Sunday, June 15, 2014

ORDEM E PROGRESSO - A HALF TIME REPORT Part 1






I'm holding too many names and too little cash. Spectra and Avesco are weak links and I should dispose of them. My long exposure to Enterprise should be expressed in warrants only rather than via a mix of warrants and stock.  Rationalizing these and closing out my gains in Hawaiian should bring me to ~30% cash.  At the same time, Texhong, Emeco and Rain Industries should be larger positions than they are.

I am too exposed to China (Emeco, Keck, Texhong) and to the Canadian oil sands (Emeco, Enterprise, Lanesborough).

I need to to something about Lanesborough REIT: commit to it or get off the pot. 

I need to find a security that is cheap and will perform especially well if interest rates rise.

No more lottery tickets like Unitek and Dolan -- they take up more time than they're worth. 

Emeco

Emeco’s debt is now more expensive and less restrictive than it was at last report. 

The company is no longer exposed to Indonesia and Chile is now a proper business with $118 million in rental assets. 


There is an encouraging "read across" for the Canadian business from Enterprise Group (see next post), which reports that "the first two months of operations for the second quarter of 2014 have delivered exceptional results with higher than anticipated demand for the Corporation's services in all three divisions and increased operating days compared to the same period in 2013. Due to the late onset of spring break-up and the prolonged winter drilling season, activity levels were above expectations during April and May that have typically been subject to a significant slowdown in the industry as a whole."
 
The Australian business is in poor shape. Utilization rates were in the low 40s, came back to 54, and seem now to be headed back to 40.

And all of this, of course, is happening in the shadow of  this expectation:


The market for new mining equipment has continued to collapse and informed observers are forecasting that it will fall by 1/3 again over the next year. 

 Komatsu earnings presentation. "FY14" ends March 2015.

Keith Gordon has been replaced as CEO by Ken Lewsey. In Lewsey's first earnings call, in February, the headline was a 20% downward revision to Gordon's prior EBITDA guidance. In May, Lewsey's February guidance was itself revised down – by 15%. Progress of sorts. 

Emeco seems to have one capable member of the executive team: the fellow who grew the Canadian and Chilean segments from scratch is now working on business development in OZ.

In FY 13, the company sold a $25 million package of equipment to one of its clients -- at book value. Lewsey indicated in the February 2014 conference call that it had two or more such packages in the pipeline. Emeco has, thus far in FY 2014, generated $68 million from other disposals, including those Indonesian assets that were sold off at half their book values. 

The script -- if coal and gold mining do not recover and idle assets are sold at 1/2 book -- appears to read as follows:




On the bright side, it could be that this has been a period in which the market has been absorbing excess used heavy equipment, that this equipment is approaching the end of its useful life, and that prices for heavy equipment will firm up a little. If so, the upside would be higher than I've indicated above. 


I've added a smidge at just above $0.19.


Hawaiian Holdings

The market for Hawaiian's shares woke up in early autumn, pulled along by the market's optimism about consolidation in the domestic airline industry. It hit the $500 million mark in January, attracted institutional support, rose further, and narrowed the valuation discount to other US carriers. 

It is now priced at 6x trailing EBITDAR, similar to ALK, its closest comp, and only 2 or 3 turns fewer than the majors.

Earnings will continue to improve as existing international routes mature, as it digests an extra 8% market share in its interisland franchise, and as capacity is rationalized in the Hawaii-to-North America routes. It is worth $25 to $35. 

I will continue to roll forward my positions and try to take advantage of the stock's volatility.  

Texhong

Texhong is a new position. I suspect that I'll have opportunities to buy more shares at lower prices in the coming months as older inventory is sold through at unattractive prices.

Texhong equity is covered by several sell side houses -- Credit Suisse, JP Morgan, CIMB, DBS Vickers, and China Stock -- and its credit is rated by both Moody's and S&P. This is DBS Vickers' take on how the narrowing spread will play out:

and this is my take on run-rate values -- i.e. ignoring the temporary compression in margins during the adjustment period:

A credit rating downgrade after H1 2014 results would be helpful.

