Friday, June 27, 2014



You may remember that E's business model is to: acquire mom-and-pop energy/infrastructure/utility businesses in Western Canada at <3x EBITDA; build them out through investments in additional equipment; maximize synergies between them through shared costs and cross-selling of services; and sell the entire package at >6x EBITDA in a market that sees an LNG construction boom stretching far into the future.

Things are thus far working out better than I expected. The company is undertaking heavy investment in specialized and, in some cases, unique assets, some of them protected by patents or exclusivity agreements, and all of which have payback periods of six to twenty four months, in order to satisfy pre-identified and contracted demand. And none of this demand is, as yet, directly tied to the LNG construction boom that is surely coming.

Happily, acquisitions, massive internal capex, etc makes E hard to screen for and moderately tricky to value. A reader has kindly sent me the transcript of a conference call conducted in March and I'll quote from that.

Calgary Tunneling & Horizontal Auguring (acquired in June 2013):
“The catalyst for growth here is this is a company that traditionally services all 3 of the segments I mentioned before: utility, infrastructure and energy . . . In the energy business they are exposed heavily to the long distance, large diameter pipeline construction world. What they do there is they put in all the crossings in a pipeline construction design . . . This is an aspect of the business and for the next 5 to 7 years this segment has never seen a construction roster as deep as we’re seeing right now for long distance large diameter pipeline construction projects. Even eliminating what is in front of us with LNG it’s a very long roster.

. . . The main thrust and catalyst for growth with this particular operation is a new micro tunneling technology. We made an investment into the first machine in Canada and negotiated a bit of an exclusive on this piece of equipment . . . So this new technology we acquired is a technology that eliminates all those under water way crossing environmental issues because it doesn’t have a fracking out problem with that type of drilling. So we expect this new technology will be the new mandated crossing technology going forward. Both Enbridge and Trans-Canada have been over to Germany to the manufacturer of this particular technology and they bought in. Of course, we’ll be the only player in Western Canada with this drilling technology . . .So we’re going to see a tremendous amount of growth in 2014, 2015 and onwards with this particular business unit . . . what we’ll see as a result is the equipment and, by the way, that piece of equipment is a $6.5 million investment in one piece of equipment. That piece of equipment the type of projects it will be exposed to will be between $4 and $15 million crossing projects each one . . .The piece of equipment is due to hit our yard late in July and right now we’re working with this world renowned engineering firm, this EPCM firm, to be doing several projects inside of 2014. They have yet to be solidified but we expect that piece of equipment will generate significant revenue inside 2014. It’s too early to know and to get proper vision of what that piece of equipment will do in 2014. We won’t know that until probably midsummer… We order the equipment because of the demand on this particular piece. We’re comfortable at Enterprise that that piece of equipment will be employed. We’re not worried about it at all.”

. . . If you don’t mind I wouldn’t mind adding that Calgary Tunneling is a very specialized tunneling company. It only has one other major competitor in Western Canada that can compete at its level and right now both companies are booked solid. You’ll see expansion in both of these divisions going forward.”

TC Backhoe (acquired in 2007):
 “Historically, I think I mentioned in my talk earlier that TC, our division, had a fleet of 6 or 7 hydro trucks and most of the activity those trucks would do were in our basket of services. In other words it was a service we provided with a technician. We’d make a hole in the ground and our technician would go down and make the repair or termination and we’d clean up the job . . . What we did in late 2013 is we hired a hydrovac expert, a long time guy in the business and at one time was with Badger (Badger Daylighting, ed.) in his history. What comes with him is not only his expertise but he has a great deal of relationships in and around the industry. He was able to bring basically hydrovac services only without any technicians.

So, in other words, providing hydrovac services to open up pipeline integrity inspections and this kind of thing was a business we never did before at TC but with this gentleman’s expertise and relationships we’ve been able to advance ourselves into that business. Now that’s the business that Badger is in and there is an extreme demand for the service that outstrips the capacity for the actual units in industry at the moment.

