomberg. Bloomberg is using 4.15mm basic shares outstanding but it is calculating the market cap using the diluted shares outstanding of 9.69mm. if 4.15mm is the right figure and the other 5.5mm shares are way out of the money or not accounted for property, then the EV would be roughly $90mm. At $90mm, I don't see much downside!

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    1. The 4.15mm figure is correct for diluted, I saw the Bloomberg market cap error as well when I first looked at this.

      I think it's safe to say that with the corrected values you're a bit more interested now?

      Delete
  10. Any known reason why quarterly's were published thru 2011, but no interim reporting for 2012?

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    1. This is something I was wondering as well, possibly Shaw and Plainfield were pushing for it. With them gone there wasn't a push anymore.

      Delete
  11. Where did you get the ownership info from? Was it something the company sent you or is there a public filing somewhere and I'm just not finding it?

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    1. It was in the news release related to the buyback. You can find it at otcmarkets.com under "News".

      Delete
  12. Back to the earlier commenter. This could easily brake. The schuff family probably views the buyback as a cheap option. They are familiar with the company and Mr Schuff is already a creditor. He wins if the company survives or fails. You could try and sue with the buyback but the judge will not care. This is not uncommon. If you like the idea of the cyclical uptake fine, but may be safer to get long the debt rather than equity.

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  13. Do they really have $26 million due in 2012? It looks like $24.413 million is from the LOC and it matures in 2016.

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  14. Reliance Steel purchased two smaller U.S. steel companies in the last quarter, each with sales around $45mn. Will be interesting to see how much they paid for the acquisitions when they report to get a sense of what types of market multiples these companies deserve (may not be a great comp but better than nothing).

    Also, looking at the debt balance, I'm not sure which balances are maturing in 2012. They've got $30mn in debt due 2015 where they pay interest and some principle quarterly ($15mn balloon pmt at end of loan), $24.4mn in notes payable to a bank in a revolver with interest payable monthly maturing in 2016, and $1.4mn in unsecured notes to the family due in 2016. So I'm assuming a couple million is due in 2012, not the $26mn, unless for some reason the revolver needs to be paid off? Any help here?

    And has anyone contacted the company about lack of quarterly reporting? I will send them an email later today.

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  15. Tim and anon,

    On page 15 of the 2012 annual report they show $26,413,000 in debt maturing in 2012. I don't know what this is exactly but after this the next big chunk is 2015.

    Anon, if you hear from the company please let me know. I need to call, haven't found the time yet.

    Nate

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  16. I spoke with the CFO today. The credit line shows as a current liability even though it is not due this year (just accounting treatment). Thus the $26 million is due when the credit line expires. Which I believe is in 2016. These things are usually rolled over anyhow.

    They are no longer releasing quarterlies because they felt it disadvantaged them against private competitors. They will put the annual on the website and pinksheets.com.

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    1. Tim,

      Thanks for following up, the annual report is a bit confusing then. This is good news, there's a lot of breathing room, although I wish the interest rate was lower.

      Nate

      Delete
  17. I know some people at Reinicke Industrial Contractors, they have more work than they know what to do with.

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    1. Interesting data point, thanks for the comment. This is good news for Schuff!

      Delete
  18. Nate,

    Great post as usual. I've dug into this a little bit and am wondering your thoughts on:

    1) Do you know how D.E. Shaw and Plainfield Direct got involved in this name in the first place and when they initiated their positions? Seems unusual for a firm like D.E. Shaw to be on the board of such a small company.

    2) Does it concern you that they were willing to sell their entire stake to the company? I realize it was a price much higher than the current price ($13.65 I think), but based on your analysis, this stock should be worth well in excess of $13. Any insights into why these informed sellers were so willing to unload their stake?

    3) What do you view as mid-cycle earnings power? Using avg. unlevered FCF from 2003-2012 of $24.1 mm and a 15% discount rate, I arrive at an equity value of $25.20. What do you see as mid-cycle earnings power? I'm worried about using the past decade, a time with a pretty big construction boom, to measure the average cycle.

    4) Perhaps I don't know enough about steel fabrication, but how is Schuff the largest player with a sub $40 mm mkt cap? That just seems too low for what sounds like an important part of the construction process.

    Anyways, great post looking forward to discussing it more.

    Connor

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    1. 1) I'm not sure how they got involved, but five years ago the company was nearing the top of their cycle, and were earning a lot of money. Maybe they thought the good times would never end like most investors and thought there was a lot more upside from there.

