March 2019 – Focused Compounding

JakeCompounder March 30, 2019

Gaia (GAIA): A Strange Value Investment in a Strange Streaming Service

Gaia operates a streaming service like Netflix, but for yoga, meditation, and weird conspiracy videos. They have many great titles, like “The Baltic Sea Anomaly; A Crashed UFO Or Natural Rock Formation?” or “Cannabis Spirituality: Using Plant Medicine as a Sacred Tool”. The company is run by its founder, Jirka Rysavy, who owns over 32% of the company’s stock. Rysavy is an experienced entrepreneur who founded Corporate Express, which became a Fortune 500 company before merging into Staples. Gaia is growing extremely fast, but has been losing money along the way. I believe the net losses are a result of investments for growth that will dramatically decrease over the next few years.

At first glance, Gaia is exactly the kind of business that value investors would avoid. The company is selling for $160 million, and produced just $42 million of streaming revenues in 2018. This gives the stock a price to sales ratio of 3.8. The company’s losses have been growing, with a net loss of $33.8 million in 2018 and $23.3 million in 2017. At this point, most value investors would have lost interest and moved on to the next idea. However, there are some very interesting aspects of this business that deserve a closer look.

Gaia has a low amount of operating expenses, while most of their net loss comes from investments for growth. This provides the business the potential to earn very high returns on capital as the investment in growth spending slows. In the 2018 Q4 earnings call, management expressed that their plan was to reduce subscriber acquisition spend throughout 2019 as they attempt to head toward profitability.

What really excites me about Gaia is the low cost of content. This can be seen within the company’s gross margin. As the company grows, the gross margin continues to rise as well, from 80.7% in 2015 to the 87.2% Gaia had in the 4th quarter of 2018. Netflix, for comparison, has a gross margin of 36.9%. In addition, the gross margin doesn’t tell the whole story for Netflix, as their amortization of streaming content leads to cash flow being much worse than net income. The opposite is true for Gaia, as they reports better cash flow than net income. However, cash flow is still negative for Gaia for the time being. This low cost of content is achieved even considering that the vast majority of Gaia’s titles are either created by or exclusively for Gaia. About 90% of Gaia’s content is exclusively available for Gaia subscribers. For companies like Netflix or Gaia, the sole product is content. With such low costs of content, there is potential for abnormal profits eventually.

The net loss for Gaia can be attributed to the ‘Selling and Operating’ line on the Income Statement, as this is currently 156% of revenue. In 2018, this value was $68.3 million. Management discloses in the earnings calls the breakdown of what they consider operating expenses compared to subscriber acquisition costs. $52 million was spent on subscriber …

Geoff Gannon March 30, 2019

Revisiting Keweenaw Land Association (KEWL): The Annual Report and the Once Every 3-Year Appraisal of its Timberland Are Out

Accounts I manage hold shares of Keweenaw Land Association (KEWL). I’ve written about it twice before:

Keweenaw Land Association: Buy Timberland at Appraisal Value – Get a Proxy Battle for Free

And

Why I’ve Passed on Keweenaw Land Association – So Far

I didn’t continue to pass on Keweenaw Land Association. Like I said, the stock is now in accounts I manage.

There are really two things worth updating you on. One is the annual report. The other is the appraisal. The appraisal is something the old management team – the one that lost last year’s proxy vote to Cornwall Capital – always did as well.

So, I can show you a summary of every appraisal from 2006 through 2018. The company includes this in its annual report:

You can read the entire annual report here.

A full summary of this year’s appraisal and methods used by the appraiser can be found here.

In today’s article: I’ll focus on the appraisal, because valuation of the stock seems to be the thing readers are most interested in. The annual report is also quite interesting though. The company’s new management is disclosing far more than the previous management. Although Keweenaw stock is “dark” (it doesn’t file with the SEC) – this latest annual report reads like a typical 10-K filed with the SEC. The company also changed its auditor to a better known firm (Grant Thornton) that audits plenty of other public companies.

As you can see in the table above, the value per acre of KEWL’s timberland was appraised at $809 this year versus $901 in 2015. That’s a decline of 10% versus 3 years ago. It’s also basically flat with an appraisal done in 2009 (so nearly 10 years ago). These are also nominal numbers. So, that means that the real value of KEWL has declined on a per acre basis over the last decade.

