Posts In: Premium Articles-01

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 …

Read more

BWX Technologies (BWXT): A Leveraged, Speculative, and Expensive Growth Stock that Might be Worth It

BWX Technologies (BWXT) has been at the top of my research pipeline for a while now. I wrote about the company – when it was the combined company that is now split into BWXT and Babcock & Wilcox Enterprises (BW) – a few years back. You can read my report on the combined Babcock & Wilcox in the Singular Diligence archives. Today, I’m not going to talk about the business – which is described in great detail in that report (see the “Stocks A-Z” tab). Instead, I’m going to talk about price.

I’ve talked before about how I need to check off 4 points about a stock. One: do I understand it? Two: is it safe? Three: is it good? And four: is it cheap? If a stock clearly and definitively fails any of these 4 criteria – it’s not something I’m going to want to buy. Since I wrote a report on Babcock a few years back – and since BWXT is the part of the old, combined Babcock I felt I understood best – I definitely think BWXT is something I can understand. I also think it’s a high enough quality business. The big concern with safety is debt. The company does not have an investment grade credit rating. However, the business itself is very safe and very predictable. So, analyzing the debt load is really just a matter of arithmetic. You can judge that part as well as I can. The more interesting question is price. On the surface, BWXT does not look cheap. It has almost never looked cheap. And so: the quickest way to disqualify this stock would be to show that it is, in fact, too expensive to consider at $53 a share.

BWXT had a missile tube issue last year. The stock price declined. And it hit a low around the start of this year. The stock has since rebounded though. We can look at the year-to-date return in the stock as an indicator of how much more expensive it’s gotten. The stock started 2019 around $39 a share. As I write this, BWXT is at $53 a share. So, it’s 36% more expensive. Obviously, the market as a whole has done well in January and February. But, it hasn’t done anywhere near as well as that. So, we’re talking about a substantial rebound in the stock price here. I had put BWXT on my research pipeline before that rebound. So, the question is: at $53 a share, is BWXT too expensive for a value investor to even consider?

The company has debt. And, normally, I’d start with an enterprise value based price metric (like EV/EBITDA or Enterprise Value / Free Cash Flow). However, I’m trying to eliminate BWXT from consideration here. I strongly believe the business is a good, safe (when debt is kept manageable), predictable business. It might be worth a very high multiple of EBITDA, free cash flow, etc. So, starting with something like EV/EBITDA might give us an inconclusive …

Read more

Resideo Technologies (REZI): A Somewhat Cheap, But Also Somewhat Unsafe Spin-off from Honeywell

This is a revisit of Resideo Technologies (REZI). My initial write-up of Resideo was done before the stock was spun off from Honeywell. Three things have changed since that initial interest post.

One: Honeywell spun-off Resideo. So, we now have a price on Resideo.

Two: I’ve created a five part scoring system – a checklist of sorts – for the stocks I write up here at Focused Compounding. This helps me more systematically order what stocks I should be writing up for the first time, re-visiting, etc. and what stock ideas I should make less of a priority. I’ll score Resideo using this 5-point checklist later in this article.

Three: Resideo released its first quarterly earnings as a public company. Management hosted an earnings call where they took analyst questions. They put out some earnings slides with that call as well. So, we have a bit of an update since last time.

I can tell you now that this third event is the least interesting. It’s the one I’ll spend the least time talking about. What matters most here is that we now have a price on Resideo stock and I can now score Resideo on my 5-point checklist. Let’s start with the checklist.

The 5 questions I’ll be asking are:

1)      Is Resideo stock overlooked?

2)      Do I understand the business?

3)      Is this a safe stock?

4)      Is this a good business?

5)      Is this a cheap stock?

I score each question on a scale that goes: -1 (“no), 0 (“maybe”), +1 (“yes”).

