Geoff Gannon November 22, 2019

Vitreous Glass: A Low-Growth, High Dividend Yield Stock with Incredible Returns on Equity and Incredibly Frightening Supplier and Customer Concentration Risks

Vitreous Glass is a stock with some similarities to businesses I’ve liked in the past – NACCO, cement producers, lime producers, Ball (BLL), etc. It has a single plant located close enough to a couple customers (fiberglass producers) and with an exclusive source of supply (glass beverage bottles from the Canadian province of Alberta that need to be recycled) and – most importantly – the commodity (glass) can’t be shipped very far because the value to weight ratio is so low that the price of transportation quickly exceeds the price being charged for the glass itself (absent those shipping costs). The stock is also overlooked. It’s a microcap with fairly low float, beta, etc. It’s also a simple business. And capital allocation is as simple as it gets. The company pays out basically all the free cash flow it generates as dividends. And operating cash flow converts to free cash flow at a very high rate, because the company spends very little on cap-ex.

That’s most of the good news. The one other bit of good news is the stock’s price. As I write this, the stock trades at about 3.60 Canadian Dollars. I did a quick calculation of what seemed to be the normal trend in dividends these past few years. The company pays out a quarterly dividend that pretty much varies with quarterly cash flow from operations. So, it’s not a perfectly even dividend from quarter-to-quarter. But, it seems fairly stable when averaged over 4, 8, 12, etc. quarters and compared to cash flow from operations. If we do that – I’d say the current pace of dividends seems to be right around 0.36 cents per share each year. In other words, the dividend yield is 10%. There are other ways to estimate this. For example, we can use the price-to-sales ratio (EV/Sales would be similar, the company has some cash and no debt) and compare it to the free cash flow margin we’d expect. Then assume that all FCF will be paid out in dividends. Again, we get numbers suggesting future annual dividends are likely to be a lot closer to 10% of today’s stock price than say 5%.

There is some bad news though. One bit of bad news is the difficulty I’ve had in this initial interest post verifying certain important facts about the business. In preparation for this write-up, I read 3-4 different write-ups of this stock at various blogs, Value Investors Club, etc. I read the company’s filings on SEDAR (the Canadian version of America’s EDGAR). While I believe the information in the blog posts to be true -they’re getting those facts from somewhere, I can’t independently verify certain things about the supply agreement, the specific customers buying from Vitreous Glass, etc. Having said that, nothing I found in the accounting and in the filing overall really seemed to contradict what I read in the blog posts. And I did notice some stuff in the accounting that matches up pretty strongly with the …

Geoff Gannon November 3, 2019

A-Mark Precious Metals (AMRK): A Dealer and Lender in Physical Gold

A-Mark Precious Metals (AMRK) has been written up twice at Value Investor’s Club. The most recent time was this year. You can read those write-ups over there. It was this most recent write-up at Value Investor’s Club that got me interested in the stock. However, it was for different reasons than that write-up itself lays out as the case for buying the stock. The VIC write-up focuses on how low volatility in the price of gold (and silver and other precious metals) in recent years means that A-Mark has under-earned in each of the last 5 years or so. Having looked at the company now – I’d say that’s possibly true. A-Mark says many times in its SEC filings that it benefits from increased volatility in the physical markets for precious metals. The company also says that the price of gold – rather than how much that price bounces around – doesn’t much matter to the company’s results. I’m less sure of this second point. There is one activity that the company engages in where I feel high (and continually rising) gold prices would be a benefit and low (and continually falling) gold prices would harm the company. Since I mentioned “activities” – let’s talk about what acts A-Mark actually engages in.

The best way I can describe this company is as an investment bank (really, a “trading house”) focused on physical precious metals. That word “physical” is important. We are talking about the buying, selling, storing, shipping, minting, lending, and many other things of actual physical bars and coins of gold, silver, etc. The business is almost completely U.S. It seems 90% of profits probably come from the U.S. I say “seems” and “probably” because of some difficulty in using traditional accounting measures when looking at a company like this. A-Mark is a financial company. It really is a highly leveraged and fully hedged – or as near as fully hedged as it can get – trader in a market. As a result, an accounting line like “revenue” is meaningless. The company reports revenue. But, revenue doesn’t matter. The first line on the income statement that is worth paying attention to is “gross profit”. Gross profit at A-Mark is always less than 1% of revenue. Usually it’s quite a bit less than 1%. This makes typical SEC requirements to disclose revenue stuff useless. For example, does A-Mark have high customer concentration? We don’t know from the 10-K, 10-Q, etc. There’s a line in the 10-Q that says about 50% of revenue comes from two companies: HSBC and Mitsubishi. However, this is just hedging activity. Because of how A-Mark’s accounting works, you could list big “customers” as just entities they are making sales to in the form of hedging activity that will never be settled with physical gold and will never result in any gross cash profits for A-Mark (on their own). So, it may be that around half of the revenue line you are seeing is hedging done with …

Geoff Gannon October 30, 2019

Daily Journal (DJCO): A Stock Portfolio, Some Real Estate, Some Dying Newspapers, and a Growing Tech Company with Minimal Disclosures

This was going to be one of my initial interest posts. Then, I started reading Daily Journal’s SEC filings for myself. At that point, I realized there just isn’t enough information being put out by Daily Journal to possibly value the company. There just isn’t enough information to even gauge my initial interest in the stock. I’ll still try at the end of this post. But, my look at Daily Journal will be a quicker glance than most.

Daily Journal is a Los Angeles based company (it’s incorporated in South Carolina, however) with 4 parts.

Part one is a stock portfolio consisting mainly of – we’re sure of this part – Wells Fargo (WFC) and Bank of America (BAC) shares. The third part of the portfolio is probably (my guess) mostly shares of the South Korean steelmaker POSCO. Yes, Daily Journal does put out a 13F – this is where sites like GuruFocus, Dataroma, etc. are getting the “Charlie Munger” portfolio to show you. However, the way that kind of filing works is that it would entirely omit certain securities. For example, it’d include POSCO shares held as ADRs in the U.S. (which is probably a small number) while not counting any POSCO shares held in Korea (which is probably a bigger number). Daily Journal does have a disclosure about foreign currency that includes discussion of the Korean Won. We can also see by looking at the 13F for periods that are very close to the balance sheet date on some Daily Journal 10-Qs that the actual amount of securities held by Daily Journal is greater than the amount shown in the 13F. There would be other differences too. For example, we know Daily Journal sold some bonds at a gain. Those bonds would not be included in the table filed with the SEC that websites use to tell you what Charlie Munger owns. Everyone can agree on the two big stock positions though. Daily Journal has a lot invested in Wells Fargo and Bank of America shares.

The value of these stakes are offset to some extent by two items.

One, Daily Journal would be liable to pay taxes if it sold shares of these companies. As long as Charlie Munger is Chairman of the company (he’s 95 now, though) I don’t expect Daily Journal to ever sell its shares of these banks. Therefore, I don’t expect a tax to be paid. If a tax was to be paid – you should, perhaps, trim the value of these stakes by over 15%. A very big part of the holdings are simply capital gains. If a stock has increased in value by 4 times while a corporation has held the shares – then, the final amount of taxes paid will seem very large relative to the size of the stake. This is because most of the stake is capital gains that would be taxed on a sale.

The other offset is margin borrowing. Daily Journal borrows using a margin account. …

Geoff Gannon October 29, 2019

Psychemedics (PMD): A High Quality, Low Growth Business with a Dividend Yield Over 7% – And A Third of the Business About to Disappear

Psychemedics (PMD) is a micro-cap stock (market cap around $50 million right now) that trades on the NASDAQ. It is not – by my usual definitions – a particularly overlooked stock. The beta is about 0.53 (low, but many stocks I’ve written about have much lower betas). The share turnover rate – taking recent volume in the stock and multiplying it to see how much of a company’s total shares outstanding would turn over in a given year at this recent rate of trading – is 102%. Again, that’s not an especially high number for the market overall. It might not be high compared to the stocks in most people’s portfolios. But, it’s very high for any sort of truly “overlooked” stock. There are some possible explanations here. Some recent events have caused Psychemedics stock to be especially volatile (this suggests the low-ish beta of 0.53 is more the result of very low correlation with the overall market than of actual low volatility in the stock) and insiders own very few shares of this company. In fact, there’s a ton of float and very few long-term investors in this stock. To give you some idea: insiders all own about 3% or less of the stock individually (and less than 10% taken all together) and Renaissance Technologies (a quant fund) was the largest holder of the stock as of the last proxy statement. This points to a stock that is not closely held by insiders, not generally held by long-term investors, etc. So, it trades a lot. It may not be overlooked. But, it’s still a micro-cap stock. And there’s a decent chance you haven’t seen a longer write-up of this particular stock. So, I do consider it overlooked enough to at least do an “initial interest post”. This is that post.

Psychemedics is in one line of business: hair testing for drugs. Actual testing services make up over 90% of revenue in any given year. The rest of revenue is all very closely related revenue such as charging for the actual collection and shipping of hair samples (in some cases). This is really just a drug testing company that uses hair to do the tests. That’s all you need to know. Historically, almost all revenue and earnings and so on came from the United States. Almost all costs still do come from the U.S. The company is headquartered in Massachusetts and rents about 4,000 square feet there, the actual lab is a rented facility in Culver City, California. Although the lab facility is rented – the equipment is owned. Psychemedics in an asset light business with one exception: it owns a lot of lab equipment. The company depreciates the equipment over 5-7 years. If you do the math on what the equipment was valued at gross, what cap-ex on the equipment is, etc. – this is the one asset heavy part of the business. The company’s assets really consist of technical know-how and a bunch of lab equipment for drug …

Geoff Gannon October 28, 2019

Vertu Motors (VTU): A U.K. Car Dealer, “Davis Double Play”, and Geoff’s Latest Purchase

Accounts I manage own some shares of Vertu Motors (VTU) – bought last week – but, far less than a normal position. Whether we end up owning a full position – that is, having something like 20% of the portfolio in Vertu – or not depends mostly on whether the stock’s price comes down and stays down for a while. As I write this, shares of Vertu trade for about 40 pence. They were as low as 31 pence not too long ago.

I wrote the stock up last year. For my initial thoughts on Vertu, read that post. For a good overview of the entire U.K. auto industry and the various publicly traded companies in it – read Kevin Wilde’s post.

I’m going to spend most of this post talking about whether Vertu is cheap enough to buy now. Before I do that, I should talk a little about Cambria Automobiles (CAMB). I had planned to do a write-up of Cambria before writing up Vertu. I decided not to. My reason for skipping a write-up of Cambria is that I realized I just didn’t have much to say about the stock. Cambria has somewhat better margins and inventory turns than Vertu. So, the actual business provides a bit higher returns on tangible invested capital. On top of this, Cambria has not issued more shares over time while Vertu has. Vertu did two very costly capital raises – both many years ago – that severely diluted existing shareholders at low values versus tangible book. This has had a big influence on the outperformance of Cambria as a stock over Vertu. One possible explanation of this is that top insiders at Cambria own between 40% and 50% of that company. At Vertu, the two biggest insiders combined own something closer to 5% of the stock. Management’s incentives for compounding PER SHARE wealth at Cambria are greater than they are at Vertu. Until recently, Cambria’s management talked a lot more about the kind of metrics shareholders care about than Vertu did. In the last couple years, this seems to have changed – with Vertu’s management using a lot of the usual buzzwords about shareholder value. And then – in the very recent past – Vertu’s actions followed those words. The company bought back over 2% of its shares outstanding in the first 6 months of this year. Those purchases were done at very big discounts to tangible book.

That explains my increased interest in Vertu today versus years ago. It doesn’t explain my reasons for preferring Vertu over Cambria. I should be clear here. I don’t really think of it as preferring Vertu over Cambria. Ultimately, I didn’t decide Cambria wouldn’t outperform Vertu – it may FAR outperform Vertu for all I know – I just decided to pass on Cambria. In a recent podcast, I told Andrew “We almost never bet on change.” I suppose you could argue a bet on Vertu is a bet on a …

Geoff Gannon October 24, 2019

Nekkar: Why We Bought It – And is It Cheap?

Someone emailed me a question about Nekkar:

“I was just curious to understand your thesis on Nekkar. Although they quite correctly have a net cash position of MNOK 0,3bn, they also have close to 0,2 in negative WC (95 in receivables/inventory minus current liabilities of MNOK 274), and I believe most of the cash in Syncrolift (0,2) comes from pre-payments, which over the course of the project will be used for buying raw materials, paying sub-suppliers etc. I am not sure of the percentage but according to the annual filings in 2018 Syncrolift had MNOK 135 in cash and 130 in pre-payments, so I would guess it is a meaningful amount.

EBITDA for Syncrolift was MNOK 30 and 40 in 2017/18. However, if we take out corporate costs of MNOK ~5 which was the average level for the two years, we arrive at a normalized EBITDA of MNOK 35-45. If we slap on a multiple of 6-7x we arrive at a range of MNOK 200-300, so lets use MNOK 250 a midpoint.

With these assumptions I get the following break-up-value of Nekkar ASA:
Net cash Nekkar: MNOK 100
Negative WC Nekkar: -180
Cash (non-restricted) Syncrolift: 25 (?)
EV Syncrolift: 250
= ~200, which is considerably less than today’s market value.”

We don’t value Nekkar on a liquidation basis. Obviously, like an insurer – or anyone with “float” – they would be worth quite a lot less if they ran down their business and closed than if they continued. Syncrolift is quite cyclical. So, this complicates things. If backlog rises over time – the negative working capital position will get more negative (cash will come in the door). If it falls, then cash will end up being used on the project.

So, you’re absolutely right that Nekkar wouldn’t be worth anywhere near what we think it is if it stopped bringing in new orders. The reason for buying the company would be that any new orders would also generate float to the extent that new orders exceed completion on existing orders (backlog rises). They’d always have the same cash on hand (basically) if the backlog stayed essentially flat. Again, this is similar to an insurer. Whenever premiums written today at an insurer drop versus last year, a portion of their balance sheet has to be liquidated and cash flows out the door. They have less customer cash on hand. Nekkar would work the same way. Whenever new orders fall the amount of pre-payments will fall. Whenever new order rise, then pre-payments would rise.

We would never have considered the company unless it was on an ongoing basis. So, the fact that cash isn’t earned isn’t as much of a negative to us looking at this as other people I think. I think other people look at it and say – rightly – that Nekkar can’t (unless they always have this long a backlog) count on having that cash on hand. It’ll flow out of the business in the future.

We look …

Geoff Gannon August 24, 2019

Monarch Cement (MCEM): A Cement Company With 97 Straight Years of Dividends Trading at 1.2 Times Book Value

by GEOFF GANNON

This is my initial interest post for Monarch Cement (MCEM). I’m going to do things a little differently this time. My former Singular Diligence co-writer, Quan, emailed me asking my thoughts on Monarch as a stock for his personal portfolio. I emailed him an answer back. I think that answer will probably help you decide whether you’d want to buy this stock for your own portfolio better than a more formal write-up. So, I’ll start by just giving you the email I sent Quan on Monarch Cement and then I’ll transition into a more typical initial interest post.

EMAIL BEGINS

I think Monarch is a very, very, VERY safe company. Maybe one of the safest I’ve ever seen. If you’re just looking for better than bond type REAL returns (cement prices inflate long-term as well as anything), I think Monarch offers one of the surest like 30-year returns in a U.S. asset in real dollars.

Having said that, I don’t think it’s as cheap or as high return as you or I like as long as the CEO doesn’t sell it. And the CEO very clearly said: “Monarch is not for sale”.

I’m basing a lot of my comments in this email on historical financial data (provided by Monarch’s management) for all years from 1970-2018.

In a couple senses: the stock is cheap. It would cost more than Monarch’s enterprise value to build a replacement plant equal to the one in Humboldt, Kansas. And no one in the U.S. is building cement plants when they could buy cement plants instead. The private owner value in cement plants is even higher than the replacement value. An acquirer would pay more to buy an existing plant than he would to build a new plant with equal capacity. The most logical reason for why this is would be that an acquirer is an existing cement producer who wants to keep regional, national, global, etc. supply in cement low because his long-term returns depend on limiting long-term supply growth in the industry he is tied to – and, more importantly, anyone seeking to enter a LOCAL cement market needs to keep supply down because taking Monarch’s current sales level and cutting it into two (by building a new plant near Monarch’s plant) would leave both plants in bad shape (too much local supply for the exact same level of local demand). Fixed costs at a cement plant are too high to enter a local market like the ones Monarch serves by building a new plant. You’d only get an adequate return on equity if you bought an existing plant. Therefore, I believe that it’s usually the case that the price an acquirer would pay for a cement plant – and certainly Monarch’s plant given its location far inland in the U.S. – is greater than what it would cost to replace the existing plant. So: Acquisition Offer > Replacement Cost. And, in this case, Replacement Cost …

Geoff Gannon August 21, 2019

Norbit: A Norwegian Growth Company Trading At 8 Times 2019 EBITDA

by VETLE FORSLAND

In the middle of June this year, Norbit ASA (ticker: NORBIT) went public on the Oslo stock exchange at 20 kroner per share, after earlier aiming for an IPO price between 23 kroner per share and 30 kroner per share. It had in the first quarter introduced European truck drivers to a new digital tachograph, a device fitted to vehicles to automatically record speed and distance and landed a seven-year contract with the German industrial giant Continental Automotive – which controls 80 percent of the European market for tachographs. This contract helped Norbit’s ITS-segment (more on this later) make 36 million kroner in sales in the first quarter, compared to 40 million kroner for all last year combined. The company’s other segment, which produces sonar products, grew revenues from 28 million in Q1 2018 to 59 million in Q1 2019. Further, the company could boast about EBITDA-margins of 32 percent, bringing EBITDA to 50.1 million in the first quarter. Despite this, the initial interest in the stock seemed non-existent, bringing it to start trading at 9.75 times (conservative) 2019 earnings. Since then, two news articles have brought the stock price up 13 percent to 23 kroner per share – but this still adds up to a 2020 P/E of 11.5, a 2019 EV/EBITDA of 7.8, in an industry where the median peer trades at an EV/EBIT of 17.6 (Pareto Securities). The company is still illiquid, cheap and somewhat overlooked, with a market capitalization of 1,300 billion kroner, or ~144 million dollars.

Business overview

Norbit is a niche-technology company with operations internationally. They produce and provide tailored technology in several markets through three business segments. The company is located in the Norwegian city of Trondheim, known as a technology-heavy town, and has 250 employees (150-170 are engineers). Further, they have sales offices all over the world, and research departments in Budapest and Trondheim. The CEO, Per Jørgen Weisethaunet, was the third employee to work at the company, when he got hired as an engineer sometime in the mid-1990s. After working at Siemens for a couple of years, he became the CEO in 2001, and is currently the second largest shareholder with a stake of 11 percent of shares outstanding, after selling 4 percent of his stake in the IPO. The largest owner is the founder with 15 percent of the shares. As far as I can tell, it’s a very focused and able management. In a longer phone chat with CEO Weisethaunet, he told me that “We have ambitions of building a solid, large technology company with a focus on customized niche products”. “There are commercial genes in us that makes us want to constantly make money. Profitable growth is our focus”, he added. Norbit is aiming for a CAGR growth of 25 percent over the next three years, and Weisethaunet said that the first quarter paves the way for just that – at a minimum. Additionally, the company has been profitable for most of its years since …

Geoff Gannon August 19, 2019

Waste Management (WM): A Capital-Intensive, Wide-Moat Garbage Collector That A Middle-Aged Warren Buffett Would Like

by JONATHAN DANIELSON

Waste Management is not a cheap stock. It does, however, have nearly all the markers of a really good business. And it doesn’t necessarily look overvalued at these levels either. It leads its industry, has consolidated returns that look to be both of high quality and extremely stable in nature, looks to have a wide moat which will be discussed further below, and all easily discernible indications would lead to the conclusion that management is competent and perhaps even value-add. Waste Management might not be a quantitatively cheap stock, but then again it’s the type of stock that never really looks too cheap. As far as valuation multiples go we have to go back to the Financial Crisis to see a time when the P/E touched low double digits. So, it’s the type of stock that takes a true crisis for it get into the “standard” fair value range as far as valuation multiples are concerned. We could classify it as a blue chip stock. Even though most normal day-to-day people are probably not familiar with the company, most investors are certainly aware of it. It would probably get the attention of a 1980s Warren Buffett. In fact, if you’re reading this write-up then you might be aware that site-favorite Allan Mecham (everyone’s favorite hedge fund manager) owned WM back in the early 2000s.

