Cummins Inc. (NYSE:CMI) is a global diesel engine manufacturer. The Company designs, manufactures, distributes and services diesel and natural gas engines and engine-related component products, including filtration, after treatment, turbochargers, fuel systems, controls systems, air handling systems and electric power generation systems.
It has four operating segments: Engine, Distribution, Components and Power Generation. The Company sells its products to original equipment manufacturers (OEMs), distributors and other customers. It serves its customers through a network of around 600 Company-owned and independent distributor locations and around 7,200 dealer locations in more than 190 countries.
In addition, engines and engine components are manufactured by the Company’s joint ventures or independent licensees at its manufacturing plants in the United States, China, India, South Korea, Mexico and Sweden. Its subsidiaries include Cummins India Ltd. and Wuxi Cummins Turbo Technologies Co. Ltd.
As we look at the Large Cap 1000 Screener this week, we can see Cummins has an Acquirer’s Multiple of 8.09 putting it in the top 30 Large Caps.
As you can see from the chart below, Cummins share price has dropped over 33% in the past 12 months, and it’s now trading at around $98, which is great news for contrarian investors!
Source: Google Finance.
Let’s take a closer look at Cummins in the Large Cap Screener.
Cummins currently has a market cap of $17.43 Billion, which is just a fraction higher than its enterprise value of $17.36 Billion.
As of September 2015, the company has cash and cash equivalents of $1.688 Billion and its total debt was just $1.622 Billion, leaving it with positive cash to debt of $66 Million.
Its operating earnings, which are taken from the top of the income statement, are $2.147 Billion.
Therefore, when the divide the enterprise value of $17.36 Billion by the operating earnings of $2.147 Billion we get our Acquirer’s Multiple of 8.09, and an inverse 12.4% earnings yield.
What’s been happening recently at Cummins?
On October 27, Cummins announced it would reduce its worldwide professional work force by up to 2,000 employees in response to lower demand for its products in the United States and key markets around the world. The employee reductions will come from all parts of the company. The company will incur a pre-tax fourth quarter charge in the range of $70 million to $90 million for the headcount reductions. In addition to these reductions, it expects to close or restructure several manufacturing facilities over time which could increase the fourth quarter charge and may result in additional charges in the future.
What’s the outlook for Cummins?
In the near term, Cummins expects demand in the North American medium-duty truck market to remain stable. It also expects North American light-duty demand to remain stable.
The new ISG engine, which began production in the second quarter of 2014 as part of the Beijing Foton Cummins Engine Co., Ltd. joint venture, is expected to continue to gain market share in China in its first full year of production, and demand in India is expected to improve in some end markets as their economy continues to improve.
- Industry production in the North American heavy-duty truck markets is expected to decline
- Power generation markets are expected to remain weak
- Weak economic conditions in Brazil will continue to negatively impact demand across its businesses
- End markets in China to remain weak
- Demand in certain European markets could remain weak due to continued political and economic uncertainty
- Foreign currency volatility could continue to put pressure on its revenues and earnings
- It expects market demand to remain weak in the oil and gas markets as the result of low crude oil prices
- Domestic and international mining markets could continue to deteriorate if commodity prices continue to weaken
So where’s the good news?
Cummins has created a cost advantage moat over its competitors.
Engine maker Cummins currently has around 40% of the North American market.
History tells us that engine design is an extremely difficult business, and its been made even more challenging by having to meet the U.S. Environmental Protection Agency’s emission reduction targets. But so far, Cummins has delivered. These same challenges however, have forced some of Cummins major competitors out of the market.
We saw what happened to Caterpillar Inc (NYSE:CAT), who lost significant market share in the North American heavy-duty engines space. We also saw similar events with Navistar who attempted to build a heavy-duty engine business.
It seems obvious to me that engine manufacturers would need to spend considerable time and money to erode the moat that Cummins has created. The company’s ongoing commitment to R&D has made it the clear winner in meeting emission reduction targets, resulted in significant increases in its market share.
Moreover, as emissions and fuel efficiency targets have become higher, Cummins ability to design both turbocharger and after-treatment engine systems in the same organization also lends itself to greater competitive advantage. The company currently has greater than 70% market share in heavy-duty and medium-duty turbochargers.
As long as Cummins maintains its R&D investment in emissions control technology, this will lead to favorable revenue growth as more countries mandate tougher emissions standards. While North America remains Cummins largest market, faster growing emerging markets account for almost one-third of the company’s revenues.
While global economic weakness has hurt Cummins, the company does appear to be great at innovation, cutting costs and allocating capital. When you combine this with the company’s resilient competitive advantage, Cummins will be able to withstand the short term downturn.
Don’t take my word for it!
According to commentary at Gurufocus, we’re not the only ones that like Cummins right now. The website states that, “Bill Nygren’s most noteworthy third-quarter transaction was his acquisition of a 1,900,000-share stake in Cummins Inc. (NYSE:CMI), a Columbus, Ind.-based heavy equipment company, for an average price of $123.51 per share. The deal had a 1.31% impact on Nygren’s portfolio”.