. . . It’s a good opportunity to take our fleet from 6 to 20. . .This is an extremely profitable division for DC. . . .We’ve ordered and taken delivery of 8 of 14 and have 6 more being delivered over the next 3 ½ months. These machines cost just under a half million to build and they bill out over that in just over 8 months. It is an extremely profitable division and we’ll expand that hydrovac division as long as we have long term commitments. We’ve got a 30 month commitment with Trans-Canada Pipelines and a 24 month commitment with Kinder Morgan and a 2 year commitment with Somerville and so we don’t mind making those investments knowing we have our money back in less than a year and great upside going forward  . . . Basically the demand is there for the product and we’ll supply it as long as we can see getting our money back and turning it into a long term investment.”

Hart Oilfield Services (acquired January 2014):
"There are other competitors in the site infrastructure rental business. The difference with Hart is they (sic, "they" should be “we” throughout, ed.) have designs on their units or what have you that create a tremendous amount of transportation efficiencies as well as the design of the equipment is very innovative . . . Basically they provide the Shells and Encanas of the world equipment that is much more in demand than any of their peers. They are operating over 2000 pieces of equipment and if they had 4000 it would be in demand. So there is a great deal of our cap-ex going to this particular operation because the demand is there . . . What they do is just acres and acres above what their peers provide. It’s a very exclusive offering that we will spend a great deal of our resources building the fleet on that particular business."

Artic Therm (acquired 2012):
Artic Therm is one of our more exclusive businesses . . . In 2000, the company was successfully heating pipelines in the field and been doing it for well over a decade. It is a business that’s growing. They only had 4 clients in the first decade out of choice. They operated the business without wanting to make it any bigger and since we bought it we tripled the client base and extremely grown the revenues in a big way of almost double the first year we took it over. We’ve increased the fleet by billing weight well over 2 times.

So it is an opportunity that has more demand than we have equipment. We’re going to be spending more cap-ex again this year on more units and the catalyst for growth for this company is quite astonishing.

The smaller units are something you’ll see all over Canada and North America, but the big trucks that technology is very exclusive and new to the industry. And right now the opportunity right in our backyard is huge for us to fulfill with all the new clients we’ve been bringing on . . . (And) what you may see this fall is us looking at licensing that technology into some of the areas of North America like the Balkan and down into Texas and Louisiana and up the Eastern seaboard. It is something that we’ll look at and kind of following the same track that Badger did with their hydrovac truck operations.

When we made the acquisition of Artic Therm the proprietor and management of the business built that business working basically from September/October and right until May and bring all the equipment home and actually not work during the summer season for two reasons: it fit the lifestyle they wanted to provide themselves and at the other side they worked so hard during the premium heating season that the break was welcome . . . We as Enterprise since the acquisition we’re of course implementing a program to make this a 12 month revenue stream rather than just 7 or 8 months. . . the tank storage shut down application for the big units is a 12 month business that the previous management didn’t pursue . . . Enterprise is pursuing it and we’ve done a great deal of marketing and have for the first time since Enterprise has owned ATI we have now booked work for this summer. So the applications for the large units for 12 months of the year will happen in earnest this year. Again, it’s a market we’re developing and shareholders should understand that it will take time to develop ATI’s business to 12 months. This year will be a very good start at it. I will definitely say last summer there was very little revenue from ATI during summer months but that will change starting in 2014 and I expect a dramatic increase in 2015 for summer work.

Full transcipt here 

Business fundamentals are only half of a roll up story and the financing/capital structure story is also discussed in that transcript.  

1. E's custom built hydrovac trucks cost $500K and bill $1.1m in revenue at 35% margin
2. E started the year with 8 hydrovac trucks and will end it with 20
3. 20/27 million of 2014 capex is to build out Hart. Hart turns its fixed assets over 1x at 37.5% EBITDA margin.
4. In the above transcript, management indicates a $33.5m EBITDA target for 2014 

Warrants or stock? A reasonable argument argument could be made for either. The smart play may be to have an equity anchor and to supplement it with trades in (~$0.20) and out (~$0.40) of the warrants.

