If I have one weakness on this blog it's the failure to follow up on companies I've previously posted about. To readers my process appears to be the following: research a company, write them up, never mention them again. I tend to keep up with most of the companies I post about, if not intimately at least from a distance. The shame about my lack of updates is that many companies remain attractive far after I've posted about them, and unless someone reads the initial post or searches the blog they would ever know. I plan to change that today with a post on Hammond Manufacturing.
The last time I wrote about Hammond Manufacturing (HMM.A:TSX) was in September of 2013 when the company was trading for 88% of NCAV, and 44% of book value. At the time they had a book value of $2.71 per share, and had earned $.15 per share in 2012. I made the case that the company was worth at least NCAV, but more likely book value.
The company is located outside of Toronto and manufactures industrial electrical box enclosures. Earnings have been volatile ranging from $0 in 2009 to $.20 per share in 2013.
In the last 10 months the shares were flat did mostly nothing until recently. Hammond Manufacturing released results of a great second quarter and the stock started to move. Even with the recent move up the company remains cheap. In the past 10 months book value has increased from $2.71 per share to $3.10 per share. The last time I wrote about them they were selling for 44% of book value, with the run up they're now at 54% of book value, hardly overvalued.
Besides the discount to book the company has shown considerable earning potential in the past year. On a trailing twelve month basis they earned $.27 per share, giving them a P/E ratio of 6.2. Management noted in their second quarter letter that sales are finally showing signs of recovery, which could indicate that their quarterly EPS of $.10 run-rate could continue.
Given Hammond Manufacturing's valuation there are only two scenarios I can think of, either I'm wrong, or the market's wrong. As an investor in the company I clearly think the market's wrong, but I want to put that aside for a minute and consider what I could be missing, let's look at the company's negatives.
The company finances their inventory with debt, they have about $10.6m in debt outstanding, their debt is a negative, but not large enough for their valuation discount. They also have two classes of stock, the publicly traded A shares, and the privately held B shares. The controlling family owns the B shares and controls the stock through these shares. Markets don't like controlled companies, especially ones that have so much control that an activist (theoretically) can't take the company over.
There is also an issue of a potential environmental liability. The company had a suit filed against them in 2013 alleging that contaminants from a property they once owned have leaked onto a nearby, but not adjoining property. The company isn't sure whether the contaminants were from their property or somewhere else. They note that a scenario exists where they need to pay $2m to have a barrier erected between the properties. If the company lost the lawsuit and were required to pay the full $2m their book value would be reduced to $2.92 a share from $3.10. While a legal loss and resulting environmental remedy is not ideal it hardly justifies the valuation.
The comments on my last post give additional insight as to why investors, and the market think this company should be cheap. Someone thought that a company that doesn't generate at least a 10% ROE shouldn't be worth book value. Someone else claims that the closely held nature is the reason for the discount. Another claimed if they paid a dividend they would be worthy of a higher valuation; the company did pay out a dividend and shares barely budged. Lastly, my favorite response is someone who said the stock has always been cheap and it should remain that way.
In a market where investors are claiming there is no value to be found I would tout Hammond Manufacturing as the exception to that rule. This is a profitable company with recovering earnings selling for 54% of book value. Maybe they're only worth 80% of book value, but if that were the case investors would still earn an acceptable return from this investment. For myself I voted with my cash and have been holding onto my position.
Disclosure: Long Hammond Manufacturing