On my last post someone suggested in the comments that I check out Federal Screw Works, a name I'd seen bouncing around the internet over the past few months. I am familiar with the company, I came across them as I evaluated hundreds of pink sheet companies over a year ago. With the a reader's prompting it was time to look at the company again.
Federal Screw Works (FSCR) is a Michigan company engaged in the manufacture and production of machined parts. An incredible 97% of their sales is to the automotive industry. A sampling of their products is shown below:
Companies like Federal Screw have a tendency to scare me, these are companies with long histories of losing money that suddenly become profitable. When the perennial money losers start to make money it's often a sign that we're in the late stages of a recovery or worse, in a market that's topping out.
Most often asset value plays are considered cigar butt investments, companies with a little juice left in them, but not much more. I believe the analogy could be extended, there is a whole category of earnings based cigar butt investments as well, of which Federal Screw Works is potentially one of them.
When an investment thesis is based around a company's assets the investor is betting that the company isn't worth less than either liquidation value, or book value, and eventually the market will agree with their point of view. An earning based cigar butt is a little different. The market already values companies on the basis of earnings, companies with good earnings are rewarded with high multiples, and low earnings with low multiples, mostly regardless of asset value. A company that suddenly has a few great quarters can be caught up with investor enthusiasm and be priced accordingly. Often the stock price rise for a mediocre company with a few great quarters can be an exciting ride, as long as you know when to get out.
The key to cigar butt investing is knowing when to get out, most deep value investments are not buy and hold investments. Because of this many people have this impression of asset based value investors as glorified traders, swapping in and out of these stocks creating a tax nightmare. The truth is much more subdued, the market is often slow to appreciate their value. An investor might purchase a stake then have to wait a few years before something happens and the share price appreciates. But when it does appreciate sell out at what you consider fair value, and be quick about it, often the price will appreciate quickly, and then rapidly decline right back to where it was prior to its ascent.
Federal Screw Works is levered to the auto industry, with most of their sales directly related to autos they do well if car sales are up, and they struggle if car sales are down. What's impressive is the company found a way to lose money from 2005 until this past year. They blame their most recent losses on the recession and reduced demand, but their losses from 2005, 2006, and 2007 can't be blamed on a poor economy. The oldest annual report I could see was 2007, where they were blaming their difficulties on outsourcing and reduced light truck demand from high gas prices.
The company's continued losses since 2005 have resulted in an incredible display of shareholder destruction. Book value declined from $59m in 2004 to -$4m in 2012, and has since recovered to a positive $2m. During this period the company has been working to change their operations, they've dramatically reduced head count, and were able to turn a profit on $57m of sales, whereas in 2005 they lost money on $85m worth of sales.
In the company's defense they are a survivor, despite the continued losses they have been able to hang on and fight long enough to see a small profit. The question is whether their profits are fleeting, or something sustainable?
Besides the company's poor earning history they have sizable liabilities that could become problematic at some point in the future. The company has a sizable pension that's partially unfunded, and retirement health benefits that are sizable. The company has steadily increased their debt, keeping them afloat as losses mounted.
Here's a five year financial history from their annual report:
It's unclear whether Federal Screw Works is cheap at the current level. The company is expensive based on every asset based metric, and even most conventional earnings metrics. The company has significant operating leverage, and it wouldn't take much of an increase in sales before profits start to flow to the bottom line in a significant way. Maybe this is best considered as a speculative value investment. The chance to buy into a turnaround right before it turns, but not having to be a shareholder for the almost decade of losses.
I don't see a margin of safety with this holding at all, and turnarounds of this type are hard to manage, but for an investor wiser than myself it might prove to be profitable.
Disclosure: No position