REO Plastics is a injection molding plastics manufacturer. Injection molding is a fairly simple concept, a mold is developed for an item, the company then injects liquid plastic into the mold, cools it and packages it, or ships it to the next step in the manufacture process. Anyone with an injection molding machine can injection mold, so to compensate for this companies offer valued added services, REO Plastics is no different in this regard.
The company was founded in 1960 by Robert E. O'Connor, hence REO. The company was run by Earl A. Patch from 1975-2008, and is now run by his daughter Carrie Sample.
What's so great about REO Plastics?
- Trades at $15, although it hung around $12 for the past year.
- Earned $3.07 p/s last year, and $.79 p/s the prior year.
- NCAV is $15.39
- Book value $27.66, grew 12% from the previous year.
- EV/EBIT 2.12
- P/E 4.88
- ROE ex-excess cash 12.86%
I should just end my post here, but I feel like it's worth explaining a few things about the company, first a summary of their financials provided by http://www.unlistedstocks.net
The first item of discussion is the company's sales and earnings this past year, they were the highest in the company's history. This could mean two things, the first is that they'll never be repeated and will become a high water mark. Astute readers will notice they recorded a loss in 2011, although they do have a large retained earnings account. The second possibility is that something has changed and the company is building sales momentum. This is clear if you look at the last three years, sales rose from $17m to $25m bringing increased profits along with it.
Injection molding is not a high margin business, but the results show that as the company's operating leverage increases their margin becomes respectable topping out at 5.37% this past year.
The company's profits and growth are interesting, but what attracted me to the company is their balance sheet. They have $2.4m worth of cash on their balance sheet with no debt and essentially no liabilities except for accounts payable and accrued compensation.
It is easy to argue that book value is a worthless metric for an industrial company, a lot of digital ink has been spilled over this issue. I have no interest in starting an argument, but want to point out a few items that I find interesting. The first, the company is investing heavily in their plant, in the last three years they have spent $4m in capex. The company is proud of their machinery, they have a list of every machine make and model available on their website. The type of company that lists their equipment models and posts pictures of them on their website is also the type of company that problem keeps them well maintained. A negative against the company is that injection molding is a commodity business, a positive for book value is there are plenty of other companies that could purchase old equipment that is in great shape at a good price.
The last point I want to make with regards to book value is that the CEO considers this a valuable metric. A CEO is the person who knows the business the best, and the metric they use to value it themselves (if rational and conservative) is one investors should consider as well. Investors value Berkshire Hathaway on book value because this is what Buffett uses. The CEO of REO Plastics considers book value to be important enough to highlight in the annual letter to shareholders. This is significant because the letter is three sentences long, and one of those sentences is asking for questions and comments. The CEO highlighted book value in last year's annual letter (also three sentences) too.
The investment case for REO Plastics is very simple, the company is selling for slightly less than NCAV, and for 55% of book value. The CEO considers book value a fairly important metric, so it could be reasonably presumed that the company is possibly worth something close to book, maybe 80% or more. Throw in growing sales and growing earnings as an investment sweetener.
The downside is the stock is extremely illiquid, it will go months without trading. I purchased shares with a GTC order at the price I wanted to pay, I believe I had a fill in less than a week. The second downside for many investors is they won't be flooded with information. You will receive a nine page annual report once a year. It's not a stretch to say it takes 10 minutes a year to follow this investment.
Disclosure: Long REO Plastics