A way to play the UK housing recover? MJ Gleeson

MJ Gleeson (GLE.UK)

Price: 100.25p (8/18/11)

This is a post for a contrarian, I'm going to highlight a company that most people would rather not invest with a company in the UK housing sector, MJ Gleeson.  The company has two divisions, a renovation division and a land division.

The renovation division takes brownfield areas and redevelops them into residential subdivisions.  I was a little surprised at the difference between a British subdivision and an American one, the homes were nice modest brick homes near city centers.  Contrast this to McMansions on the outskirts of cities, but I digress.  The company has a few programs to help buyers design and purchase their dream home.  MJ Gleeson appears to be the note holder of certain buyers as well.

The land division seems to be more of a land banking operation.  MJ Gleeson buys options on pieces of land and then improves the plots with the hope of making resale easier. The company prefers to buy land without the correct zoning and work to develop a master vision for parcels. 

Value Proposition

The company is a net-net ignoring the value of their land, they are also profitable (barely) and cash flow positive.  The following is the net-net worksheet:

With the price at 103p the shares have a 50% upside to NCAV from here.  Before discussing where value might exist with MJ Gleeson I want to take a look at a few operating notes:

• The home renovation division contributed 83% of the revenue but actually operated at a loss.
• The land bank division is 17% of revenue but accounts for all of the group's profits.
• The land bank group has a 47% net margin.
• The company sold one piece of land in 2010 verses two pieces in 2009.

So where is the value? The main investment thesis is that eventually the UK housing market will turn around making the renovation division profitable, in addition to increased land sales.  The problem is there is no idea on when the timing might be for a turn around.  MJ Gleeson has touted that sales in the renovation group are up but the profit hasn't come alongside it yet. 

The good news is that there is a margin of safety, the company is trading for less than the value of its cash, inventory and receivables.  This estimate of value doesn't take into account any consideration for the loans it holds, or the profitable joint venture interest.  So an investor who wants to bet on a UK recovery can buy MJ Gleeson at a significant discount and wait things out.  The company has been limping along and is cash flow positive meaning that there is a good chance the margin of safety won't become impaired.  The other good news is that once the market ticks upwards there is a good amount of operating leverage built into the business which could give a great boost to earnings. 

Concerns

Although this seems like a decent investment I have my reservations.  The first is that it is often hard to realize land value, while the land might be appraised at a certain value it's almost impossible to liquidate quickly and get anything close to book value.

The second concern is of profitability, the company's current period profits come from the interest in a join venture, and in the past in the height of the bubble the company's earnings were very lumpy as well.  I appreciate the discount MJ Gleeson is trading at, but I would need a silly cheap price to entice me to buy in.

Talk to Nate about MJ Gleeson

More Information:
MJ Gleeson Website
Financials

Disclosure: No position in MJ Gleeson.

Argo Group Revisited

Argo Group (ARGO.UK)

Price 15.25p (8/15/2011)

I wrote a post about Argo Group here and it garnered a lot of attention, a lot more attention than I expected at the time.  There was some great information captured in the comments regarding some valuation methods that I wanted to discuss, secondly I wanted to talk about some new developments in the troubled Argo Real Estate Opportunities Fund.

Argo Group previous post link

Valuation

One of my readers Wexboy posted a comment

btw my valuation approach to asset management companies is to generally value them at Cash & Investments plus X% of Assets under Management. If you look at asset manager purchases, this X% approach is far more relevant than evaluating revenues, operating margins, eps etc. (although in most cases these can be used to support the valuation anyway) - this makes perfect sense, as the economics of any fund management business can often be changed radically/quickly after a purchase, i.e. a small fund management business that is breaking even, can quickly achieve the same operating margins as the rest of the purchaser's business, for a number of reasons but mostly, to be blunt, by firing people

I have been thinking about this a lot and it's a great way to model out asset managers.  This view was further confirmed later in the comments along with a quote referencing the same framework in Barrons a week or two ago.  I went back and put together a small spreadsheet showing different asset managers and the percentage they're currently trading at after learning about this valuation method.

