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
Another nice post. FYI, annual reports going back all the way to 1995 are available on otcmarkets.com under the filings section. You can see FSCR was once a solid company that paid generous dividends.
ReplyDeleteUnfortunately, the company was absolutely walloped by the near-demise of the American auto industry. Management made a lot of good moves, cutting staff and management compensation, closing facilities, freezing the pension and slashing capital expenditure to the bone, but it just wasn't enough to prevent losses for the better part of a decade.
Now that demand has rebounded, the cost cutting measures have allowed FSCR to become marginally profitable again. The bull case for the company rests on the fact that production is still running so far below capacity. If demand rose another 10% or more, that idle capacity would allow FSCR to increase production with minimal additional expense in terms of manpower or capex. The additional gross margin would flow almost entirely to EBIT.
But that might not move the needle. Even in the best of times, FSCR's gross margin is under 10%. A 10% increase in revenues might yield only another half million in gross margin. A more realistic 3-5% annual revenue increase would yield far less than that. The harsh truth is that FSCR's product is a commodity and any increase in demand will bring price competition from other manufacturers with excess capacity.
I think a useful valuation metric for FSCR is Enterprise Value/Gross Margin. With an enterprise value of just over $40 million (including the pension) and a 2013 gross margin of $4.15 million, that ratio is about 10. That compares extremely poorly to much larger, globally diversified OEM suppliers like Lear or Magna or Johnson Controls. These companies have EV/Gross margin ratios ranging from 4.8 to 5.5.
I see little reason to pay twice as much for a tiny, low margin supplier.
FSCR may have decent asset value, but I suspect a good deal of its equipment is good only for scrap value at this point. FSCR is a pass for me.
Dave,
DeleteThanks! I was only looking at their OTC filings, I failed to see the SEC filings at the bottom.
I did see that they were a strong company for a while, it's amazing the fall that they endured, I can't believe the shareholder value that's been destroyed.
Interesting way to look at them, EV/GM, I'd never considered that before. I agree with you, there is nothing special here, and if demand does suddenly increase they're going to face a lot of competition.
I've watched FSCR since the early 90's. Their HQ is about 2 miles from my father's house, and I've driven past it more times than I can count. Family used to own stock in it many years ago.
ReplyDeleteIn the 90's, this company was a powerhouse. They had a FORTRESS balance sheet. In 1999, they had NET earnings of $7.56 a share! They paid a dividend of $1.76/share. They had very little debt...Sales were WELL over $100MM.
Now look at it...The company is/was decently managed. They just ran into forces that could not be countered. A lot of their labor is unionized. Manufacturing in the USA, particularly in Detroit, has collapsed. Michigan has lost HALF of their manufacturing jobs since 2000! How many jobs have been lost in Michigan since 1975? 1985? 1995? an incredible amount.
Even so, they've managed to still stay in business and have not had to file for BK. Unfortunately, the share price went down over 90%, no more dividends, and a much weaker financial position.
An interesting company, but unless they can make some serious money, and strengthen their financial position, this is speculative at best...
DTEJD1997
DTEJD1997,
DeleteI love hearing about first hand experiences, it's amazing, and humbling to see how far companies can fall.
I agree that at best this is speculative, there really isn't any meat left on the bone after their fall, they need earnings to grow out of this, or else they might finally fail.
Nate
Wow I can't believe my comment spawned a post! This company is definitely on the "butt" end of the "cigar butt" analogy.
ReplyDeleteWhat attracted me to it is the large D&A expense which creates the losses they experience. Capex is much lower than annual depreciation charges. Additionally, any changed to the pension discount rates (if rates do in fact rise) will help out the underfunded liability.
I get ideas from everywhere! I guess this goes to show that I do actually take comments seriously, I figure I have a very informed reader base and if they take the time to email or comment I should at least listen.
DeleteCapex is indeed running a lot lower than D&A, although I'm not sure what the state of their plant is either. They might be unofficially in runoff mode with their equipment. If they failed to invest for years at some point they will either need to replace everything, or it could impact their performance.
You have a good point on the pension liability, although the pension isn't that concerning. It's the $12m they owe for health benefits with nothing reserved. Maybe that's a pay as you go setup and the $12m liability is an accounting artifact, but even if it's pay as you go costs could spiral out of control.
Nate:
DeleteI've seen some of their facilities first hand. From my limited expertise, they look clean, well run, and not dilapidated. I do not think they are in run off mode. I am going to guess that they are going to try their best to make a run of it. They still employ people, and of course themselves. I think they will do everything they can to keep going.
I think they will probably bump along, and make it. If I remember correctly, they've been in business since 1917!
Even if they keep going, that does not make them a good investment. I think they need 5 or 6 years of improving sales and earnings. Maybe combine that with entry to a new industry or perhaps picking up another manufacturer. I believe their largest customer is Ford, by far. They also sell to GM. Maybe pick up one of the Korean transplants? I don't know.
Still, worth keeping an eye on.
I hope they make it.
DTEJD1997
Nate:
DeleteThis "public" company has been closely held by the same family since the 1930's. Since the late 1980's the family members have occupied all of the executive positions within the company and the majority of the board of director spots. The remainder of the board of directors have either been former employees or related parties (general counsel, etc.) most of whom have had consulting agreements in addition to their positions on the board. For over 30 years they have owned over 40% of the stock with the balance owned by mutual funds and the like. Oh, there are a few individuals who own a few shares, but the annual shareholders' meetings resemble more of a family reunion than anything else. Likewise, most board decisions are simply rubberstamps of the family's wishes. That being said, this family, and particularly the Chairman of the Board, views this company as both a family legacy and a stewardship with responsibilities to not only their own family members and future generations, but also those of their employees. Many years ago during profitable years they paid themselves very conservatively in terms of base salaries relative to the industry; choosing to further compensate themselves through modest bonuses, consistent, but modest, dividend payments and the buy-back of company stock which was subsequently issued to the "officers" aka family members as year-end bonuses.
This offered the benefit of further consolidating ownership with the family without having to buy it themselves. Not wanting to truly go private they slowed this program once they got to a comfortable level in the low 40% range. At that time, and as the 3rd generation of family members took over the top positions in the company, they also began to rachet up the officer salaries. In some case 4 to 5 times what they used to be.
Today, members of the 4th generation of family members have entered the upper management of the company and they will no doubt assume the officer positions as their fathers "retire" to board-only positions. But don't expect that to happen too soon. This family intends to maintain stewardship of this company for generations to come and will continue to do conservatively and always with preservation of the family's ownership foremost in their minds. This company will never make huge profits. There are simply no profit margins in its product lines. Although they exclusively manufacture what are referred to as "specials" in the industry their parts are generally priced by the 100 and rarely are over $1 on a per unit basis.
Of course, they are concerned about share-price, because it represents their family's long-term financial legacy, but they are just as concerned with the continuance of the "family" business as an on-going concern for generations to come.