So we know Waste Management is a leader of its market, they also have a long runway for growth, and in addition the market in which they operate is extremely durable and continually generates robust cash flow throughout various economic cycles. The reasoning for this is pretty intuitive. That is, people are going to have trash whether or not the economy grows or contracts by X% in a given fiscal year. Now the degree to which the company is sheltered from the economy is minimal, I want to stress that. But the business isn’t overly cyclical certainly. Compared to most companies – certainly compared to the index – WM is a far more stable business.

Given that the characteristics of this company are such that investors only need complete preliminary due diligence to begin to reach the conclusion that WM is likely to be extremely high quality, the goal of this article is to serve as a comprehensive overview of the business.

Business Overview

Founded in 1971, Waste Management (WM) is a Houston, Texas based company with 43,700 employees and services over 20 million customers. Of the greater than 20 million customers, close to 18 million are residential, 1 million are commercial, and .2 million industrial. No one single customer accounts for more than 1% of total revenue.

Waste Management is its current form is largely the product of the late 1990s merger between Waste Management and USA Waste. Management has described the several years following this merger as the darkest in the company’s history. The entire industry had been on a buying spree as the industry leaders …

Geoff Gannon August 11, 2019

FFD Financial (FFDF): A Conservative Community Bank with a High ROE Trading at Less than 10x Net Income

by REID HUDSON

FFD Financial Corp. (FFDF) is a small Ohio bank holding company that owns all the outstanding shares of First Federal Community Bank. It is headquartered in the town of Dover, Ohio, where it also has its two largest branches. The bank has a market cap of just under $54 million and is listed on the OTC Pink Sheets. It is extremely illiquid, with average daily volume over the past year at 173 shares, representing around .02% of shares outstanding (although that daily average has jumped to 232 shares in the last three months). The bank delisted from the NASDAQ stock exchange in 2012, pursuant to relaxed reporting requirements put in place by the JOBS Act for companies with less than 1200 shareholders. This allowed FFD to save money by avoiding periodic filings with the SEC as well as NASDAQ compliance. The company does, however, still file annual reports with the SEC and posts them on its website.

FFD is an interesting potential investment because of the way it has been able to vastly outperform almost all community banks and most large commercial banks when it comes to return on average equity (ROAE) and return on average assets (ROAA). The bank has also decreased the cost of its deposit base since the financial crisis, with CDs as a percentage of total deposits going from 54% in 2008 to around 30% in the third quarter of FFD’s fiscal year 2019.

FFD just released its unaudited financial statements for the fiscal year-end 2019. Its total assets stood at just under $414 million, its loans at about $336 million, its deposits at around $371 million, and its shareholders’ equity at just over $39 million. Also, FFD’s borrowings are down significantly, standing at just $257,000 compared to over $13 million at year-end 2018. This financial data, however, is unaudited.

The bank’s fiscal reporting year ends on June 30 each year, and its audited financial statements, as of June 30, 2018, show total assets at $382 million, total loans at around $306 million, deposits at about $332 million, and shareholders’ equity at about $34 million. FFD’s audited financial results only go back to 2004, so that is the earliest year I will be able to reference in this report. From 2004 to 2018, FFD’s assets grew at a CAGR of 7.66%, its loans grew at 7.28%, its deposits at 8.5%, and its shareholders’ equity at 5.1%. These results have increased in recent years because of the company’s higher returns which it is able to retain to fuel deposit and loan growth. In the last five years, FFD’s deposits have grown at a rate of 9.3%.

FFD’s 2018 year-end ROAE was at 15.3% and its ROAA was 1.35%, and its unaudited year-end 2019 ROAE was at 17.4% and its ROAA at 1.59%. Obviously, as a small bank this is very impressive, especially considering FFD has been able to achieve this by utilizing only a traditional banking business model. Most small banks you find that …

Posts By: Geoff Gannon

by GEOFF GANNON

by JONATHAN DANIELSON

by REID HUDSON