What’s tricky about this though is the last row you see “appraisal as a percent of standing inventory”. As you can see, the effective gross timber value – this is the value of all of the wood on Keweenaw’s land less the estimated gross costs of cutting and trucking that timber away – has risen pretty consistently. It went from $728 an acre in 2009 to $1,130 an acre today. But, the appraisal as a percent of that standing inventory went from 110% in 2009 – meaning the appraiser was then valuing the timberland above the gross value of the timber itself – down to just 72% this year. You can also see that the physical volume of timber – measured in cord equivalents – has compounded at something like 4% a year over the last 12 years. So, physically there is more timber on Keweenaw’s land every 3 years – and at least in the 2012, 2015, and 2018 appraisals this timber’s value has also increased per acre every time. However, the property’s appraisal has not. In fact, it declined by …

Geoff Gannon March 26, 2019

Ball (BLL): A Debt Laden, “Economic Value Added” Obsessed Organization with a Super Wide Moat

Write-up by Mister Compounder

The 3 most important variables to the Ball (BLL) investment thesis are:

The industry structure and the symbiotic relationship with beverage companies, that naturally leads to “survival of the fattest”.
The EVA approach that links interesting site economics to the creation of shareholder value.
Credit risk (having the right level of debt).

Ball is one of the world’s leading suppliers of metal packaging to the beverage and food industry. The company has a long history and was founded in 1880. Through its entire history, Ball has been involved in close to fifty different segments. Today, the business is mainly based on delivering aluminum beverage containers to the beverage industry. The company’s business is about delivering aluminum cans to large consumer staple companies like: Coca Cola, Unilever and AB InBev.

This sounds like a really dull, capital intensive and boring business. So, why should it interest you?

Interesting Site Economics

The source of Ball´s competitive advantage is dependent on local scale and switching costs, resting on a highly consolidated industry among both producers and customers. The plants making the beverage container cans are huge. This is best illustrated by the size range of the production plants from about 100,000 square feet to around 700,000 square feet. The company’s largest site is the Findlay, Ohio plant (733,000 square feet) that produces both beverage cans containers and food containers.

To get an understanding of the underlying unit economics driving both revenue and profitability at Ball, it might be interesting to do some guesstimates on the profitability of the site locations.

In the North American segment, the beverage container industry represents about 110 billion units, where five companies dominate the market in the U.S, Canada and Mexico. For fiscal year of 2017, Ball produced 46 billion units, hitting a market share of 42%. This volume is served by 19 plants in the US, 1 in Canada and 2 in Mexico. They have also one joint venture production facility, but I have not included that one in this calculation. In total 22 plants, which means an average of 2.1 billion units per plant per year.

This means that – each year – the typical Ball plant should make:

1 billion units
$190 million in revenues
$37 million in gross profit at a 19.5% gross profit margin
$25 million in operating profit at a 13% operating margin
Which is: $624 of revenue per square foot in and $81 in profit per square foot

Ball typically generates 9 cents in revenues per beverage can and 1.2 cents in operating profit per can. This is what generates sales and earnings at Ball. In other words, these are huge operations. Just like with distributors, it will be difficult to compete with a fully functioning and operative production plant. Given this, it is highly unlikely that a competitor would add excess capacity near an existing plant. It leads naturally to local markets as it does not make sense to transport the products …

Geoff Gannon March 21, 2019

IEH Corporation (IEHC): May Be a Good, Cheap Stock – But, Definitely in the “Too Hard” Pile for Now

As this is an initial interest post, it’ll follow my usual approach of talking you through what I saw in this stock that caught my eye and earned it a spot near the top of my research watch list – and then what problems I saw that earned it a low initial interest score.

I’ll spoil it for you here. IEH Corporation (IEHC) is a stock I’m unlikely to follow up on because of the difficulty of digging up the kind of info that would make me confident enough about a couple key problem areas I’ll be discussing below.

I think I have a pretty biased view of this stock. Or, at least, some of what I’ll be discussing in this article might give you a negative, biased impression of the stock. And there are actually a lot of good things here. So, I’d like to start by linking to some bloggers who have discussed this stock in-depth in a way that’s different from some of what I’ll be focusing on here.

I recommend you read theses posts:

“My Trip to the IEHC Annual Meeting” – Bull, Bear and Value (2014)

“Why I Bought IEHC” – Bull, Bear and Value (2013)

“IEH Corporation (IEHC)” – OTC Adventures

“IEH Corporation: A Tiny Company with the Potential for a Big Dividend” – Weighing Machine (2013)

“Recent Numbers at this Company Say Buy, Hand over Fist” – Dylan Byrd (2015)

“IEH Corp (IEHC)” – Value Investors Club (2013)

In case you chose not to click those links, I’ll give you a quick explanation for why I might be interested in this stock at first glance.

It’s Overlooked

The stock is overlooked. I manage accounts that focus on “overlooked” stocks.