At Cummins current share price of around $100, this would seem like a much greater discount than what Mr Nygren paid at $123.51.
Now let’s take a look at the numbers:
Acquirer’s Multiple – 8.09
Magic Formula Earnings Yield – 12.4%
P/E – 10.69
P/B – 2.29
P/S – 0.92
ROE – 21%
In terms of valuation, Cummins looks cheap!
How safe is the business?
Cheap is one thing, what we want is a cheap safe investment! So we use some other metrics to determine the stability of the company.
Its Altman Z-Score–a measure of the likelihood that a company will end up in bankruptcy within 2 years–of 4.34 indicates that it is far from financially distressed (greater than 2.6 is considered safe).
Its Piotroski F-Score is 6 out of a possible 9, which is about average for a stable company.
Its Beneish M-Score of -2.57 means it’s not an earnings manipulator (anything greater than -2.22 is good news). From a statistical perspective, it’s not close to financial distress (in fact it’s financially strong), and there’s no indication of earnings manipulation.
So, there you have it. For this investor, Cummins Inc is clearly a great stock to add to your portfolio right now.
Submitted by Valueaki.
I am an investment banking associate by trade.
I deal with A LOT of private equity firms. They all define themselves as great fundamental value investors that like to back great management teams, etc … As such, it is getting harder to identify true value investors (as defined by Graham) … esp. since Buffett touts investing it great companies at a fair price > a bad company at a great price (he’s not wrong, he’s just confused things)
Even Graham has been misunderstood. In Intelligent Investor, Graham states the best investor is the most ‘business-like.’
This statement of being impartial and un-biased has been confused and read as “the best investors are the ones whose knowledge of the industry rises to that of an operator in said operator’s business” … this confusion, I believe, possibly exists b/c of Buffett’s misunderstood definition of ‘Circle of Competence.’
Believe it or not, in Intelligent Investor, Graham actually recommended minimizing all industry analysis …
But here is the tell sign … and no one really quotes this from The Intelligent Investor:
The future itself can be approached in two different ways, which may be called the way of prediction (or projection) and the way of protection.
Obviously these options are on two opposing sides of the spectrum.
But if you fall hard under the ‘prediction’ side, you start asking too many due diligence questions, get too involved, expose yourself to too many biases to act rationally, probably have high due diligence costs, etc. and will almost always never buy a bargain. You sacrifice value to fulfill your curiosity.
When selling companies as a banker, I often think that I’d greatly help the private equity investor’s investment process if I limit the amount of questions he/she can ask the bankers or management team. If you ask too many questions, you don’t have an investment philosophy that you have internalized…
Food for thought …
Welcome to the second lightening round of the 5-Stock Bonanza! Today we will take a concise, but yet comprehensive look into the top five positions in Tobias Carlisle’s All Investable Screener.
First, Apollo Education Group, Inc. (APOL) is the top contender with an Acquirer’s Multiple rating of -0.07. At first glance, this is a position that value investors love indulging in because its enterprise value is -0.05. When the enterprise value is negative, it simply means that the company currently has more cash and cash equivalents on hand than the sum of the company’s market capitalization, preferred equity, non-controlling interests, and total debt. In short, this company is a steal! Furthermore, APOL is a privatized education provider for both domestic and international students. Educational services include, but are not limited to, undergraduate and graduate programs, certification courses, and educational workshops for avid learners. APOL operates through many separate segments, including The University of Phoenix, Carnegie Learning, Western International University, and several other reputable entities. One of Apollo Education’s main objectives is to tailor its services to the needs of the educational community. For example, candidates can achieve degrees by means of the delivery of preference; online or on-campus. Moreover, APOL is currently well undervalued when compared to its peer group.
Apollo Education’s global Impact illustrated below:
Second, MoneyGram International, Inc. (MGI) is a domestic and international money transfer and payment services provider. MGI has two branches, Financial Paper Products and Global Funds Transfer services. The Financial Paper Products leg offers check services to financial institutions, as well as, provides money order services to consumers. Its Global Funds Transfer leg offers money transfer and bill payment services to unbanked and under banked clients. MoneyGram’s most popular products and services include money orders, prepaid debit cards, online bill pay, and wire transfers. First and foremost, MGI is a $527 million capitalization corporation with an Acquirer’s Multiple rating of 0.25, which is incredibly undervalued. MGI also has an enterprise multiple of 0.14, which means current investors are basically receiving this company for free! Although MGI has had inconsistent earnings, we do see a progressive uptrend in their net income throughout the past five years.
|MoneyGram International, Inc.|
Furthermore, MGI has a P/S of 0.4, which is fantastic in relation to the industry average of 3.6. We do see some weaknesses in the past profitability of MGI, as their profit margin from the most recent reporting period is -4.90%. Also, return on assets for the most recent reporting period measured 0.59%. Although MGI has had instability problems with earnings, this company is extremely cheap and would be a wonderful asset for quantitative value investors.