The comparison is interesting, the spread goes from around 3.80% for Fortress up to 14% for Och Ziff.

One really interesting data point is RAB Group who's trading at 9.28% of AUM.  What's interesting about RAB is that they've been hemorrhaging assets, they've lost 50% of AUM this year alone, and they're down 93% since 2007.  RAB is facing a delisting from the AIM and yet still trades at double the percentage that Argo trades at.  RAB also is trading at a discount to NCAV but I would make the argument that Argo is probably a much better investment considering AUM is stable.

The commenter also suggested the best way to value a company such as Argo is cash + investments + % of AUM.  Using the current trading metric for Argo I get the following value:

$44.9m + $18.4m = $63.6m or £38.66 which equals .55p per share

While this amount seems a bit on the high side I think it's interesting that management granted options that exercise at 24p/sh.  What I like about the 24p/sh is that this is the same value as NCAV per share which I think is realistic, a company shouldn't trade for less than NCAV.  While I'd be happy with 55p/sh I will also take 24p/sh as well.

Real Estate Developments

I noticed a RNS for Argo mentioning a share offering for the Argo Real Estate fund.  To give some background the Real Estate fund purchased some shopping centers in Eastern Europe (Romania, Ukraine, Moldova) at inflated prices and now that real estate has crashed the fund is experiencing some problems.  Argo is the manager of the Real Estate Opportunities Fund.

The problems are really two fold, the first is that asset values are down which has been impairing the NCAV of the fund and preventing the high water mark from being hit.  The second is that the tenants have been asking for rental concessions (and Argo is granting them) which is putting a crimp on the operating income of the fund.

The management of the fund believes that the NCAV has bottomed, and that the real estate market has hit bottom in Eastern Europe as well which is good.  The hope is that they can dig out of the hole they're in.  Looking at the past interim statement for the fund they are slightly cash flow positive.

So why all the background?  Management released a circular (proxy?) stating a few things:

• A secondary offering doubling the size of share capital
• The purchase of two shopping centers in Romania
• The revision of the Real Estate fund highwater mark downward to .15/share (current NAV is .12/sh).  This makes it more reasonable that management will be able to get the performance earn-outs in the next few years.
• A proposal to extend the life of the fund five more years.

In addition the circular also includes some details with regards to the working capital constraints the real estate fund expects to hit in June 2012.  The notes indicate that Argo has provided a letter of credit which they hope to be sufficient to get £4m in borrowings, and if that doesn't pan out Argo themselves will lend the £4m.  While this isn't ideal it also doesn't seem like an endgame scenario for Argo.

My take is that the Real Estate fund management is hoping that the market will turn enough that they'll be able to work out their financing problems by possibly an asset sale.

Hopefully the two items in this post are helpful to a prospective Argo shareholder. 

Talk to Nate about Argo Group

Disclosure: I ended up purchasing a small position after my previous post.  I haven't decided on if I want to increase my position yet, I'm still digesting some of the circular notes.

Treasury Wine Estates an attractive spin-off

Treasury Wine Estates (TWE:AU, TSRYY.OTC)

Price (A$3.16, $2.90) - note that you can buy the ADR for less than the AU share

Treasury Wine Estates is an Australian wine producer with wineries worldwide, the company was spun out of Fosters Group back in May.  The good news for a potential investor is sampling the product could be a worthwhile undertaking, invite some friends over and "research" the Treasury brands.

Company Background

Treasury owns 54 brands spread across three continents.  Prominent brands include, Beringer, Lindemans, and Penfolds among many others.  The company has annual sales of A$1.9b a year, the biggest markets are Americas, ANZ, Europe and Asia.  Asia is the fastest growing market for Treasury.  The company produced 35.6 million cases of wine in 2010.

I'm not going to re-hash the entire prospectus, if you're interested in reading more about the company here is the spin-off filing.

Reason for Spin-off

Fosters stated that the reason for the spin-off was that each company would be able to focus on the individual products (beer/wine) with greater intensity.  While that might be true I think there were other drivers at play.

