Enterprise Group - Q3 Update

Three of my large positions -- Hawaiian Holdings, Future Bright, and Enterprise Group -- have reported quarterly results over the last month. 

Of these, the most attention grabbing has been the set of results posted by Enterprise, in large part because the company has now announced two consecutive quarters of rental volumes and margins that are below its own projections. The pace of delivery of new equipment has been slow, third party equipment has had to be employed, and the outcome hasn't flattered management's ability to deliver according to expectations. 

The discrepancy is, in the grand scheme of things, and over a sufficiently long time horizon, trivial and immaterial. Still, one has to scrap its previous guidance of $33.8 million in 2014 EBITDAS and one has to instead to use the available record to reconstruct one's own estimates for the 4th quarter and beyond.

This is how I see it now: 

and

Some notes:

Within the Utility and Construction segment, we know that the company started with 6 hydro-vac units at the start of the year, had taken delivery of 8 additional units at the end of May, and that it will own another 6 units by the end of the year for a total of 20. These units are apparently in order to satisfy demand under three consecutive multi-period contracts and each fully employed hydro-vac unit generates revenues of $750K per year. I assume that four hydro-vac units are newly empoyed in the 4th quarter at 30% EBITDA margins. 

The company says that it intends to purchase another 15 hydro-vac units units in 2015, for a total of 35 owned units. I assume that an average of 25 units are employed in the course of 2015.

Enterprise has taken delivery of one custom built "direct pipe" unit that it states can generate between $30 and $45 million in revenue per year at 40% EBITDA margins. This unit was immediately placed into service and will show $4.5 million in Q4 revenue. I assume that it generates $30 million in revenue during the course of 2015. 

Hart Oilfield Services has generated an annualized revenue run rate of $17 million at 50% EBITDA margins. I have left this as is. 

The newly acquired Westar Oilfield Rentals generates $8.7 million in revenue at 47% EBITDA margins. I have left this alone, too.

Other more or less comparable companies are trading at ~6x EBITDA. Other things being equal, Enterprise ought to trade at a premium based on its substantially higher margins, improving seasonality profile, and growth trajectory. But ceteris is not paribus and companies that promise one thing and deliver something less can expect to trade at a discount to the peer group.

At 4.5x what I think is a reasonably conservative estimate of EBITDA the warrants will expire worthless. (The $1.21 valuation at the low end uses a diluted share count that excludes these warrants that are presumed to have expired worthless).

Also, only 4% of Enterprise's current revenue base is directly exposed to the oil sands but a prolonged oil price slump will, of course, permanently impair the company's value anyway since much of the economic activity in Alberta and BC is predicated on long-term oil prices that are above, say, $60/barrel.

It's therefore important too insure against such a scenario by having a stake in a security that becomes more valuable when oil prices fall. In my case, it is Hawaiian: the recent fall in jet fuel prices from ~$3.10 to $2.36 ought to add about $10/share to its valuation when its hedges roll off.  

Disclosure: I am long Hawaiian Holdings, Enterprise group, and Future Bright.

Macro Enterprises

I maintain a watch list of two hundred or so names that I have looked at and think are interesting in the expectation that the one or more will, sooner or later, come down to a price I'm comfortable paying. I use google drive.

Macro is a straightforward enough idea that it requires very little narrative and therefore provides a good opportunity to share the form and content of my watch list. 

It links to more detailed notes and to a spreadsheet whose essential elements look like this:

 

Disclosure: I am long MCR

Texhong Textile 1st Half Results

Texhong has reported its first half results. Those of us who have been following this stock saw what we had expected to see: 3 months of cotton inventory bought at higher than current market prices were sold at lower cotton yarn ASPs. Gross margins were crimped, and operating leverage ensured that net margins were gutted.

If we add back the 302 million yuan lost due to this temporary mismatch between the historical cost of cotton inventory and its current market cost, we would have something that looked like this:

The higher cost cotton inventory should have already burned off and the second half of the year should see margins return to near normal levels. Plus, added capacity in the second half of 2014 and in 2015 should see earnings resume its upward trend. 

We had also expected to see brokerage downgrades and they have arrived with target prices ranging from ~$5.50 to ~$10. The most significant would have been a downgrade of Texhong's debt by Moody's but that hasn't happened (yet). Consequently, the shares have not sold off as much as I would have liked.

A  29% forward earnings yield is interesting if one believes, as I do, that Texhong is a long term compounder benefiting from major tailwinds.

Disclosure: I own shares in Texhong.

Future Bright - Part 2

(2) Industrial Catering

The largest integrated casino resorts employ up to 24,000 staff each and the employees live where they work. These workers are currently fed and watered by the casino's own kitchen and Future Bright is hoping to wrest that business for itself.

To that end, the company has adopted a two step strategy: (1) in November 2012, it raised $75 million via a secondary placing in order to construct a 100,000 sq ft central kitchen in Zuhai; and (2) it has sought and won contracts to provide catering at Macau’s universities, schools and hospitals that it hopes will serve as a demonstration of its competence (in terms of food safety, capacity, logistics, and cost).