This stock has a $40 million market cap – of which, probably close to 50% doesn’t actually trade (it’s owned by insiders, etc.). So, we’re talking about a “float” of about $20 million or $25 million. Something quite small.

The company also does something quite boring. It makes connectors which go into products assembled by defense contractors serving the military, space, and aerospace industries. Investors would know the end products this company’s output goes into – Boeing 737, Airbus A380, F-35, Apache AH-64, Hubble Telescope, etc. And investors would know the customers who buy connectors from IEH – Raytheon, Northrup, Honeywell, Lockheed, NASA, etc. But, neither the company itself nor the products it produces would be high visibility to investors. I find this tends to make it more likely a stock is overlooked. For instance, in the movie industry – investors would focus immediately on the theater owner, the studio producing the film they’re watching, etc. and less on the companies that make the theater’s sound systems, digital projectors, etc. or provide the ticketing kiosks or run the theater’s loyalty program.

In this way, IEH Corporation could be something like George Risk (RSKIA) – a company that has a market cap of under $50 million, is about half owned by insiders (so, the …

JakeCompounder March 18, 2019

Inspira Financial (LND.V): Liquidation of Business Provides Low Risk Opportunity

*I own shares in this company, and it is a very illiquid stock

Inspira Financial trades under the ticker LND.V on the TSX Venture exchange in Canada, and trades OTC under the ticker LNDZF in the US. While the stock has more volume in Canada, LNDZF is very illiquid. For most of my purchases of LNDZF, my trades accounted for the entire trading volume that day of the stock.

Inspira Financial is selling for about $4.8 million USD, or $6.4 million CAD. The company reports in Canadian dollars, so for simplicity the rest of the information I write will be in CAD. This is a small business that used to lend money to medical offices. They also operate a small billing subsidiary. Management decided to get out of the lending business, so they are collecting on their loans and liquidating that business. They also put their billing subsidiary up for sale as well. This is a weird situation since the stock is basically in liquidation. I think the stock will either be bought out, or the company will use all the cash generated from the liquidation to acquire a new business.

The company is selling below the value of its cash in the bank minus all liabilities. The whole company is selling for $6.4 million, which is 30% below their $9.2 million in cash. Their total liabilities are $1.7 million, which is mostly made up of a provision for legal matters related to a billing competitor. Their other assets, not counting cash, come to $4 million. So let’s assume either their other assets can only be liquidated for less than half of their book value, or that the legal matter is understated, and they cancel each other out. That would still leave us with a company selling 30% below the level of cash in the bank. These other assets of $4 million are made up of $3.7 million of receivables and deposits, while the remainder is equipment. I think it would be conservative to assume the other assets offset the company’s total liabilities.

Inspira also has a billing subsidiary called Inspira Saas Billing Services that they are looking to sell. I am skeptical about this billing business, as I get the feeling they use Saas as a trendy buzzword. This business generated sales of $1.8 million in 2017, and has been growing slightly over the past year. If you extrapolate their latest quarter, the business would have $2.3 million of annualized sales. Last quarter, they reported that they only have two customers within this business, and that one customer makes up over 90% of sales. This quarter, they added 3 new customers bringing the total to 5. However, the main customer still makes up over 90% of sales. Total billing revenues did increase 5% in the quarter, but this is still a tiny business. I’m not sure what this business is worth, but if they could sell it for half of its level of sales, that would be $1.15 million. …

Geoff Gannon March 14, 2019

PRAP Japan (2449): Japan’s Healthiest Public Relations Firm – Trading At Just 4 Times EBIT

This article originally appeared on Kenkyo Investing, a value-driven service specializing in Japanese small and microcap stocks. Each month, Geoff will pick his favorite article from Kenkyo Investing and share it with you here at Focused Compounding. To read all of Kenkyo Investing’s articles, visit Kenkyo Investing’s website and become a member. Don’t forget to use discount code “FCPODCAST” to get 10% off.

Write-up By Kenkyo Investing

Thinking Points

PRAP Japan (TSE: 2449) is Japan’s fourth largest public relations consulting firm offering marketing communications, corporate branding, crisis communications, event management, and content production services to corporate customers in a variety of industries.
Compared to its competitors, PRAP has the healthiest balance sheet and has delivered business performance at a consistently elevated level.
Over the last decade, the company built its China business, which now accounts for nearly a third of consolidated 2018 revenues. Meanwhile, its Japan business has remained mostly stable, with modest growth. PRAP plans to expand in the Asia Pacific region going forward.
Despite its consistently strong business performance and industry-leading balance sheet health, PRAP trades at an adjusted 4.3 EV/EBIT, considerably lower than its peers, which trade between 9.7x and 25x.
Though there is no clear catalyst in sight, if investor sentiment shifts and PRAP trades at comparable multiples, investors can expect a three year investment CAGR of 21% with minimal business risk investing at today’s 1,599 yen per share price.