Lots of sell-side coverage for a microcap and the latest initiation is  here.  

Edited June 29 to correct spreadsheet stupidity.

Sunday, June 15, 2014


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’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 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.

Friday, June 6, 2014

Texhong Texile Group - Yarns


This is a gross profit story. I'm going to work backwards from the notional bear case to the opportunity. If you don't know Texhong, this write up is a good place to start. 

Texhong's competitive advantage and earning power are presumed to rest in large part on the difference between international cotton prices (for which "Cotlook A" is a proxy) and domestic Chinese cotton prices ("CC 328"). That spread is narrowing and the market's view -- as reflected in the share price, articulated nowhere -- is that Texhong's earnings and competitiveness will therefore be eviscerated. 

One can see the notional bear case illustrated as follows:
The spread has widened...

 Note: Texhong holds 90 to 100 days of inventory so I have offset the cotton prices above in order to better match cotton prices/costs to Texhong's reporting periods.

Vietnam's share of Texhong capacity has grown...

and therefore earnings have quintupled on a mere doubling of total capacity...

... QED.

I am taking the other side of the argument. I doubt gross margins can fall to anywhere near the level implied by the current market cap and I think they will be higher in 2015 and beyond than they were in 2013.

Texhong Deconstructed: A Simple Model

If one assumes that all of the Vietnam capacity is used to produce cotton yarns that are then sold in PRC -- i.e. that the company has taken maximum possible advantage of the cotton price differential -- everything else falls into place. 

This is what we can surmise/conclude about Texhong's cost structure:


That's the base. I'll emphasize here that there are thousands of grades of cotton and thousands of varieties of cotton yarn, each with their own costs and prices: "Cotlook A", "CC 328", and "ASP" are averages and approximations.

As a reality check, one could go back to 2007 when Vietnam was a mere 2.2% of capacity and compare the consolidated gross margin to the PRC margin presented in this model.  


Using the unit economics illustrated above, and applying consensus ASP and cotton prices expectations to the Texhong's realizable capacity in 2014 gets one to the following:

and therefore:

PRC gross margins expand and Vietnam gross margins shrink.That's not surprising. But if the dominant narrative in one's mind was that Texhong's strength lay in its arbitraging of the cotton price differential, the fact that the consolidated gross margin does not move when the spread is halved is going to seem both counter-intuitive and wrong. (And, if I may be so bold, reading this once is not going to do much to dispel that sense of implausibility; one has to reconstruct the unit economics for oneself to believe in its implications). 

At ~19% consolidated gross margin the equity earns $HK 1.70 and pays $0.50 in dividends in 2014, and $2.33/$0.70 in 2015. This is consistent with management's guidance in April of a 10% earnings margin for 2014.

Margin of safety

The margin of safety is defined by the gross margin that would prevail if the cotton price differential disappeared altogether: 14.7% for cotton yarn, 16.6% for synthetic yarns, 8.8% for fabrics, implying a consolidated gross margin of 15.7%.

This is consistent with HK$0.86 in 2014 in earnings and a $0.26 dividend in 2014. The return on capital at this gross margin is 15% and improving. That's important because it implies that Texhong would grow its way to higher MOS values. 

So anyway

Why this stock? It's volatile, it's cheap, it's well-watched; and I (think I) understand the reason for the sell-off. If I'm right, therefore, the share price will triple in short order, probably upon publication of the 2014 full year results in March 2015.
Also, the owner-operators are, upon the available ten year record, as smart, young, entrepreneurial, and honest as one would like them to be. The company pays out 30% of earnings and grows via debt and cash flow rather than by raising equity. The "runway" is long and well-lit – with or without the Trans Pacific Partnership. When things get bad, Texhong buys failed competitors, when things go well it makes lots of dough.

Disclosure: I own Texhong shares. Do your own work.