The first driver was that Fosters spend around AU$8 billion to build out the Treasury portfolio.  The portfolio didn't exactly play out as Fosters expected and they ended up writing down a large portion of their investment.  The problem was that as Fosters was building out a wine portfolio other companies were doing something similar, the end result is a large glut of capacity at Australian wineries.

The second driver is a bit more interesting, Fosters received an unsolicited bid for Treasury at a price between A$2.3b and A$2.7b which Fosters turned down as too low.  Fosters has also been the subject of a takeover bid from SABMiller as well.  It seems that management broke the companies apart with the idea that each company as a pureplay would be a much simpler takeover target.  This is good news for an investor, the catalyst is built in.

Investment Catalyst

There are a few catalysts as I see them for investment into Treasury.  The first is that the company is a spin-off and management is motivated to improve operations which is a similar thesis to all spin-offs.

The second is that the company is trading below book value, currently the shares trade around 25% lower than book value.  Book value should be pretty accurate considering Fosters took a lot of write downs pre spin-off.

The biggest catalyst is that the company is a takeover target, this was part of the motivation for the spin-off and it appears there is a potential buyer in the wings.  Rumors started to float about a month ago that Chinese Brighthouse Foods was considering a bid for Treasury.  As of this post nothing has materialized but Brighthouse is in the market.  There have been some other market rumors that a few private equity groups are interested in acquiring Treasury as well.  I think with the recent decline a sizable bid is even more likely.

The last catalyst is that the strong AUD has been a bid of a headwind for Treasury.  They produce and sell a lot of wine in the US and EMEA and then bring the currency home to Australia.  In doing so they've been able to buy less and less Australian dollars which hits the bottom line negatively.  While the company is profitable a weaker AUD will have a large impact on profit for Treasury.

I should also point out that often an investor is able to buy the ADR shares for less than the AU shares.  I ended up purchasing the ADRs myself after noticing this.  For a while the ADRs were selling for almost 15% less than the AU shares, but the spread really depends on the day. If an investor doesn't buy into the Treasury story they could still make money buying the ADRs and converting them to AU shares and making the spread.

Risks


-The biggest risk is that there is overcapacity in the wine market currently.  While this is currently an issue the company is still profitable and should be able to weather the storm.
-If the AUD strengthens the impact could result in losses for Treasury Wine Estates.
-The buyout thesis could fail to materialize, although I'm happy to own the company stand alone.

Resources

This is a great article about Treasury from Bloomberg
Company Website

Talk to Nate about Treasury Wine Estates

Disclosure: Long Treasury Wine Estates

National Presto a Ben Graham NCAV stock is cheap again

National Presto (NPK)

Price: $87.01 (8/8/2011)

This is an idea that I read about in Barrons, the company seemed my speed, industrial, conglomerate and cheap.  I apologize for the lack of depth in this post, I want to jot down a few thoughts on a few different stocks this week as I'm looking to deploy cash.  I'm not sure how long prices will remain depressed, and I know there will always net-nets laying around but better stocks tend to appear and then disappear quickly during panics.  If I can get a quality business on the cheap I'd much prefer that to a net-net.

National Presto is a diversified manufacturer located in Eau Claire WI.  The company has three divisions: Housewares/Small Appliances, Defense Products, and Absorbents.  Housewares and Small Appliances are things like pressure cookers, skillets, and coffee makers.  The Defense Products division manufactures ammunition which it sells to the DOD.  The Absorbents division manufactures private label adult diapers.

National Presto has some allure with value investors, the company was mentioned in the Intelligent Investor as a NCAV stock with great ratios.  National Presto again traded below NCAV back in 2001 following the dot-com bust.  It seems an investor could buy close to NCAV in 2009 but not below.  We're far off from that now, but I think the stock is still compelling.