Lombard Risk Management

The business itself is doing well enough: the regulatory business is gathering customers at an acceptable rate; and LRM's agreement with Broadridge Financial Solutions should prove a useful distribution system for its collateral management products. UK and North America are strong, Asia is flat, and EMEA is weak.

What will they do with the cash flow after 2015? Nobody knows -- not me and not the market. Over two hundred software engineers in Shanghai says one thing, a depressed share price another. The longer the share price languishes, the more they dilute. 

This should be trading at £80 - £90 million and I think losing money on this name is highly unlikely, but I wouldn't be shocked if it didn't reach its full potential.  



Disclosure: I own these securities. Always do your own research and thinking.

30 comments:

  1. Some of my favorite picks you might like (since you gave me some great idea's). I like that most of them are very recession proof, and all of them are dirt cheap, with most good things not priced in. And I can clearly identify why they are cheap, and why the market is wrong to misprice them for those reasons.

    OPRX:
    http://moatology.com/2014/06/05/optimizerx-update-gearing-up-for-a-big-second-half-of-the-year/

    Health care software stock with huge upside and v solid market position. Lot's of operating leverage that is about to kick in and largely uncaptured market, and a serious value proposition. I think somewhat similar to LRM.

    ASPS:
    A play on rising interest rates, it returns 200% on capital, trading at around 9-10x FCF, and growing explosively. Very misunderstood I think, and Bill Erbey is a beast, he could be in the next outsiders book. The news paints them (OCN as well) as incompetent, but they are actually more competent at mortgage servicing then all the banks.

    You also need to somewhat understand OCN tho. There is a great post on VIC and this blog:
    http://oraclefromomaha.wordpress.com/


    GNCMA:
    I saw you owned alaska communications, this is their competitor, and the better pick imo. Could do 100-150 million$ in FCF in a few years (without much growth), v cheap, and has a way better market position then ALSK. Also cheap on EV/EBITDA basis.

    Because of operating leverage, pretty mispriced.

    ACW:
    I think I told you already about this one. The most shaky of them all, but I like the odds here. They will do 150-200m$ in FCF (almost their market cap) when the cycle kicks in.

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  2. Thx for taking the time to post these, John.

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  3. You have interest costs falling in 2015 and 2016, yet Emeco are financed via a high yield bond, with first call in 2017. Interest obtainable on cash is far lower than the cost of debt. Is this correct?

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  4. Sure. I figure it buys these back at market prices since that would be the sensible thing to do.

    You could play around with the premium paid (and reduce the property disposal discount accordingly) and you'd get to the same approx valuation.

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  5. Nice update. What made you change your mind on Avesco? They just sent me a couple of AR's, was about to dig into them. You are no longer convinced?

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  6. Nothing at all wrong with Avesco. Might get taken out by PE or MBO at lower multiple than one would like but that's it.

    It bores me to tears but that's nothing more than a sign of a mature bull market :)

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  7. Enjoyable and productive reading, as always.

    Have you looked at the Lanesborough warrants? I was nibbling the common and the A warrants and came to an on/off pot decision a little more than a year ago and began buying A warrants in earnest. You're still paying only a small premium for 1.5 years of leverage to upside (and downside!).

    And speaking of warrants, Huntingdon Capital--also on the TSX--has an interesting warrant issue outstanding, though I suspect it's not your kind of thing: middling real estate business undergoing strategic review they anticipate (we'll see) being completed this month; stock price at $12.10, warrants with a $9 strike good through 12/2016 at ~$3.30, so you're paying only a minor premium.

    But it's a reversion-to-book/strategic review story, which manages to be both boring and dangerous...

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  8. Aharon,

    I've thought long & hard about the Lanesborough warrants. The problem is that I can't let securities with an expiry date exceed ~10% of my portfolio (at cost).

