Posts In: Geoff's Writeups

NACCO (NC): First Earnings Report as a Standalone Company

Two days ago, NACCO (NC) released its first quarterly results as a standalone company. Yesterday morning, the company had its first earnings call as a standalone company. The stock dropped 10% following these events. I’m not going to write about NACCO each quarter. But, some people asked for my thoughts on the quarter and the stock drop. So, I’ll do it this once.

Overall, the earnings call and the stock drop reinforced my belief that it could take a year or more of NACCO trading “cleanly” as a separate company before it’s well understood by investors. More on that at the end of this post.

First, the earnings release. Here, everything was as expected.

You can – and should – read NACCO’s full earnings release here. These are the items I highlighted:

• “After the completion of the spin-off, NACCO ended the third quarter with consolidated cash on hand of $93.9 million, debt of $58.7 million and net cash of $35.2 million.  The cash on hand included a $35 million dividend received from the housewares business prior to the completion of the spin-off.” So, the company now has $5.13 in net cash per share.
• “NACCO’s board of directors will evaluate and determine an ongoing dividend payout rate at its next regularly scheduled meeting in November. When doing so, the board will consider the financial conditions and prospects of NACCO and North American Coal following the spin-off of the housewares-related business.” We’ll see what they decide to start the dividend at. The “financial conditions” are strong. The “prospects” are bleak.
• Not a highlight, but a note: The after-tax numbers are meaningless here because of a very unusual tax timing situation. The company had a 44% tax rate on continuing operations. In the future, I expect the normal tax rate for NACCO as a standalone company will be 23%. So, ignore all after-tax numbers.
• Centennial is NACCO’s consolidated (so NACCO bears all the risk) failed mine: “Centennial will continue to evaluate strategies to optimize cash flow, including the continued assessment of a range of strategies for its remaining Alabama mineral reserves, including holding reserves with substantial unmined coal tons for sale or contract mining when conditions permit. Cash expenditures related to mine reclamation will continue until reclamation is complete, or ownership of, or responsibility for, the remaining mines is transferred.”
• NACCO confirmed that the customer will bear the risks related to the Kemper plant / Liberty mine failure and NACCO will be paid to do the mine closure work: “The terms of the contract specify that Mississippi Power is responsible for all mine closure costs, should that be required, with the Liberty Mine specified as the contractor to complete final mine closure. Should the decision to suspend operations of the gasifier and mine become permanent, it will unfavorably affect North American Coal’s long-term earnings under its contract with Mississippi Power.”
• “…capital expenditures are expected to be approximately $21 million in 2018.”
• “While the current regulatory environment for development of new

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Cimpress (CMPR)

Guest Write-up by Jayden Preston

 

Introduction

Vistaprint was founded in 1994 by Robert Keane, on the idea that there was a market for producing business cards cheaply for companies too small to order in large quantities. Through utilizing the internet, creating better software and printing technologies to make such mass customization cost effective and efficient, the business has turned out to be a huge success.

23 years later, Vistaprint has become a clear leader in mass customization of marketing materials for small businesses. It has also increased its portfolio of businesses and target markets through acquisitions and now offers thousands of products that customers can customize to their needs. It was renamed to Cimpress in 2014 to reflect their growing number of business units.

 

Business Summaries

Cimpress has changed their business segmentation a number of times in the past. We look at their current segmentation below:

1. Vistaprint

This is still their core business. Vistaprint currently operates globally, with a special focus on North America, Europe, Australia and New Zealand markets. Their Webs-branded business is also grouped under Vistaprint.

The target customers of Vistaprint are micro businesses, i.e. companies with fewer than 10 employees. Since they are small operations without marketing expertise, they rely heavily on the software technologies provided by Vistaprint when designing and making their marketing materials.

In FY2017, Vistaprint served 17 million micro businesses and generated $1.3 billion in revenue, representing 60% of Cimpress’s overall revenue. Adjusted net segment operating profits were $165 million, for a margin of 12.6%. This is a depressed margin though. The two-year average from FY2015 and FY2016 is higher than 17%.

2. Upload and Print

This segment is mostly built up through acquisitions. Companies/brands in this segment include: druck.at, Easyflyer, Exagroup, Pixartprinting, Printdeal, Tradeprint, and WIRmachenDRUCK businesses. These companies mostly focus on Europe.

Some companies that have more resources would look for professional graphic designers, ranging from local printers, print resellers and graphic artists to advertising agencies and other customers with professional desktop publishing skill sets, for their marketing needs. The segment focuses on serving such graphic professionals.
As a group, they generated $589 million in revenue in 2016, which is 28% of the total. Adjusted net segment operating profits were $64 million, for a margin of 10.9%

3. National Pen

This business was acquired at the end of 2016. Given its scale and vertical integration, National Pen is the leading provider of a wide array of customized writing instruments for small- and medium-sized businesses in more than 20 countries. The company also sells other promotional products, including travel mugs, water bottles, tech gadgets and trade show items.

It serves about a million small business customers through a successful direct mail marketing and telesales approach, as well as a small growing e-commerce business.

The business generates around $113 million in revenue.

4. All Other Businesses

This segment includes the recently sold Albumprinter, Most of World, and Corporate Solutions businesses. These businesses have been combined into one reportable segment based on …

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What’s NACCO’s Margin of Safety?

 

After reading my write-up, a member asked me about the margin of safety in NACCO (NC):

“…why would someone put half of their portfolio weight in a stock like this where there is customer concentration risk plus a real risk that one of the customers may close shop? Agree that its FCF yield is 10% or so but does it deserve that kind of weight?”

I don’t want to exaggerate the safety of this stock. I didn’t write it up for a newsletter. This isn’t a recommendation for anyone else to buy it. I put 50% into it knowing I would have future control over decisions to sell that 50%. I don’t think I’d recommend this stock to anyone else because the headlines will all be negative and that is very tough for people to hold through.

Having said that, let me take you through how I might have seen the potential margin of safety when I bought the stock at under $33 a share on October 2^nd. The way I framed it, the margin of safety in NACCO was a lot higher than what I can get in other stocks. That’s despite the customer concentration and the possibility those concentrated customers are coal power plants about to be shut down.

When I bought the stock, I believed it was then trading at something like a 10% to 15% free cash flow yield. I also believed that the company’s balance sheet will be essentially unleveraged pretty soon (taking into account build up of cash during this year, the expected $35 million cash dividend from Hamilton Beach just before the spin, etc.). The parent company has liabilities but these are not immediately payable in full. Meanwhile, the unconsolidated mines pay cash dividends immediately each year. So, what I’m saying here is that I don’t believe the parent company is more leveraged, more short of cash relative to potential liabilities, etc. than an average stock.

So, the balance sheet is like an average stock.

But, a normal, unleveraged stock usually trades at about a 5% free cash flow yield.

So, NACCO’s free cash flow yield is 5% to 10% higher than an average stock while the balance sheet is similar.

Now, if it is true that when NACCO loses a big contract this means it mostly loses an equal percentage proportion of both revenues and expenses (this is an exaggeration – but I don’t think it’s a huge exaggeration because the mines really are administered very independently and are non-recourse to NACCO), you can kind of think about your margin of safety and the value in this stock as follows…

NACCO has a free cash flow yield no lower than 10% to 15%.

A normal stock has a free cash flow yield no higher than 5%.

5% is 0.50 to 0.67 times less than 10% to 15%. Therefore, NACCO would decline to a normal valuation after it has lost about 50% to 65% of its earnings. Let’s …

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Does NACCO (NC) Have Any Peers?

A Focused Compounding member who analyzed and bought NACCO himself read my write-up on NC and was curious if I did a “peer analysis” for NACCO:

“Did you consider looking at any potential peers with your analysis? I was quite simplistic with my approach. Omnicom splits cash out year in year out. Its current EV to free cash flow is around 10x whereas I looked at NACCO and thought its EV to free cash flow was around 5x (NOTE: At the much lower spin-off price he bought at) and appeared very undervalued as it should at least be 7 to 10x even though Omnicom is a higher quality business. My hurdle for any new position is Omnicom.”

 

I tried to keep it simple. Really, I asked myself 3 questions early one:

 

1. After the spin-off, will the balance sheet be pretty close to net no debt/no cash (you did something similar seeing there would be the $35 million dividend but then there’s the asset retirement obligation and the pension).

