Posts In: Idea Exchange

Argan (AGX): A Cheap, Cyclical Construction Company With a Ton of Cash and No Debt

MEMBER WRITE-UP BY JACOB McDONOUGH

Argan is a holding company that owns a few different businesses, but the most important by far is Gemma Power Systems (GPS). GPS is an engineering, procurement, and construction contractor and consultant. The company mostly provides services related to the construction of natural gas power plants, but also has worked on wind and solar projects in recent years. Argan acquired GPS in December 2006 for $33 million, and since then it has produced over $607 million in cumulative EBITDA. Argan has a ton of cash with no debt, and is selling at a very cheap price based on historical earnings. Also, the company doesn’t require any capital to operate. However, there is a lag time in between projects, which will lead to poor results over the next few quarters.

Invested Capital

In most cases, Argan can operate with negative invested capital. When projects are in process, the business is funded through accounts payable and deferred revenue. In the most recent 10-K from January 2018, the company had total assets of $603.4 million, and cash of $434 million. As long as the company has new business coming in, this cash is not needed for operations. Accounts payable was $100.2 million, and deferred revenue was $108.4 million. If we subtract these items from total assets, this comes to a negative figure of -$39.2 million. If you include the accrued expenses and long term deferred taxes, the invested capital figure becomes even more negative. This is important because the profits Argan generates becomes cash for owners, even when the business is growing rapidly. In 2007, Argan had cash of $27.7 million with $6.7 million in debt. Since then, the company has produced net income of $303.4 million. If you add up the cumulative net income, the 2018 accounts payable and deferred revenue, then subtract the cumulative dividends paid and reduction of debt, this gets us within $18.9 million of the actual ending cash balance in 2018, which is pretty close. The remainder can mostly be explained by acquisitions over the years.

In most businesses, owners must invest money in order to grow. Argan’s cash was able to build up on the balance sheet even during a period of rapid growth. Sales in 2008 were $206.8 million compared to $892.8 million in 2018, which is a compound annual growth rate of 15.8%. The company had a net loss of $3.2 million in 2008, compared to net income of $72 million in 2018. The accumulation of cash during a period of such growth is proof of the low capital requirements of the business.

High Uncertainty and Volatility Ahead

With so much cash on the balance sheet and zero debt, the risk of the business failing is very low. However, the company’s near-term future is uncertain. GPS finished some large projects this year, and will have a lag time before new projects begin in 2019. This lag time will cause the company to have a few rough quarters coming up. The …

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A few thoughts on Progressive

Geoff and Andrew did a podcast last week where they discussed all of Geoff’s picks when he wrote the Singular Diligence newsletter. One of those stocks was Progressive (ticker PGR). Progressive is primarily a personal auto insurer. The best thing you can do to familiarise yourself with the company is, obviously, to read Geoff’s report.

Progressive’s stock is a lot more expensive than it was when Geoff wrote his report, and it’s a lot more expensive than his appraisal of the company as well. But I really think that of all the stocks Geoff recommended, Progressive is one of the most interesting right now and one that would be of most benefit for members to look at.

 

There’s a few reasons for this. First, it seems clear to me (and it sounds like Geoff agrees) that the risk he identified relating to autonomous vehicles was overblown. I don’t mean this as a criticism. It was quite right to worry about that when Geoff was writing the  report. But this post really isn’t about that. It’s about the second reason – customer retention.

 

Geoff pointed out that one of the key constraints Progressive faced was its customer retention, which is lower than peers such as GEICO, USAA and Allstate. So, even if Progressive acquires customers at a fast rate (and it does), its snowball is melting faster than those of its competitors. It can still grow, but obviously the higher rate of attrition is a serious limiting factor in its growth and its economics. The reasons for Progressive’s lower retention rate are complex but really boil down to (i) having more single, renting, young people in their customer base, (ii) not offering bundled insurance (i.e., offering only auto insurance, not home and other insurance) and (iii) attracting more high risk drivers as a percentage of their customer base. The impact of bundling is particularly significant. I’ve seen a report that industry wide retention rates are 83% where the policyholder only buys auto insurance, but 95% where auto and home insurance are bundled. This is clearly a huge difference from the insurer’s perspective.