Is Resideo stock overlooked? – Maybe (0). The answer can’t be a straight “no”, because this is a spin-off. Spin-offs, in general, lead to stocks being overlooked – at least at first – because shareholders of the bigger company (in this case, the very big company Honeywell) get shares in this much smaller company without doing anything. They may sell the stock without giving it a lot of thought. Also, this spin-off didn’t seem to be a huge focus for value investors and what I did read online from value investors often treated it as something of a throwaway by Honeywell. Basically, not a lot of people are writing about how this is a high quality business. They are writing about how this company is slow growing, fully mature, and includes the burden of paying Honeywell indefinitely to cover environmental liabilities. So, this isn’t a particularly focused on spin-off. But, it’s still a stock with a market cap over $2 billion. It’s listed on a major exchange. It did an earnings call with analysts. I didn’t hear questions from analysts at especially big firms. This is probably a pretty overlooked stock for a $2 billion to $3 billion market cap. But, in the world of the kind of stocks I often look at – it wouldn’t count as overlooked at all. I’ll split the difference and say Resideo “maybe” overlooked (0 points).

Do I understand the business? – Yes (+1). I owned a stock – …

Read more

Vertu Motors: A Cheap and Safe U.K. Car Dealer

Vertu Motors owns more than a hundred car dealerships in the United Kingdom. About half of the time – so, at 50+ locations – Vertu Motors also owns the land on which the dealership is built. They lease the other half of their locations. The stock trades on the London Stock Exchange (the AIM market, specifically) under the ticker “VTU”.

Back on November 14^th, 2017 Focused Compounding member Kevin Wilde sort of wrote up Vertu Motors. He did an idea exchange post on U.K. car dealers. The stock he focused most on was Vertu Motors.

Why?

Why focus on Vertu Motors specifically?

And why focus on U.K. car dealers generally?

Publicly traded U.K. car dealers seem to trade at lower prices than their U.S. peers. In the U.S., car dealerships are usually sold at a premium to tangible book value. Car dealer stocks tend to trade at a premium to tangible book value. In the U.K., some publicly traded car dealers – like Vertu Motors – have shares that can be bought below tangible book value.

We can try to come up with arguments for why U.S. car dealers should be more expensive than U.K. car dealers. But, the math isn’t very convincing. For example, if we look at the rate of growth in Vertu Motors’ tangible net assets per share over the last 5 years – it isn’t lower than what U.S. car dealers would be able to achieve. At times, Vertu Motors stock has grown net tangible assets per share by 10% or more a year while also paying a dividend. The company was not very successful growing PER SHARE asset values in the years immediately after its founding (though it did increase the size of the company and improve its economics during this time). Since scaling up, the company seems capable of getting a 10% growth rate in net tangible assets without using leverage. Car dealers often use some leverage. And – as I said earlier – Vertu Motors stock can sometimes be bought below its tangible net assets. The company’s management includes their own 10-year calculation of free cash flow generated versus assets employed and comes up with a number around 10% a year. If I take the most recent half of the company’s existence and use the rate of compounding in net assets per share (instead of FCF like the company uses) I’d get a similar rate of value creation. Basically, I’m going to assume here that Vertu Motors can generate about 10% worth of “owner earnings” relative to its net tangible assets.

We can use that information to answer the question: “Is it cheap?”

When first looking at a stock, I often ask 5 questions: 1) Is this stock overlooked? 2) Can I understand this business? 3) Is the business safe? 4) Is the business good? 5) Is the stock cheap?

Because I started today’s discussion with the company’s ability to generate earnings relative to tangible equity – let’s start …

Read more

Green Brick Partners (GRBK): A Cheap, Complicated Homebuilder Focused on Dallas and Atlanta

I chose to write-up Green Brick Partners (GRBK) this week for a couple reasons. The first is the company’s headquarters: Plano, Texas. I live in Plano. And the company gets about half of its value from its Dallas-Fort Worth homebuilding operations. My “initial interest post” checklist goes something like this:

• Do I understand the business?
• Is it safe?
• Is it good?
• Is it cheap?

The single most important questions is number zero: “Do I understand the business?” Since I’ve lived for about seven years right by this company’s lots – I should understand it better than most homebuilders. The other half of the company, however, is in the Atlanta area. That is a place I know nothing about. So, the answer to question zero would be that I understand half the business here well.