    I would do anything for love / but I won't do that.

    So I had to choose between the Lanesborough warrants and the Enterprise warrants and, even though Lanesborough is much cheaper in principle, I could more clearly see a path to "price discovery" for E and I picked that.

    Huntingdon rings a bell, you know, but I don't recall anything about it. Thanks for the heads up.

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  9. Mayur Uniquoters really took off. Indian small & mid caps are so volatile.

    Are you buying Mayur at all on "dips" ?

    It really was a no-brainer investment back when you first posted it. Buy it and forget it for 3 years.

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  10. So do you have any "no brainers" at the moment you're considering? Something like Mayur - buy it and forget it for a few years.

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  11. Keck Seng Investments fits that bill.

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  12. About Emeco,

    Could you please Red tell me whats the meaning of WDV and how do yo calculate it?

    Thanks

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  13. WDV is just another way of saying book value
    http://www.investopedia.com/terms/w/writtendownvalue.asp

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  14. Red,

    One question about Hawaiaan Holdings:

    In the table of your post "ORDEM E PROGRESSO" you put a cost bases of 1.55 (first JAN 2014). I don´t understand this number because the shares are quoting in NASDAQ at current price of 15,50. And in first January were in 9.50.

    Could you please tell me where i´m wrong?

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  15. David, This post is commentary about the tracking portfolio at the top of the page. You'll see that my Hawaiian position is via options.

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  16. how can you be comfortable with emeco at 16% of your portfolio?

    -heavily dependant on coal and gold. US just basicly banned building of new coal powerplants. Gold price could easily lower as well

    -book value doesn't really offer protection in a total liquidation. It helps them get through tough times, but I doubt you recover your investment in a quick liquidation. But I guess that won't happen, since management has zero incentive to do that. And without the covenants they are not forced to anytime soon.

    -Insiders own little, and dont seem that concerned about not wasting value

    -Mine construction was still like 25% of their revenue, and a lot of analysts are very bearish on this.

    I can see a lot of ways that utilization will not recover that much here, and in that case these guys could be floating along like this for years, slowly liquidating to pay off that debt.

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  17. Me:
    "The script -- if coal and gold mining do not recover and idle assets are sold at 1/2 book -- appears to read as follows"

    You:
    " can see a lot of ways that utilization will not recover that much here, and in that case these guys could be floating along like this for years, slowly liquidating to pay off that debt"


    You can imagine that I'm perplexed by your comment.

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  18. I supose I didnt phrase it right. I mean you assume copper and oil sands pick up. But as we have seen in indonesia and europe, the smaller markets are different and less stable then Australia. It could dissapear 2 years from now once it stops booming.

    These smaller markets seem more unstable then australia and coal and gold could be depressed further. What makes you reasonably sure this won't happen after 2015?

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  19. "I mean you assume copper and oil sands pick up"

    They pulled assets from Canada to seed Chile. There's adequate demand for their machines / services in both places -- it's the supply that was wonky. So, I'm not assuming these two regions pick up.

    I'll say this: Emeco, like every other investment, depends on the details.

    What's level of capex consistent with the bottom of the so-called supercycle? What % of that capex is via leases? What happens to sales volume & prices of used equipment in that scenario?

    The chart above suggests that the last trough was in 1999/2000 so it is possible to answer those questions with enough accuracy to know whether an investment in Emeco is too close to call or safe enough.

    Each mineral in each extraction zone has its own cost profile and therefore its own story. Chilean copper, Oil sands, Aussie coal& gold -- all very well covered by sell side, the host governments, the annual and interim reports of listed miners like Antofagasta, equipment and service companies like Enterprise and Macro, etc.

    If you conclude -- based on actual specific research - that there is a reasonable chance that Emeco could generate zero or close to zero EBITDA over the next four years,then the MOS is going to be stressed and an investment in Emeco is probably a little silly.