Quick Investment Thesis
-EV/EBIT 5.12 TTM
-P/E ex-cash of 7.65
-$15.20 cash and securities per share
-No debt
-A declared $1/sh dividend, management has typically declared a special dividend paying out almost 100 % of earnings.  This past year they paid out $8.14 vs $8.99 in earnings per share, a 90% payout ratio.
-17% ROA, 20% ROE
-ROIC of 14%
-There is a $329m order backlog for the defense segment, this is orders that have been received where revenue can't be recognized yet.
-There are still two wars (along with Libya) and soldiers who need bullets.
-There is a longer term demographic trend of aging baby boomers of which a small percentage will need adult diapers.  As the proportion of the population grows in age this should be an expanding market.

Risks
-TTM cash conversion of 67%
-The most recent quarter saw a 25% decrease in defense sales although attributed to timing it's still concerning.
-National Presto is spending $30m to upgrade the absorbent machinery.  This segment has one customer which accounts for 12% of consolidated sales.  The customer is building out their own facility which can make similar products, they have told National Presto they expect to continue purchasing from them, but this is a concern.
-The product mix is eclectic and can be viewed as a diversifier, at the same time if the US is heading into a recession there could be reduced demand for small appliances as well as reduced defense spending.
-30% of revenue is derived from consumer spending, appliances aren't necessary purchases.
-Wal-Mart accounts for 11% of National Presto's sales.

Final Thoughts
-I like National Presto, they have been growing sales, cash flow and net income steadily for the last decade.
-The company seems cheap on a multiples basis, with a rough DDM I get $114 a share.
-I don't like that absorbents is capital intensive and only became profitable in 2009, there isn't a lot of great history there.  While things seem great now if there is a bump in the road I worry about this segment sucking up cash.
-If we continue to see a downdraft in oil prices that would boost the bottom line of absorbents.  Steel pricing and aluminum pricing affect the houseware and defense segments.
-NCAV is $39 a share, book value is right around $40 a share as well.

Disclosure: I am looking to build a position near this price or at a lower price.

George Risk, ignored yet very cheap

George Risk Industries (RSKIA.OTC)

Price $6.40 (8/2/2011)

George Risk (GRI) is a holding I've had for a while that I originally picked up as a net-net and have continued to hold as the business has recovered.  This probably won't be a very long post because GRI is a very simple company.

The company was founded in 1967 and is located in Kimball Nebraska they are what I would consider a public private company.  I say this because Ken Risk the CEO owns 58% of the company and runs things like a small town operation.  The company is small, with a market cap of $32M, here is their facility in Kimball.  The company makes small electronic switches and sensors, additionally they also make pool safety sensors.

The company states that 88% of their revenues are from the security alarm segment.  The security segment has over 4,000 customers of which 42% are sold to through one distributor.  This is one of the biggest risks I see for the company, the loss of the distributor.  The company states that they feel safe with the distributor because they have had a good working relationship for years.  While this sort of thing might fly out in Kimball NE it doesn't exactly give me a warm fuzzy feeling.  The good news is GRI and the distributor have a 3 year agreement in place outlining purchasing terms, prices, product delivery schedules and terms for termination.  This agreement is found in the SEC filings here.

Value Proposition

As I mentioned earlier I originally purchase GRI at a discount to NCAV, the net-net worksheet is below:

The big items to note is the large amount of cash, and the $19m securities portfolio which is a net $4.72 per share or 73.8% of the current market value.

A serious look at GRI also merits examining the investment portfolio.  Management states in the filing that they view the securities portfolio as a way to put money to work that can't be used in the business, and provide a boost to earnings in down markets such as 2010.  In the 10-K GRI shows the breakdown as follows:

Municipal bonds          $ 9,426,000
Corporate bonds          $    84,000
Equity securities        $ 8,576,000
Money Markets and CDs    $ 1,426,000
Total                    $19,512,000

The portfolio is managed by an advisor.  The equity holdings are split across the following types of mutual funds, growth, growth and income, and foreign stocks.  I'd love to know where exactly the money is invested as the equity portion has stayed between flat and a slight loss since 2009 which is a bit surprising.