These demonstration contracts contributed $18 million to Future Bright’s 2013 gross operating margin and, with the addition of full year contributions from Macau University’s Hengqin Campus and the International School of Macau, will contribute ~ $38 million in 2014.

The company expects that the economics of catering for casino staff would look something like this:

It's anybody's guess as to how many casino catering contracts the company will win: it could be zero and it could be 6. I have modeled 1 at the low end and three at the high end.

(3) Food wholesale

The company is the largest importer of Japanese ingredients and foods for wholesale to the Pearl River Delta region. 

(4) Macau rental

The company owns Yellow House, a six story building located across the way from the ruins of St Paul's Church. (St Paul's is, in tourism terms, Macau's version of the Eiffel Tower). 

Yellow House had, until January, been rented out to the Macau tourism authority at $14 million a year and is now let to Forever 21 at $28m/year. The company has reserved some space for use by its own food souvenir business discussed below.

(5) Food Souvenirs

The company has built a production plant and formed a 70/30 joint venture with Macau Yeng Kee Bakery, a recognized Macau brand with 85 years' heritage, in order to get into the business of selling Moon Cakes (and almond cookies, egg rolls, and beef jerky) to tourists. I mentioned above that it plans to retail these items from Yellow House but it has also rented store fronts in Old Macau for that purpose. However, the company (and I) expect that its restaurant network will be its most important distribution channel. 

The company expects to carve out a 3% to 5% market share for its JV which, long story short, translates into just over $16 million in margin contribution to Future Bright, a figure that one wouldn't be crazy to think grows along with both the number of visitors to Macau and the number restaurants that Future Bright operates.

--

So that's the current operating business. I think it achieves at least $800 to $1,200 million in run rate EBIT in three years. 

(I've left out same store sales growth, remember, and that in itself could constitute an additional $200 to $400 million in additional run rate EBIT and would therefore be worth Future Bright's entire enterprise value. For my purposes, though, it is a buffer).

I think 10x EBIT  (or 11x earnings) is a reasonable exit multiple -- it corresponds to a 4.5% dividend at 50% payout. 

I'll talk about the Hengqin project in the next post.

Future Bright Holdings - Part 1

Future Bright is a food and beverage business in Macau with six sources of value: (1) Retail catering; (2) Industrial catering; (3) Food wholesale; (4) Macau rental; (5) Food souvenirs; and the (6) Hengqin project.

I think it will be worth HK $20, or 5x its current market price, in three years.

(1) Retail catering

Retail catering mostly consists of in-casino restaurants and food court concessions.  The restaurants are mid- to high-end establishments with average ticket prices ranging from HK $750 at the Edo nameplate, to $150 in the "Other" category which consists mostly of the Pacific Coffee chain for which Future Bright is the franchisee.

These store fronts are leased from cooperative landlords who want the punters to stay on their property, and serve time-conscious and price insensitive tourists.

Constant, recession-resistant traffic; high margins; no advertising and marketing expense; rapid turnover of inventory; and low rents: the economics of this segment are as good as it gets in food retail. 

By the close of 2014 there will have been a big step up in this segment's footprint and earning power. The star next to "2014" in the table above indicates my estimate of the run-rate values based on the 268K sq ft in operation at the end of 2014 and adjusted for the slightly different mix of formats and locations. (Each format has its own gross operating margin: Japanese = 38%: Chinese = 30%; Western = 50%; "Other", which is mostly coffee shops, = 38% , and  food court concessions = 50%. Casino restaurants earn more than mall and airport locations, etc.)

Casino, resort and hotel rooms will double from ~29,000 now to 60,000 in 2017.  Future Bright is the largest food and beverage company in Macau, its owner operator is the Chair of the Food & Beverage Merchants Association (and a Macau legislator), it has working relationships (and has renewed its existing leases) with all six casino operators. The company has made plain its intent to open 28 new restaurants in the Cotai Strip between 2015 and 2017 as new hotel/casinos open. I therefore don't doubt that its footprint and earnings power will close to double over that period - as indicated in the "2017" column above.  

Finally, Macau's problem has long been a shortage of accommodation. Rooms are (and have long been) 95% occupied on average, placing a limit on the number of overnight visits to Macau. As a consequence, the average length of a stay in Macau is something like 0.96 days compared to 3.5 for Las Vegas. More rooms means more overnight stays, which means more -- and more evenly distributed -- traffic at Future Bright's restaurants and food court concessions. 

If the length of the average stay lengthened to 1.5 days,  the retail catering segment could enjoy up to a 45% increase in its earning power (56% more revenue per sq ft x 74% gross margins). I haven't accounted for that in the table above.

Some context:

.. to be continued in the next post

Disclosure: I am long Future Bright. My facts could be wrong and my judgment warped. Do your own research and use your own judgment.