    If you conclude that it will generate some minimum level of EBITDA -- name your number, and remember that Chile is the gateway for South American mining generally -- then the MOS is less stressed and the IRR won't be shameful.

    If you actually pull out a spreadsheet or pencil and paper and work through cash flows over the next 4 years, you may find it awfully hard to think of a way that an investment in Emeco at $0.20 doesn't come good.

    That's why it's 12% of my portfolio by value. In my experience the easiest money is made when uncertainty is mistaken for risk.

    ps. If you want a possible insight into mgmt's behavior thus far, consider that they seem to have targeted $50m in FCF per half year. They've thus far managed to hit that number pretty exactly by reducing working capital, getting out of the spare parts business, eliminating "growth capex", and selling a freehold building, and have therefore dragged their feet on reducing their fleet size.

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  20. ok thanks for writing it out, I didnt know weakness outside australia was due to weakness in supply. And I guess your right that even if this goes remotely right, the price should at the very least double.

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  21. Red,

    Why do you use for the value of Hawaiian Holdings 6.5 times TRAILING EBITDAR?

    I usually use 15 times FCF.

    Thanks.

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  22. FCF, free cash flow.

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  23. David, let me rephrase: what is your estimate of Hawaiian's free cash flow?

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  24. Red,

    What I was trying to ask is why 6 times EBITDAR. I don't know why you use this number. I'm learning I haven't too much knowledge about investing. But when I'm valuing a company I always try to obtain FCF and then I multiply for 15 for obtaining the objectiv price. Of course also taking into account debt/cash.


    I don't understand why do you use 6.

    Thanks.

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  25. Well, FCF means different things to different people. For me, FCF = "cash earnings", so

    (1) EBITDA minus (2) maintenance capex minus (3) cash interest minus (4) cash taxes minus (5) required cash contributions to the defined benefit plan.

    Normalize cash earnings over time -- to account for cyclicality, normal tax rates, normal pension contributions etc -- and you get to earning power in the Buffett sense.

    So, for Hawaiian you might have (1) 286 minus (2) 55 minus (3) 54 minus (4) 38 minus (5) 20 = 119 million of $1.85 per share.

    A lot of new routes and some rejigging so normalizing capacity utilizarion would get you to around $2.50/share.

    15x cash earnings is what you'd pay for Unilever or WD 40 where revenue, margins, eps, FCF, and payout are all very predictable. This is an airline and all of those things fluctuate.

    But you could argue that 10x is fair, especially if that stream of cash earnings will grow over time.

    And, if so then Hawaiian is worth $2.50 x 10 = $25

    EV/EBITDAR allows for an apples-to-apples comparison between airlines since they have different levels of debt, different propensities to lease aircraft, different D&A policies.

    And it so happens that (a) this corresponds to 6.5 to 7x EBITDAR; and (b) US-based airlines cluster around this multiple.

    There's a wide range of experience among the dozen or so readers of this blog. The experienced ones know what 6.5x means and they'll scoff at it or find it interesting.

    I do worry that HA is not appropriate for a novice investor and I suppose that I subconsciously try to mystify the idea by using an abstract, rather than a concrete, multiple.

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  26. Thanks Red,

    Air companies are very dificult to value for me.
    I' ve never invested in one of them, but I always wonder how to study them.

    The way you evaluate companies is fantastic. I hope to keep learning.

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  27. David, have you read Jason Rivera's book? He is a self-taught investor like me and I thought his book was good.

    http://www.amazon.com/How-To-Value-Invest-Excellent-ebook/dp/B00EQP3MAU

    he blogs here:
    http://valueinvestingjourney.com/

    Also, Geoff Gannon's blog
    http://gannonandhoangoninvesting.com/

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  28. Thanks a lot Red,

    I´ll buy it.

    I´ll also take a look to the web you told me.

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  29. Red,

    Your recent sell in Emeco shares has anything to do with the future issue of shares for paying the CEO?

    Thanks.

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