With a company trading with a large amount of cash and close to NCAV the presumption would be that the business is in the dumps with little hope of recovering, in actuality the opposite is true.

Operations

Here are a few quick stats when looking at GRI's profitability:
-EV/EBIT of 4.47
-EV/FCF 4.22
-47% gross margin, 19.9% operating margin, 22.8% net margin.
-ROIC of 39%, this is incredible but keep in mind the company can't continue to invest at this rate which is why they've built up a stash of securities and the fixed plant has remained stable.

GRI earned $.40 per share in 2011 (April 2010 -April 2011) verses $.30 a share in 2010.  Part of net income is derived from dividend and investment income.

The business took a hit when the housing market crashed but has recovered nicely.

Valuation

I think the simplest way to value George Risk is a simple cash plus earnings power.

Upside
$4.72 + $.40 x P/E of 10 = $8.72
$4.72 + $.40 x P/E of 15 = $10.72

Downside
NCAV of $5.40
Net cash of $4.72

Risks
-As stated above GRI has a distributor who accounts for 42% of sales, losing this distributor would impair the business.
-Ken Risk the CEO owns properties which the company leases from him.  In addition the company leases a small plane from Ken.  While the amounts are small and everything seems above board it reinforces the impression that management is running the company as a family operation.
-The stock is illiquid, it goes days without trading.
-The marketable securities could be mismanaged destroying a valuable portion of the NCAV.

Disclosure: Long George Risk

Sangoma Technologies a cheap turnaround

Sangoma Technologies (STC.TSX, SAMOF.Pink Sheets)

Price: C$.52 (7/27/2011)


note: All $ amounts in this article are Canadian dollars.

This is a company that was suggested to me by a reader of the blog as a cheap company that's in the process of turning around.  I've kept the company on my radar and finally decided to write them up.

Sangoma is a technology company that develops and sells hardware and software solutions for the telephony market.  I'm actually somewhat familiar with this technology because I worked in a building where the landlord was obsessed with Asterisk (a Sangoma product) an Open Source PBX software product and he'd routinely come upstairs and tell anyone who was listening (or not) all about what he was playing around with.

Sangoma is fascinating because they are a company that was founded on an Open Source platform and successfully sell Open Source software and hardware solutions.  For any non-gearheads out there Open Source is software where the creator gives away the computer code used to generate the program for free and allows users to modify the code.  Other examples of Open Source programs are the operating system Linux, OpenOffice, Sun Solaris, amongst millions of other programs.  Many advocates of Open Source treat it as a bit of a religious campaign, but it's really just a way of licensing software in a way that enables work to be shared with a community.  The best analogy I could think of is that Open Source software is like if an automaker gave away all of the specs to build the car to anyone who asks for them.

While Open Source has a reputation for free software Sangoma has taken that platform and build customer hardware devices and customized software and turned a nice profit with it.  Sangoma states that they are the biggest distributor of Asterisk outside of the company which holds the copyright to it.

The best way to think about Sangoma's product suite is to think of your office phone system.  Sangoma builds all of the hardware to handle voicemail systems, routing calls to different offices, transitioning between digital and analog among other things.  The software to manage the entire system is custom built on the Open Source platform.

A customer might buy a Sangoma telephone card for a standard PC and then install the Asterisk software on the PC turning a cheap PC into an office PBX solution.

Investment Thesis

-The company is very asset rich, with $7.6m net cash/share against a market cap of $15m.
-The company is profitable and cash flow positive.
-Free cash flow has gone into buying back shares, the company has authorized a 5% reduction in shares.
-EV/EBIT of 3.33 on a TTM basis
-EV/EBIT of 6 for the 9 months of the 2010-2011 fiscal year.
-Margins: 72% gross, 13.5% operating,  11% net.
-A new CEO was appointed in September 2010 which could be a catalyst for improved growth.
-High insider ownership 20%+.

Catalyst?