 

Progressive has recently been posting very strong (20%+) rates of growth in premiums. Obviously a big part of that is strong rates of new customer acquisition (and we could probably talk a lot about how Progressive has restored growth in its agency business). But, it’s also in very large part due to increased customer retention. Progressive has made huge strides in increasing customer retention towards the levels of their peers. There are a few components to this, but one of the really big differences from when Geoff wrote about the company is that Progressive now offers home insurance and so can bundle home and auto. They are attracting more and more customers who buy both home and auto insurance from them – a customer group they refer to as “Robinsons” – and who have by far the highest retention rates. Progressive segment customers into four categories (which they call …

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DHI Group (NYSE: DHX)

This will be short and sweet.

DHI Group (NYSE: DHX) is the parent company of subsidiaries that are engaged in online career sites and services. Think indeed.com or monster.com. Their major platforms (assets) are Dice.com, ClearanceJobs.com, and efinancialcareers.com. The sites are more targeted to specific groups than their larger competitors with dice.com being geared towards technology/software professionals and the other two, I’m sure you can guess.

The company’s performance over the last decade has been less than stellar. Ten years ago today, the stock price was at $6.40/share. It reached a peak of $18.75/share in 2011 and has since, steadily tumbled to its $1.85/share price today (all while the job market has boomed and their competitors have grown larger). Naturally, this has drawn the attention of activists.

Most recently, on May 25, 2018, TCS Capital Management filed a 13D, announcing that they had purchased 9.7% of the total shares. On August 23,2018, they released a scathing Letter to the Board, reprimanding them for the usual: terrible performance compared to S&P and peers, bad strategy, enriching themselves at the cost of long-time shareholders, low insider ownership etc. etc.. However, the interesting part is that they publicly disclosed that they were prepared to buy the Company for $2.50/share in cash (a 25% premium to the $2.00/share closing price the day before the press release). TCS closed with the ultimatum that if they didn’t accept, they’d start a proxy battle next year (2019) to campaign for seats. They closed the letter telling the company to respond to the offer by September 5, 2018.   

DHI’s response the next day- “The Board and Management, consistent with their fiduciary duties, plan to fully explore and respond to TCS’ new proposal.  The Board and Management are committed to acting in the best interests of the Company and its shareholders and will continue to explore any opportunity to enhance shareholder value. In its review and discussions with TCS, the Company is being advised by Paul, Weiss, Rifkind, Wharton & Garrison LLP, Evercore and Arbor Advisory Group.”

The price moved up to $2.40 in the following days.

Since, no word from either side. The September 5 date has passed, and the price has moved down to $1.85/share.

Maybe there’s an expensive 2019 proxy battle on the horizon, but then again, the company is definitely worth $2.50/share to a private buyer (and probably more since they wouldn’t make an offer they thought was a bad bargain). In other words, the $2.50 price tag probably has some margin of safety baked in. At some point, there will be an update on the review and discussions.  

May 2019 Call options are available for those interested.

Disclosure: I hold no position

https://www.sec.gov/Archives/edgar/data/1167167/000092189518001829/sc13d10608004_05242018.htm
https://www.sec.gov/Archives/edgar/data/1167167/000092189518002471/ex991to13da110608004_082318.htm
https://www.sec.gov/Archives/edgar/data/1393883/000095014218001796/eh1801013_ex9901.htm…

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CountPlus (CUP)

 

CountPlus Investment Thesis

Market data

Ticker:                         ASX:CUP

Price:                            $0.66

Net debt:                    ~$0m

Market cap:               AU$74m

 

Elevator pitch

After years of poor performance, a revolving door at the C suite and ongoing restructuring charges/impairments, recent insider buying gives us confidence that CountPlus has reached an inflection point in its turnaround. Looking through the one-off charges to cash profitability and assuming no improvement in operating margins (~10% vs. peers >20%) we believe the shares are selling for a pre-tax free cash flow yield of 14%. As the turnaround begins to show up in the reported financials and the company re-instates a dividend policy, we believe the market will wake up to this emerging growth story.