Introduction

PRAP Japan (TSE: 2449) is a public relations (PR) consulting firm offering marketing communications, corporate branding, crisis communications, event management, and content production services to corporate customers in a variety of industries. Founded in 1970, the company is among the older and established PR firms in Japan. Over the past decade, PRAP has increased its efforts in China, mainly targeting Japanese companies wanting to establish a presence in China.

Source: Company filings

Though PRAP offers a variety of services, it is a single segment company. As of 2018, PRAP is the 4th largest PR firm in the country by revenues.

The business & environment

The Public Relations Society of Japan (PRSJ) estimates that the PR industry size in Japan was 101.6 billion yen ($90 million USD) in 2016 (Japanese). Long term historical data isn’t available for the industry as it is still small. That said, PRSJ notes that the industry is rapidly growing:

Source: Public Relations Society of Japan

Over the last 8 years, the Japanese PR industry has grown at a 4% CAGR. In the last couple years, newswire services and video production and promotion services have fared particularly strong. The key players in the PR industry are:

Source: Company websites

Vector (TSE: 6058), Sunny Side Up (TSE: 2180), PRAP Japan, and Kyodo PR (TSE: 2436) are publicly traded. Dentsu Public Relations is under Dentsu (TSE: 4324), Japan’s largest advertising agency, and Ozma is affiliated with Hakuhodo (TSE: 2433), Japan’s second largest advertising agency.

Although Japan’s PR industry has been growing quickly, PRAP’s revenue growth pales …

Geoff Gannon March 4, 2019

Universal Robina: A Good, Growing Filipino Branded Food and Drink Business – That’s Not Quite Cheap Enough for Value Investors

Write-up by Jayden Preston

Overview

Founded by John Gokongwei Jr., Universal Robina Corp. (URC) has come a long way since its humble inception as a corn starch manufacturer in 1954. Through decades of diversification, URC is now a leading producer of branded snacks and beverages in the Philippines. To a certain extent, URC is like a mixture of Pepsi Co. and Mondelez in Southeast Asia. While URC does not have a cola product, the Company, similar to Pepsi Co., does have a diverse portfolio of snacks, including potato chips and cheese rings, and beverages, such as bottled water and other ready-to-drink (RTD) beverages. URC also competes with Mondelez in the confectionery business through its products of cookies and chocolates.

In addition to its home market, URC also has presence in 12 other countries in Southeast Asia and Oceania. Its major international markets include Vietnam, Thailand, Indonesia, Australia and New Zealand.

However, URC is more than just a branded food producer. In the Philippines, URC has two other segments, Argo-Industrial Group and Commodity Foods Group. The former is engaged in hog and poultry farming, while the latter involves flour and sugar milling. This part of the business is similar to Seaboard Corporation.

URC is thus divided into 4 segments: 1) Branded Consumer Food Philippines (CF Philippines), 2) Branded Consumer Food International (CF International), 3) Argo-Industrial Group (AIG), and 4) Commodity Foods Group (CFG). (3 and 4 are collectively known as the Non-Branded consumer food segment. We will refer it as the Non-Branded segment, even though there are still some branded offerings within this segment.)

Segment Breakdown

CF Philippines is the most important segment for URC. It contributed 48% of revenue and 53% of EBIT in 2017. It is followed by CF International in terms of revenue contribution at 34%. Yet, the international segment actually has the lowest margins among all the segments. As such, only 19% of EBIT comes from this segment. In other words, while the Non-Branded segment only generated 18% of total revenue, it was responsible for 28% of EBIT.

In summary, in terms of operating profits, URC is roughly 3 quarters a branded consumer food company spanning in Southeast Asia and a quarter of a commodity foods producer in the Philippines.

Durability and Quality

Branded Consumer Food Segment

Branded snacks and beverages, with brand heritage, tend to score very highly on the scale of durability. The keys to the business are brand recognition and shelf-space availability. The more well-known your brands are, the more willing retailers are to stock your products; and, the more available your products are, the more frequent customers will come across your products. There is thus a reinforcing element in the equation that favors incumbent players.

This is not to say that there is no threat from new entrants. A major concern to the durability of well-established players in this space is the ongoing change in customer behavior, such as the trend toward healthy foods, …

Posts In: