Posts By: Geoff Gannon

Transcat (TRNS): A Business Shifting from Distribution to Services and a Stock Shifting from Unknown and Unloved to Known and Loved

Transcat is an interesting stock for me to write-up, because I probably have a bias here. Quan and I considered this stock – and researched it quite a bit – several years back. We were going to write it up for a monthly newsletter I did called Singular Diligence. All the old issues of this newsletter are in the stocks “A-Z” section of Focused Compounding. And – you’ll notice, if you go to that stocks A-Z section of Focused Compounding – that there’s no write up of Transcat there. I’ve never written about the stock. Why not? Back then, Transcat was a somewhat smaller company with a much, much smaller market cap. It didn’t do the kind of investor relations stuff it does now. Quan and I could read what management was saying and see the company was trying to move from being a distributor of test equipment to being a service company focused on calibration. Quan and I MIGHT have bought the stock for our own personal accounts (I’m not sure we would have, but I am sure we would’ve had an open mind about Transcat). But, those Singular Diligence newsletters were 10,000+ words long. I didn’t see how we could gather enough info on Transcat to write something that long. So, maybe it was a good stock. But, it probably wasn’t a good newsletter issue.

How does that make me biased now?

Well, in the years since I chose NOT to write it up for Singular Diligence – Transcat’s management did what they said they were going to do. The company has now transformed itself from mainly a distributor of handheld measuring equipment to mainly a calibration service provider. I don’t want to overstate this “mainly” part. If you look at each of the last two full years, I think Transcat got something like 48% and then 50% of its revenue, operating profit, EBITDA, etc. from the service segment and about the same amount from the distribution segment. However, looking at this fiscal year – Transcat is only 6 months into it in terms of what it’s reported so far – I’m getting a number for “adjusted EBITDA” (basically, EBITDA with stock compensation added back – Transcat has a lot of stock compensation) that tells me about 60% of the company’s profit is now coming from the service segment. The other 40% is coming from the distribution segment. That didn’t happen entirely due to a revenue spike in services and a decline in distribution. Part of what has happened this fiscal year is something Transcat’s management has been talking about for a very, very long time and only now really started to deliver on: margin expansion.

Margin expansion is probably the key to deciding whether or not to invest in Transcat. Right now, it’s a good and growing business. But, it’s not a great business. The company has never had amazing returns on capital. It does now use some debt (though usually closer to 1.5 times EBITDA in …

Hilton Food (HFG): A Super Predictable Meat Packer with Long-Term “Cost Plus” Contracts and Extreme Customer Concentration at an Expensive – But Actually Not Quite Too Expensive – Price

Hilton Food Group (HFG) trades on the London Stock Exchange. It qualifies as an “overlooked stock” because it has low share turnover (17% per year) and a low beta (0.28) despite having a pretty high market cap (greater than $1 billion in USD terms).

On a purely statistical basis, Hilton Food is one of the most predictable – in fact, in one respect, literally THE most predictable – companies I’m aware of. There’s a reason for this I’ll get into in a second. But, first let me explain what I mean about the predictability here. Over the last 11-13 years, Hilton Food has shown very, very little variation in its operating margin. EBIT margin variation can be measured in terms of ranges (this would be 2.2% to 2.9% in the case of Hilton Food), standard deviations (this would be like 0.2% in the case of Hilton Food) or the coefficient of variation (0.08 in the case of Hilton Food). When talking about margin variation – I almost always am talking about this coefficient of variation, which is the standard deviation scaled to the mean. So, if a company had 27% EBIT margins on average and a 2% standard deviation or a 2.7% average margin and a 0.2% standard deviation – I’d talk about those two situations as if they were equally stable or unstable margins. Another way to look at it would be to think about standard deviations. If you own a stock for any meaningful length of time, you’re going to see one standard deviation and probably two standard deviation moves in margins. You may not see a three standard deviation move. And it’s entirely possible – unless something major changes with the business, which of course, it often does – you won’t see a 4 standard deviation move. With Hilton Food, a move of 4-5 standard deviations to the downside would only be a 1% of sales move in EBIT. Now, margins at Hilton Food are so low that 1% of sales is like 35% of EBIT and awfully close to 50% of earnings. So, it’s a big move. But, 4-5 standard deviation moves in margins are obviously unusual. And you’d be surprised how common 35% of EBIT to 50% of after-tax earnings swings are for many public companies. They happen all the time. I don’t want to go too far into the statistical weeds here – but, I will say that margin fluctuations that literally happen every 1-3 years for a normal company might only happen once in like 1-3 decades for Hilton Food. Now, Hilton Food has not been around for 3 decades (the original plant started operating in 1994 and the company only went public like 12 or so years ago). And what I’ve been discussing here is the predictability of earnings in cases where sales are fixed. Sales fluctuate. So, Hilton Food’s earnings will move around. It’s just that earnings will move around very, very little relative to sales compared to almost any other …

Geoff’s Thoughts on Cheesecake Factory (CAKE)

Someone asked me my thoughts on Cheesecake Factory. It’s a stock we’ve looked at before. But, I have written about it recently. The stock hasn’t done well lately. It looks fairly cheap. Here was my answer:

“I haven’t followed it lately. I know the stock hasn’t done that well. I did a very quick check of the stock price just now looking at the long-term average operating margin, today’s sales, today’s tax rates, etc. It seems that on an earnings basis (normalized for a normal margin on today’s sales) it would be about 13x P/E. That seems like a good price for a stock like this that has grown EPS almost every year. By the numbers alone, it reminds me of a Buffett stock. I was recently reading what I think is one of the best books on Warren Buffett. It’s called “Inside the Investments of Warren Buffett: Twenty Cases”. And one thing that stands out in each case study is his looking at the last 10-years or more of historical data. In time after time, the increase in revenue and net income and EPS year-over-year is positive in almost 10 out of 10 years. Sometimes it’s 9 out of 10 or something. But it’s very consistently positive compared to most stocks. Also, while people talk a lot about moats and high ROE – I’m not sure that’s as much as a focus for him. I think he looks more to find something that is already consistently showing good results year over year almost every year. Then, if the ROE is 20% or 30% – that’s enough for him. Because the stock is unlikely to be able to grow that fast anyway – it’s just a question of whether it can get a higher return on retained earnings than he can. ROE at Cheesecake Factory is generally adequate. It’s high enough that you could buy it based on its growth rate and P/E ratio. Now, I do notice that the 10-year results in terms of the top line really aren’t that strong. However, this has been true for a lot of restaurants in the U.S. I think Cheesecake also has the added problem that it doesn’t grow same-store real sales after the first year. These restaurants open VERY full compared to the industry. So, some companies have restaurants that do better in year 2 than year 1. That’s not the case here. But, the growth in things like earnings per share versus assets has been good. So, the economics have been – if anything – improving in terms of free cash generation versus the tangible assets used in the business. I’m not, however so sure it’s a growth stock anymore. But, in the company’s defense I think these last 10 years have been some of the toughest for restaurants. Inflation has been very low. Food inflation at supermarkets has been incredibly low to the point where eating in has been much more attractive than eating out. I don’t think that’s …

Canterbury Park (CPHC): A Stock Selling for Less than the Sum of Two Parts – A Card Casino and 127-Acres of Land (Plus You Get a Horse Track for Free)

Canterbury Park (CPHC) is a sum of the parts stock.

After our experiences – and when I say “our”, I mean my decisions to buy – Maui Land & Pineapple, Keweenaw Land Association, and Nekkar – Andrew has a sticky note on his desk that says: “When thinking about SOTP, think STOP”.

Canterbury Park (CPHC) is a sum of the parts (SOTP) stock. Since we’re thinking “SOTP” should we also be thinking “STOP”?

Yes, Canterbury Park is a sum of the parts stock. But…

That doesn’t mean it is primarily an asset play. Though it might be. I’ll talk about the company’s horse track and card casino in a second. But, first let’s get the hardest part for me to value out of the way.

I find it difficult to value the real estate assets of this business. So, I will be judging them based in large part on the range of per acre transaction prices – for both sales of land and purchases of land – I found in the company’s filings. Amounts paid or received per acre seem to range from about $180,000 to $385,000. Some of these deals are a bit more complex – for example, it’s difficult to determine what the price per acre the company received was when it exchanged land for an equity stake in an apartment complex or something like that. In one specific example of this – I would say the company exchanged about 1 acre of land for every 8 apartment units (I mean here the equivalent of owning 100% of 8 units, actual ownership is a minority stake in a greater number of units). Well, what exactly are 8 apartment units worth in the area? I don’t know. Could 8 apartment units be worth something in that same $180,000 to $385,000 range? Could it be more? I’d have to do a lot more research – and be a lot better at understanding real estate investments – to get definitive answers to how much Canterbury Park’s real estate is worth. It’s an important part of the investment case here. But, it’s not one I can evaluate well.

The real estate not being used by the business is 127 acres. Total real estate ownership is more like 370 acres. But, most of it is tied up in the horse track – so, I’ll limit discussion to the 127 acres that is planned to be developed into apartments, townhomes, extended stay hotels, etc. The lowest values I found for actual transactions the company has engaged in were around $180,000 per acre. If we assume the company receives the equivalent of $180,000 in value – sometimes in cash from sales of land, sometimes from equity stakes in joint ventures that rent out apartments for years to come, etc. – we’d place a value of about $23 million on all this real estate. It might be worth $25 million.

It could be worth a lot more than that depending on how it’s developed. For example, …

Stella-Jones: Long-Term Contracts Selling Utility Poles and Railroad Ties Add Up to A Predictable, Consistent Compounder that Unfortunately Has to Use Debt to Beat the Market

Stella-Jones mainly provides large customers with pressure treated wood under contractually decided terms. The customers are mainly: U.S. and Canadian railroads, U.S. and Canadian electric companies, U.S. and Canadian phone companies, and U.S. and Canadian big box retailers. Stella-Jones has some other sources of revenue – like selling untreated lumber and logs – that provide revenue but no value for shareholders. The company also has some more niche customers – probably buyers for using wood in things like bridges, piers, etc. – that probably do provide some profit, but not profit meaningful in scale to the categories of customers I mentioned above. The company also sells some stuff that I’d consider more or less byproducts of their main business. Everything they do is clearly tied to either wood or the treatment of wood. Because there is less information about the smallest product categories the company sells and because those categories are either low or no margin or are probably too small to move the needle for making a decision about whether or not to buy this stock – I’m going to pretend Stella-Jones sells only 3 things: 1) Ties to U.S. and Canadian railroads, 2) Poles to U.S. and Canadian electric and phone companies, and 3) Pressure treated wood (for outdoor decking, etc.) to U.S. and Canadian big box retailers.

First, let’s discuss the economics of this business. One: the first two categories – railroad ties and utility poles – are super predictable, because the U.S. and Canada already have basically all the railroad ties and utility poles they’re ever going to need. What these countries need is simply annual replacement of those products. These are long-lived assets. On average: a utility pole can go 65 years before needing to be replaced. Railroads and utilities can defer replacement due purely to age. But, why would they? This isn’t the most expensive form of cap-ex to spend on. Eventually, network performance will degrade if they don’t maintain this stuff. And these are usually very, very creditworthy customers. They don’t have to rely on short-term borrowing from banks. Stella-Jones’s most important customers can all issue long-term bonds to raise the capital needed to fund not only normal maintenance projects but even growth cap-ex. So, there could be some cyclicality here. But, it’s probably a lot less than you’d think. It’s going to be far, far less cyclical than companies like suppliers of newer technology products to utility and telecom customers. It’s going to be a lot less cyclical than suppliers of locomotives to railroads. Although technically Stella-Jones is clearly selling a physical (and pretty much commodity) product to these customers – the economics here are going to look a lot more like they are being paid to maintain something on behalf of their customers. They’re providing a constant supply of replacement parts.

The physical scale of Stella-Jones and their customers is possibly a lot bigger than you might be thinking. What I mean by this is that the company moves a large …

Points International (PCOM): A 10%+ Growth Business That’s 100% Funded by the Float from Simultaneously Buying and Selling Airline Miles

Points International (PCOM) is a stock Andrew brought to me a couple weeks ago. It always looked like a potentially interesting stock – I’ll discuss why when I get to management’s guidance for what it hopes to achieve by 2022 – but, I wasn’t sure it’s a business model I could understand. After some more research into the business, I feel like I can at least guess at what this company is really doing and at how this helps airlines. My interpretation of what the company is doing is sometimes a bit different than what I’ve read about in write-ups of this stock on Value Investor’s Club, Seeking Alpha, etc. The company’s own investor presentation doesn’t lay things out quite the way I will here. So, everything you read in this initial interest post should be consumed with the understanding that it’s my best guess of how this business works – and that guess could be far off the mark.

Points International has 3 segments. One of these is “Loyalty Currency Retailing”. That segment produces more than 100% of the company’s economic profit because the other 2 segments together add up to a slight loss, break even result, etc. depending on the exact year or quarter. At this point, I see no reason to assign any value – positive or negative – to the other two business segments. Points International also says it serves a lot of different clients. It mentions a total of 60 clients who it does some work for. However, only 30 use even one of the company’s “Loyalty Currency Retailing” functions. As a side note: in a YouTube video I saw, the company’s President seems to mention the number 36 in reference to Loyalty Currency Retailing – so, when I say “30” going by the company’s reports to regulators and so on, the actual number may now be 36 but I’m not 100% sure that’s what the President was referencing. So, I’m going to keep saying they have about 30 out of 60 clients actually allowing them to do any Loyalty Currency Retailing. Loyalty Currency Retailing is the only business that produces value here. So, all profits are from only 30 (or so) “partners”. Customer concentration seems extreme here if you read the note that 70-75% of revenue comes from 3 partners. However, gross profit is the more meaningful measure here. I would just cross out revenue and replace it with gross profit for most discussions of this company. The one exception would be “float”. I’ll discuss that later. It’s possibly best to treat gross profit as this company’s top line revenue and to treat the reported revenue as a form of “billings” as other marketing companies might put it. So, gross profit concentration is such that 80% of gross profits comes from 12 partners. Based on other things the company says, I would assume these partners are airlines based in the U.S. and Europe. I think the concentration here is really that almost all profits …

F.W. Thorpe: A Good Business Making Durable Products that May Have Already Peaked

Today’s initial interest post is a company I like a lot. It’s trading at a price that could be justifiable – possibly – based on that company’s past performance. But, it’s not a stock I’m going to give a very high initial interest level too. The reason for that is uncertainty about the future.

I’ll get to that uncertainty in a second. First, I want to describe what FW Thorpe does. The company makes lights. I won’t go into too much detail here. You can always read a company’s annual report for yourself. So, I hate to go into analysis free re-hashes of a company’s basic business model. I’ll do that a little here, though, because I don’t want you to think FW Thorpe makes light bulbs for your house.

The company’s focus in on professional lighting with the lowest cost of total ownership. It makes lights for everything from clean rooms to warehouses to retail shops. FW Thorpe’s products are used for street lights, in tunnels, up on the ceiling of the office you may be working in now (though, if you’re not in the U.K. or the Netherlands – it’s a lot less likely that’s an FW Thorpe product). The company also makes lighting for emergency signs. It has a business unit that seems to me to be focused on making emergency sign lighting that complies with regulations while looking aesthetically pleasing (the customers all seem like locations that care about the look of the interior of their building). Some lighting is used to illuminate advertisements and things like that. It’s a whole variety of professional lighting where the main focus is not having the cheapest initial purchase price. It’s about what the lighting does and how little it’ll cost you in electricity bills, replacement, etc. over many years into the future.

Basically: FW Thorpe makes lights. Decades ago, lighting was not a very durable product. But, that changed in recent years. Unfortunately, not so recent that we’re still in the middle of this shift from more disposal lighting to more durable lighting. What was once often fluorescent (and incandescent) lighting became LED. As you probably know, a lot of governments put in rules phasing out incandescent lighting. Many of these rules were put in place anywhere from 5-15 years ago. So, again – we’re talking about a tailwind that was stronger in the past than it will be in the future.

I’m sure there are people reading this who know more about the lifespans of incandescent, fluorescent, and LED lights. But, from what checks I could make – it seems that a typical LED light can have a life as much as 10 times that of a typical fluorescent lamp. I was, however, able to find references to some fluorescent lamps designed to have similar lifespans to LED lights. So, companies have probably always been working on extending the lifespan of any of these types of lighting. For us as investors here – the problem is that …

Gamehost: Operator of 3 “Local Monopoly” Type Casinos in Alberta, Canada – Spending the Minimum on Cap-Ex and Paying the Maximum in Dividends

Today’s initial interest write-up is a lot like yesterday’s. Yesterday, I wrote about an Alberta based company paying out roughly 100% of its free cash flow as dividends. In fact, that company was paying almost nothing in cap-ex. Today’s company is doing the same. It pays almost everything out in dividends. And it doesn’t spend much on cap-ex. So, cash flow from operations translates pretty cleanly into dividends. And like yesterday’s stock being written up (Vitreous Glass) – today’s stock being written-up (Gamehost) probably attracts a lot of investors with its high dividend yield. As I write this, Gamehost’s dividend yield is a bit over 8%. Like the dividend yield on Vitreous Glass – that sounds high. But, you need to be careful. If a stock is paying almost all of its free cash flow – and, in fact, almost all of its cash flow from operations in this case – out as a dividend, then you might need a much higher dividend yield than you’d think. There are three reasons for this. One, if the company pays everything out in dividends then it’s obviously not paying down debt or buying back stock or piling up cash. So, the free cash flow yield is no higher than the dividend yield. A dividend yield of 8% sounds amazing. But, a stock trading at 12.5 times free cash flow (for an 8% free cash flow yield) isn’t unheard of. It’s still cheap. But, you need to do some research to make sure there aren’t good reasons for it being that cheap. Two, the dividend coverage ratio is obviously 1 to 1 on a stock that has a dividend payout ratio of roughly 100%. A stock paying out just one-third of its earnings as dividends can see its earnings drop by 65% and still cover the dividend from that year’s earnings. Any decrease in the earnings of a stock with a 100% payout ratio would threaten the dividend. Three, it’s usually hard for a company to grow it sales, earnings, free cash flow, etc. over time if it retains literally no earnings in any period. For some companies, it’s not impossible. But, for a stock like Gamehost – which does have a fair amount of tangible assets – it’s impossible to organically grow those things aside from just capacity utilization increases. Luckily, Gamehost’s properties are currently operating far below capacity. When I describe what these properties are and – most importantly – WHERE they are, you’ll see why.

Gamehost’s EBITDA and other measures of earning power peaked about 5 years ago. The company operates both hotels and casinos in Alberta. It also provides food and beverage services in those hotels and casinos. The company claims to have 3 segments – casinos, hotels, and food and beverage. It also owns a strip mall. However, the only real source of profit we’ll be talking about here is the first segment: casinos. The other segments don’t lose money. They make a slight profit. And they do …