 

Investment thesis

• New CEO who co-founded one of the best performing groups within the network, and who has a non-monetary vested interest in the success of the business due to relationships with many of the employees he mentored, is implementing a strategy he successfully employed while managing Hood Sweeney and recently acquired ~$400k of stock on market
• Sticky, diversified, annuity like revenues provide downside protection. Operating margins of 10% due to a loss-making division and poor incentivisation under old model vs. peer group margins 20%+. Every 1% improvement in profitability adds $0.08 in value per share (if capitalised at 8x)
• Increased regulatory pressure on the back of a Royal Commission should drive consolidation as sub-scale firms look to partner with a well-capitalised competitor to scale fixed compliance overheads, providing an attractive backdrop in a highly fragmented industry
• Current valuation implies extremely low expectations. Assuming no improvement, it should currently be generating $10-12m in pre-tax owner earnings (14%+ earnings yield). Given the low capital requirements of the business, the majority of this cash flow can be used to pay dividends or make acquisitions. As the CEO has a track record of finding and executing value accretive acquisitions, combined with a board rich in M&A experience, and a consolidating industry backdrop, we believe CUP is in a prime position to increase value for shareholders
• The convergence of cash profits and reported financials, together with the dividend returning, should provide a hard catalyst for the Aussie small cap community to take another look at the business

 

History

CountPlus (CUP) was born within Count Financial (Count), one of Australia’s largest network of advisory firms. Count, which is now owned by The Commonwealth Bank of Australia (ASX:CBA) spun CUP off into its own publicly traded entity in 2010 and still retains a 36% shareholding. CUP generates revenues through a network of ~17 firms (wholly and partially owned) with a fairly even split between accounting and financial advice fees.

After an initially successful IPO, CUP began to get into trouble when Count Financial went from a stand-alone public entity, to being acquired by CBA. While this had little impact on the underlying operations of CUP member firms, because of the unique relationship between CUP and Count, CBA began making “loyalty payments” …

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Industrial Logistics Properties Trust (ILPT)

Industrial Logistics Properties Trust (Nasdaq: ILPT)

Summary: ILPT is a busted REIT spin/IPO with high-quality assets trading at a 35% discount to NAV. As a recent spin, ILPT has limited coverage and buy-side recognition. The company’s assets, which are located in Hawaii and the Mainland US, are 99.9% leased with an average lease duration of 11.2 years, and contractual rent-resets provide a clear pathway for modest organic growth. ILPT’s leverage of 2.6x net debt/EBITDA is less than half the peer median of 5.3x, and it’s 6.4% dividend is double the peer set median and conservatively covered by cash flow. ILPT is cheap on a nominal and relative basis, trading at only 12.3x 2018E FFO vs an industrial REIT average of 22.4x, as well as a deep discount to NAV. At the current price you’re essentially buying the Hawaiian assets at a fair price and getting the Mainland logistics assets for free. We believe the stock will return 44% over the next 12 months in our base case, with nearly 100% upside in our bull case based on the recent PLD/DCT transaction, and 15% downside in our bear case.

Price: 21.30

Total Diluted Shares 65MM

Market Cap: 1.38BN

Cash: 20MM

Debt: 351MM

EV: $1.711 BN

2018E, 2019E, 2020E FFO Per Share: 1.68 12.3X, 1.75 11.8X, 1.77 11.6X

2018E, 2019E, 2020E EBITDA & EV/EBITDA: $123MM 13.2X, $137MM 12.2X, $148MM 11.3X

 

Background

Industrial Logistics Properties Trust (ILPT) is an industrial/logistics REIT that spun-out/IPO’d on January 12^th, 2018. ILPT owns two sets of assets: Hawaiian and Mainland US. The company has owned the HI assets since 2003, and occupancy at those properties has never dropped below 98% during that time. The mainland assets were primarily purchased in 2015 and are 100% leased with Amazon as the largest customer. The company’s assets were formerly owned by Select Income REIT (SIR), who continues to own 69% of ILPT common stock. As many of you likely know, SIR and ILPT are RMR managed REITs, not exactly a compliment in the REIT world. The RMR family of REITs is managed by the Portnoy family, who had a very pubic and nasty fight with Corvex and Related over Commonwealth REIT. The rub on the Portnoy family of REITs was that they were vehicles to enrich the family while not doing much for outside shareholders. We believe the risk of this happening at ILPT is largely mitigated by the company’s compensation structure, which only really pays off for management if ILPT outperforms the REIT index by a significant margin. The idea behind the ILPT spin was the high-quality Hawaiian and Mainland assets would get a premium valuation compared to the legacy SIR office assets. With little in the way of leverage, management could continue to acquire high-quality mainland logistic assets at ILPT. As the company acquires mainland logistics assets, coupled with contractual rate increases at the legacy properties, NOI and the dividend will grow over time.