The company experienced a very disappointing Q1 2011 (July - Sept) with a 20% drop in sales and a 90% drop in net income.  The company attributed the drop to a lack of new products in addition to softness in the North American market.  At the same time they brought in a new CEO who has been successful at past companies.

In addition to the drop in sales and net the company also experienced a contraction in margins.  While gross margin has remained somewhat steady the net margin has gone from the low 20% to 11% an almost 50% drop.

While Sangoma appears to be cheap on some basic metrics they also look like they have the perfect conditions in place for a decent turnaround.  If the CEO is able to jump start product development (which is happening in the most recent quarter an increase in R&D was recorded), and raise the net margin back to the historical norm the company should treat shareholders well.

Valuation

Due to the volatile nature of the business and the company being in the midst of a turnaround I decided to work out a few different valuation scenarios.

Worst Case

For the worst case I put the latest Sangoma numbers into my net-net template:

The raw NCAV is $.36, with cash per share of $.30 and net cash per share of $.25.   I should also point out the income tax item which I added to this spreadsheet.  You might be wondering why they are getting a tax refund if the company's profitable, I asked the same question as well.  Sangoma is the recipient of some tax credits, and development incentives from the Canadian government regardless of profitability.

The base case assumes that Sangoma will be liquidated or is only worth its asset value, for a company with consistent profitability and free cash flow I don't think that's accurate, so let's take a look at two other models.

Medium Case

This scenario has Sangoma earning $.04 a share for the fiscal year which I think is reasonable at the current run rate.  Applying a 10x P/E to $.04 plus the value of the net cash gives us the value:

$.40 + $.25 = $.65/share or 25% above the current price.

I think the medium case value is an accurate fair value for Sangoma if profits stay steady at the current level.  As mentioned above I think the medium case is probably a bit on the low side as well assuming performance will stay depressed, so onto the best case scenario.

Best case

I did the best case in two parts, the first is zero revenue growth with a return to the previous net margins, and the second is 5% revenue growth with the same 20% net margins.

It's pretty clear the value proposition with the shares is that management will be able to reverse the margin contraction and restore net margins to the historical 20%.  If they're able to do that Sangoma is the proverbial $1 for $.50.


Talk to Nate about Sangoma

Additional Resources
An excellent thread about Sangoma can be found here: Corner of Berkshire
Investor material: http://sangoma.com/about_us/investor_relations.html

Disclosure: No position in Sangoma

Solitron Q1 results out

Solitron Devices gets limited visibility and I noticed they filed a 10-Q for Q1 a few weeks ago so I figured I'd highlight the latest results.

I have posted about Solitron before in a three part series
Part 1
Part 2
Part 3

The company is a classic net-net and I'm happy to report with the latest quarter the company is still trading below NCAV, my thesis is still intact.  I have a copy of the updated net-net template below:

The biggest changes are an increase in cash, and a slight uptick in liabilities due to an increase in payables.  The NCAV is slightly lower at 3.71 vs 3.80, this is related to the uptick in payables.

Operating Performance

The good news is the company is performing well, revenue increased 2% while net margin increased from 21% to 24% due to lower material costs.  Net income increased 17.5% on the lower goods costs.

The company generated $459k in operating cash flow, and spent $10k on capex, the free cash flow went directly onto the balance sheet as an increase in cash and treasury bills.

The negative news is that the order backlog decreased 7% YoY and the company has changed their line from expecting to operate at a break even in the future to the possibility of a loss if current conditions continue.  Management also mentions that higher cost of materials could result in a loss, which seems to be in direct conflict with what they actually experienced this past quarter.  I take these statements with a grain of salt considering at the end of the year they expected to merely break even yet the company generated a 17% increase YoY on it's net income.

Final Thoughts

I'm happy with the quarter, the company is still profitable, cash flow positive and growing their cash balance.  My biggest concern is the change of the language in their filing regarding future orders.  No one can predict the future, and Solitron has generally been very negative regarding future prospects but it's still a point of concern for me.  I haven't changed my position at all, I'm still waiting for the market to recognize Solitron's value.

Disclosure: Long Solitron Devices