 

2. Would NACCO produce its earnings mostly in the form of free cash flow?

 

3. Would “earning power” be 10% or higher as a percent of my purchase price.

 

In the end, the decision is really just whether you would buy a stock or wouldn’t buy a stock. To me it didn’t matter if the stock’s earnings would be $3.25 a share or $6.50 a share if I was buying at $32.50. What mattered was how certain I was of the $3.25 number. Once I think I have a 10% yield, I don’t spend a lot of time wondering if I have a 13% yield, 15% yield, or 20% yield. So, I didn’t spend time worrying about this. If the stock was pretty much unleveraged, the earnings pretty much came in the form of free cash flow, and the earnings yield was greater than 10%, that would be enough.

 

As far as growth, it’s difficult to value that. The company has a goal of growing earnings from unconsolidated mines by 50% within the next 5 years or so. However, they had the same goal about 5 years ago. Because the Kemper project was cancelled, they won’t achieve this. However, they will achieve growth of say 15% or so over last year due to newer mines producing closer to the tons they were eventually expected to produce.

 

I don’t know what they’ll use free cash flow on. I know that the two businesses I like are the unconsolidated contracted coal production and the lime rock draglines. But, neither of those businesses absorbs capital. So, they will grow through signing new deals in that area but they shrink through losing existing customers. I couldn’t judge one way or the other on this.

 

I feel they have no peer. Omnicom (OMC) is not a good peer, because OMC is permanently durable in my view. I think advertising agencies will be around in 2047 and even 2067. It’s …

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MSCI

Guest write-up by Jayden Preston.

 

Overview

Spun off from Morgan Stanley in 2007, MSCI is a leading provider of investment decision support tools to investment institutions worldwide. They produce indexes and risk and return portfolio analytics for use in managing investment portfolios.

 

Their flagship products are their international equity indexes marketed under the MSCI brand. They also offer other products that assist investors making investment decisions. These include portfolio analysis by their Barra platform; risk management by their RiskMetrics product; provision of ratings and analysis that institutional investors to integrate environmental, social and governance (“ESG”) factors into their investment strategies; and analysis of real estate in both privately and publicly owned portfolios.

 

Their clients include both asset owners and financial intermediaries.

 

Their principal business model is to license annual, recurring subscriptions to their products and services for a fee, which is, in a majority of cases, paid in advance.

 

They also charge clients to use their indexes as the basis for index-linked investment products such as ETFs or as the basis for passively managed funds and separate accounts. These clients commonly pay MSCI a license fee, primarily in arrears, for the use of the brand name mainly based on the assets under management (“AUM”) in their investment product. Certain exchanges use their indexes as the basis for futures and options contracts and pay them a license fee, primarily paid in arrears, for the use of their intellectual property mainly based on the volume of trades.

 

Clients also subscribe to periodic benchmark reports, digests and other publications associated with their Real Estate products. Fees are primarily paid in arrears after the product is delivered.

 

As a very small part of their business, they also realize one-time fees related to customized reports, historical data sets and certain implementation and consulting services, as well as from certain products and services that are purchased on a non-renewal basis.

 

 

Business Segment

MSCI categories its business segments into the following: 1) Index, 2) Analytics, and 3) All Other.

 

Index Segment

 

This is their key segment. As I will explain below, this is where I believe the lion’s share of value of MSCI lies.

 

MSCI indexes are used in many areas of the investment process, including index-linked product creation and performance benchmarking, as well as portfolio construction and rebalancing. Index-linked product creation generates asset-based fees and the latter is the source of their subscription revenue within the Index segment.

 

MSCI currently calculates over 190,000 global equity indexes, including approximately 7,300 custom indexes.

 

For 2016, Index generated $613.5 million in revenue, or 53% of their total revenue. Adjusted EBITDA from this segment was $431.5 million, or 76% of total EBITDA. You can see that the EBITDA margin from this segment was 70%.

 

Analytics Segmen

This segment uses analytical content to create products and services which offer institutional investors an integrated view of risk and return. A few examples of major offerings under …

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