      2) Not really, mostly because these are bigger funds, and five years is a significant holding time in today's investment world. So they had a losing position, waited it out and got frustrated. Often for a large fund a position like this can become an annoyance, if it's not going to make a meaningful difference to the fund it's easier to just cut the loss.

      3) This is tough, the future isn't going to be as good as the past for sure. Even if they get back to $18m, which is what they earned in 2009 that'd be about $4 p/s. I think your estimate of $24m is reasonable.

      4) I think the thing here is the industry is fragmented, I-beams are heavy, and it's not cost effective to fabricate an I-beam in AZ and ship it to Ohio. So you get a lot of local fabrication, or semi-local. Schuff has a number of facilities, and while their marketcap is only $40m, they've done a considerable sales amount in the past. The tiny marketcap is really an indication of the lack of interest rather than anything else.

      Delete
  19. Schuff International is a company that is in the steel business. With the economy weak as it is I do not think its the best time to buy a stock like this.

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  20. Actually, most analysts agree construction is set to rise..

    Nate certainly deserves the credit on this one and made me start looking at it, but here is my analysis (from a slightly different angle):

    http://thevariantview.com/2012/11/15/schuff-international-shfk-cheap-ugly-and-a-potential-multi-bagger/

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  21. Will BeuttenmullerMarch 21, 2013 at 2:28 PM

    Nate, thanks for the great work on the site. Any thoughts on the release last night?

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    1. Will,

      Quick on the trigger for the results! I have skimmed them and I like what I see so far. Debt came down by about half and FCF equaled roughly 50% of the market cap.

      Unfortunately the market hasn't turned yet, but I was glad to see they were profitable. Book value grew slightly, I believe the thesis remains intact. I'm glad to see everything is moving in the correct direction, makes it easier to be patient.

      Any things you noticed?

      Nate

      Delete
    2. Will BeuttenmullerMarch 21, 2013 at 3:37 PM

      Agreed on all points.

      Positives:
      + 14% y-o-y revenue growth and 32% y-o-y EBITDA growth
      + Very positive NWC capital dynamics (generated $20.5mm in cash)
      + Continued low capex spend
      + $27.4mm in debt repayment

      Negatives:
      + Gross margins fell another 100bps
      -- would love to understand what's going on here
      -- based on historical performance at these revenue levels, I assumed there would be much more operating leverage in the business
      -- my best guess is that prices have compressed as competitors are desperate for business in a slow growth world
      --- if I'm right that this a price and not cost problem, I'm not sure I like this company as much if they are going to bid projects to a 4% EBITDA margin into the future
      + They are not in compliance with some of the terms of their credit agreement (though they received waivers)

      Areas of further diligence
      + Billings in excess of cost spiked
      -- Why?

      Though I'm definitely long and continue to be long, the biggest concern for me is still that management may be attempting to pick up the ~40% they don't own on the cheap rather than attempting to increase the value of the 60% they do own by increasing liquidity, visibility, etc.

      The latest piece of evidence that management has the former approach rather than the latter is that they gave investors no notice that they published the Annual Report (even though they provide the option to subscribe to news updates on the website).

      Delete
    3. Will,

      Good points, I agree, I think management is trying to get this cheap still. Part of me was liking the de-leveraging because it prevented them from just taking the company, they were forced to pay down the debt. Yet here they with a lot of FCF and paying off the debt.

      It's worth looking at CanAm, they're very similar to Schuff but operate in Canada. As an investment they're not as attractive, but the industry dynamics are the same, they're a good comp.

      Delete
  22. I work for Schuff Steel and have met the Schuff family. They truly believe in this company and so do I. The Albany GA plant stands behind this family and this company



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  23. Anon, any insite into the restructured Southeast operations??

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  24. Is there anybody who has any insight in this M&A deal they did; where they sold this plant to CanAm? Why are they doing this - they wrote on their website that it was non-strategic, however - isn't the big trick in this buis to make sure that you have plants all over the country, such that you can produce close to your customers? I can't imagine that it takes a lot of pain/costs to change a factory from producing a certain steel structure into another one.

    Another funny thing to see is that CanAm almost doubled in share price since Jan and that Schuff is down (i am not sure if CanAm has a more leveraged cap structure; but I would be surprised).

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  25. Nate---any updated thoughts here? HC2 buys all of the Schuff family's stake, and Scott retires. HC2 closes the Florida plant and laid off 50+ people. Net-net, I think this is positive, but I'd be interested to hear your thoughts.

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  26. The Florida plant was closed prior to the purchase by HC2

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  27. As an FYI, I won't be tendering my shares. I think this thing is worth way more than $31.50.

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