The next easiest question to answer – after “do I understand the business?” – would be #3 “is it cheap?”.

So, we’ll skip right to that one. It is, after all, the other reason that put Green Brick Partners at the top of my research pipeline.

I have in front of me the balance sheet for Green Brick Partners dated September 30^th, 2018. This is the last day of the most recent quarter the company has provided results for. Under “inventory” we see $648 million. Under “cash” we have $33 million. There’s another $12 million under “restricted cash”. The unrestricted part of cash is offset almost exactly with customer deposits. The restricted part of cash is just $12 million. Debt is about $200 million gross. So, that leaves about $188 million in net debt. If we netted out that inventory less that net debt we’d be left with $648 million in inventory less $188 million in net debt equals $460 million. The company has a little less than 51 million shares outstanding. So, $460 million in real estate free from debt divided by 51 million shares outstanding equals $9.02 a share. Let’s call that $9 a share. That’s very close to the company’s officially stated net tangible book value of $8.97 a share. Again, that’s basically $9 a share. We can compare this to the market price of $8.06 a share at which GRBK stock closed today. So, we have a stock with tangible book value – almost all land (about 50% in Dallas Fort-Worth and about 50% in the Atlanta area) – of $9 a share against a market price of $8 a share. Green Brick Partners is trading at about 90% of book value. So, a price-to-tangible-book ratio of 0.9 looks cheap.

However, this is where we start getting into the more complex aspects of Green Brick Partners. The company’s balance sheet shows only $15 million (about 29 cents a share) in “noncontrolling” interests. Green Brick, however, has only a 50% economic interest in its Dallas Fort-Worth and Atlanta homebuilders. The fair market value of the 50% owned by its partners – basically, the top management of these “controlled builders” – would …

Read more

Follow-Up Interest Post: Resideo Technologies (REZI) – Stock Falls, My Interest Rises

The Resideo spin-off has taken place. And the stock has traded on its own for a bit now. So, I thought I would very quickly re-visit the stock here.

You can check the ticker REZI (Resideo Technologies). It’s $19.56 a share as I write this. Here is a link to the press release announcing the completion of the spin-off:

https://www.otcmarkets.com/stock/REZI/news/story?e&id=1207602

“Honeywell distributed one share of Resideo common stock for every six shares of Honeywell common stock held as of 5:00 p.m. Eastern Time on October 16, 2018, the record date for the distribution.”

Honeywell had 740 million shares outstanding about 17 days before that date. So, let’s assume Resideo now has 740 million / 6 = 123 million shares outstanding (actually, slightly more – but I’m simplifying).

Actual quote from a recent 8-K: “Immediately following the Spin-Off, we estimate that approximately 123,451,420 shares of our common stock will be issued and outstanding.”

Before we re-visit my initial interest post, you may want to read it.

Here’s my initial interest post (where I give Resideo a 30% likelihood of me following up further with it):

https://focusedcompounding.com/resideo-honeywells-boring-no-growth-spin-off-might-manage-to-actually-grow-eps-for-3-5-years/#comment-293

And here are the notes I took when reading the company’s spin-off document:

https://focusedcompounding.com/wp-content/uploads/2017/06/Focused_Compounding_Resideo_Notes_by_Geoff_Gannon.pdf

Now that you have that background. Let’s talk about why I’m upgrading my interest level in Resideo.

So, as I write this…

Resideo Technologies (REZI)

Price: $19.56 / share
Shares Outstanding: 123 million

Market Cap = $19.56 * 123 million
Market Cap = $2.41 billion

Net Debt = $1.15 billion

Taken from this recent investor presentation:

https://www.sec.gov/Archives/edgar/data/1740332/000119312518296364/d617866dex991.htm

(Slide 45)

So…

Enterprise Value = Market Cap + Debt
Enterprise Value = $2.41 billion + $1.15 billion
Enterprise Value = $3.56 billion

Let’s call it $3.6 billion in enterprise value

Now, there are two ways of doing this. One: we can capitalize the environmental obligations and add that capitalized value to the EV and add-back the $140 million a year payment to Honeywell to arrive at some sort of “adjusted EBITDA” figure.