The ILPT IPO could not have come at a worse time, which …

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Vestas Wind Systems A/S (OCSE:VWS)

Opportunity Summary:

• Vestas holds the top position among wind turbine manufacturers.
• The industry has attractive economics (high ROIC) and long-term growth prospects; wind as an energy source has crossed the threshold of being able to compete with fossil fuels without the aid of subsidies.
• Vestas (>16% market share in cumulative capacity & new builds), Siemens Gamesa (~15% market share), and GE (~12% market share) are the dominant players. 
• Due to scale advantages and cost cutting initiatives started in 2011, Vestas has the best EBIT margin (>10-% vs. 5-8% for GE & Siemens and <5% for most other competitors).
• Vestas’ stock is down 50% in the past few months based on concerns on how well wind energy can fair against other energy sources without government subsidies and competitive industry pricing that was predicated on the industry’s move to an auction system.  My research suggests these risks are overblown considering the already cost competitive nature of wind and Vestas’ competitive position / profitability.
• Management has done a great job of running the company over the last few years, having reduced fixed and variable costs by streamlining the business and by growing the highly profitable / fast growing / sticky services business.
• My first pass at a valuation suggests that the stock could do well as a long-term holding. 

NOTE: I first became aware of the opportunity via VIC.  See link for detailed write-up:

https://valueinvestorsclub.com/idea/Vestas_Wind_Systems/141645

I would love to hear your thoughts if you have some industry insight or have looked at the opportunity.  Send me a reply here in the thread, or directly at [email protected]. 

Cheers,

Kevin

 …

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AutoNation (AN): A Cheap Cannibal with Minimal Downside

Member write-up by Dave Rottman

 

Introduction and Overview

AutoNation (AN) is the largest automotive retailer of new and used vehicles in the United States. As of the end of 2017, they owned and operated 360 new vehicle franchises with 33 different new vehicle brands through 253 dealership locations concentrated in major metropolitan areas primarily in the southern Sunbelt region. AutoNation also owned and operated 76 collision centers scattered throughout the continental US.

Prior to 1999, AutoNation was named Republic Industries and was involved in waste management and then later electronic security services, vehicle rentals, and automotive retailing. Since the turn of the century, AutoNation has been focused exclusively on the automotive retail business.

Despite changing conditions in the coming years with the advent of online automotive retailers, autonomous vehicles, increased ride sharing, and electric vehicles, AutoNation offers investors several attractive characteristics.

First, as the largest automotive retailer in the United States, AutoNation enjoys benefits of scale both in terms of lower general and administrative overhead and in volume discounts when purchasing parts for the repair business and even inventory from manufacturers. As the automotive retail industry continues to undergo consolidation into a less fragmented market, these benefits are likely to amplify and strengthen the competition position of those players with scale, like AutoNation.

Next, the business generates a large and noncyclical stream of cash flow related to its parts and service business that has increasingly become a larger portion of earnings. While new and used car sales and the associated finance and insurance revenues are cyclical, parts and service earnings have provided a stable base of cash flow. In addition to stabilizing the cash flow of the overall business, this has also allowed AutoNation to consistently funnel cash into stock buybacks when shares prices are attractive, leading to a 5, 10, and 15 year growth rates of approximately 10% in earnings per share. This is impressive considering that the sales volume of actual new and used vehicles has essentially been flat over the course of the cycle.

Further, AutoNation holds a large amount of attractive real estate that provides a meaningful asset-based value that can be sold as a next-best use that supports valuations if earnings power were to become impaired or if/when AutoNation decides to decrease its physical presence.

Finally, and more speculatively, in late 2017 AutoNation announced a partnership with Waymo – Google’s autonomous vehicle company – where AutoNation will maintain and repair Waymo’s autonomous fleets. While the actual value this will provide to AutoNation is extremely uncertain at this point, it does serve as an offsetting factor to the risks posed by increased use of autonomous vehicles and ride sharing by hitching AutoNation up to the dominant player in autonomous vehicles in the nascent stages of this development.

 

The Business

There are four parts to AutoNation’s business: new vehicle sales, used vehicle sales, parts and service (P&S), and finance and insurance (F&I).

New and used vehicle sales are straightforward: generally speaking AutoNation purchases new vehicles from …

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