Or, we can just use $3.6 billion in EV and we can fully include $140 million a year payment as an annual expense. We then have to understand that the expense can go down from $140 million toward zero over time.

The easiest way to do this is to assume the $140 million annual payment is a perpetual obligation that will never be less than $140 million a year and will never go away.

In that case…

Enterprise Value = $3.6 billion
Last 12 months EBITDA = $475 million

Enterprise Value / LTM EBITDA = $3.6 billion / $475 million
Enterprise Value / EBITDA = 7.58x

Let’s round that up…

EV/EBITDA = 8x

Is that cheap?

It seems like it. Historically, an EV/EBITDA of 8 was pretty normal for a U.S. stock – paying a 35% tax rate at the federal level – because an EV/EBITDA of 8 translated into about an unleveraged P/E equivalent of 15 or 16. Basically, what I’m saying is that if a company had zero …

Read more

Resideo: Honeywell’s Boring, No-Growth Spin-off Might Manage to Actually Grow EPS for 3-5 Years

Yesterday, Honeywell set the distribution date for the spin-off of its home comfort and security business “Resideo”. So, I thought now would be a good time to do an “initial interest post” on Resideo. In this article, I’ll give my first impressions of the stock and then I’ll conclude by giving you an idea of how interested I am in following up with this stock idea. As always, I’ll grade the idea on a scale ranging from of 0% interest to 100% interest.

To give you some context, let’s start with a review of how interested I was in the five other stocks I looked at.

Keweenaw Land Association (KEWL): 90% initial interest level

Pendrell: 90%

Maui Land & Pineapple (MLP): 80%

U.S. Lime & Minerals (USLM): 50%

Babcock & Wilcox Enterprises (BW): 10%

The details for the ratio of shares of Resideo to Honeywell (1-for-6), record date (October 16^th), and distribution date (October 29^th) can be found here:

https://www.sec.gov/Archives/edgar/data/773840/000119312518290912/d528228dex992.htm

The notes I took when reading the Resideo spin-off document can be found here:

https://focusedcompounding.com/wp-content/uploads/2017/06/Focused_Compounding_Resideo_Notes_by_Geoff_Gannon.pdf

Resideo includes a products business (“Honeywell Home” or “Products”) and a distribution business (“ADI global distribution” or “Distribution”). Resideo will operate in multiple countries. And it will spin off with about $1.23 billion of debt from Honeywell and liabilities related to over 200 environmental clean-up sites. We’re interested in valuing the stock (the equity portion, not the debt). So, it’s easy to get lost in the complexities of this situation. The first thing we need to do, then, is to focus on those aspects of this spin-off that could drive returns in the stock. In other words, we need to start simplifying things right from the start.

Here are some of the first questions we need to ask:

How much debt will Resideo have when it spins off?

How big will Resideo’s environmental liabilities be when it spins off?

How expensive will the stock be when it spins off?

Where will most of Resideo’s “owner earnings” (“free cash flow”) come from?

Let’s start with the last question first. In recent years, Resideo has gotten about 75-80% of its profits from the “products” business rather than the distribution business. There’s a lot of information in the spin-off document – and therefore, in my notes – about ADI. However, ADI only accounts for about one-fifth of profits (about half of revenue) at Resideo. It’s easy to get sidetracked by spending as much time on ADI as we would on Honeywell Home (“products”). On a sales basis, the two businesses are equal in size. But, sales aren’t what matters to a shareholder. Profits are what matters. Gross margins at Honeywell Home (the products business) are about 4 times higher than gross profits at ADI (the distribution business). Therefore, the same amount of sales at each business translates into roughly 4 times more profit (80% of profits versus 20% of profits) at Honeywell Home.

In this initial interest post, I really want to set ADI …

Read more