Third, Perion Network Ltd. (PERI) is an Israeli media and internet company that provides search-based monetization solutions. Primary clients include mobile application developers and online publishers, in which Perion provides data-driven solutions to promote and monetize their client’s content and services. Now, I must say I am very excited about this company’s current positioning and achievements in relation to competitors. Without further ado, we will let the numbers speak for themselves:
|Revenue Growth (3 Yr Avg.)||122.1%||10.9%|
|Net Income Growth (3 Yr Avg)||96.2%||(10.6%)|
In conclusion, PERI has an Acquirer’s Multiple rating of 1.09 and an enterprise multiple of 0.87, which is extremely attractive. Therefore, Perion Network is a wonderful company that is currently well positioned to deliver extensive shareholder value for those seeking to add another position to their portfolio.
Fourth, CTC Media, Inc. (CTCM) is a $170 million capitalization independent media company, who is based in Moscow, Russia. CTCM operates three free-to-air television channels, which offer: entertainment for families, women’s lifestyle, and action films and shows. The company’s primary mission is to create stories that inspire viewers and promote positive, uplifting emotions. CTC Media’s primary audience is located in Russia and Kazakhstan. In 1996, CTCM became the first Russian broadcaster to adopt the U.S. network structure. CTC currently has an Acquirer’s Multiple rating of 1.63 and an enterprise multiple of 1.38. CTCM is well positioned in its industry, as expressed below:
CTCM clearly appears to be very cheap and valuable in relation to the industry average. In conclusion to the data, CTC Media has extensive value to provide for potential investors.
Lastly, Brasilagro Companhia Brasileira de Propriedades Agricolas (LND) is a $168 million capitalization company that engages in cattle raising, agriculture, and forestry activities in Brazil. LND’s three primary operating segments are grains, sugarcane, and real estate. The company also produces soybeans, corn, rice, cotton, and sorghum. Furthermore, LND currently owns 10 farms spread across five Brazilian states, in which the company owns 769,936 acres and has leased 43,735 acres. Moreover, LND has an Acquirer’s Multiple rating of 1.76, with an enterprise multiple of 1.54. Lets take a brief look at LND’s current positioning in relation to its peers:
|Revenue Growth (3Yr Avg.)||14.5%||0.1%|
As illustrated in the data, LND provides much strength, in which we believe a prudent investor should be aware of. In conclusion, we view LND as a buy prospect for investors looking to expand their current quantitative value portfolio.
My name is Brodie Hinkle and I am currently a senior at the University of Oklahoma. I am a double major of finance and energy management. I will be periodically writing opinionated articles about individual companies that show up on Tobias Carlisle’s stock screeners. All of my numerical data can be traced back to both Yahoo Finance and Morningstar.
Fluor Corporation (NYSE:FLR) is a professional services company. The Company provides engineering, procurement, construction, fabrication and modularization, commissioning and maintenance, as well as project management services.
It operates in five segments: Oil & Gas, Industrial & Infrastructure, Government, Global Services and Power. Through its Oil & Gas segment, Fluor serves the oil and gas production, processing, and chemical and petrochemical industries.
In the past 12 months Fluor’s share price has dropped by over 24%, something we love to see as contrarian investors. Back in November 2014 you could have bought Fluor for $69, today its share price sits around $50.
Here at The Acquirer’s Multiple we like to keep things simple, so here’s 11 reasons why I think you should add Fluor to your portfolio:
1.High earnings yield
Fluor has a current Magic Formula earnings yield of 16.4%, based on current operating earnings of $1.026 billion divided by its enterprise valuation of $6.247 billion.
2.Record EBIT margins
At the end of 2014, Fluor managed record EBIT margins despite declining revenues, 2014 EBIT was (1.23 billion) on revenue of (21.5 billion) compared to 2013 EBIT of (1.20 billion) on revenue of (27.4 billion).
3.Loads of cash and low debt
Fluor currently has just over $2.3 billion in cash and short term investments sitting on its balance sheet, compared to its debt of just $1.0 billion.
This means Fluor has a negative debt to equity ratio of -40%.
This is calculated as debt minus cash and short term investments, divided by total equity.
4.Positive cash flow funding surplus
This is one of my favorite metrics regarding cash flow.
I call it ‘cash flow funding surplus’. Put simply it means ‘cash flow from operations’ ($642 million) minus ‘cash flow from investing’ ($199 million) minus dividends paid ($126 million) minus other financing cash flows ($156 million) minus foreign exchange effects ($67 million),
After all of that, Fluor still had a positive cash flow funding surplus of $93 million.
A cash flow funding ‘surplus’ means a company is not required to borrow money or raise equity to cover any of its actual cash commitments.
A cash flow funding ‘gap’ means a company is required to borrow money or raise equity to cover some of its actual cash commitments.
5. High ROE
Fluor’s ROE has continued to be around 20% since the end of 2014. The company is now generating higher returns on its equity despite its negative growth in revenues.
6.Commitment to share buy back program
Fluor’s cash-rich balance sheet remains a competitive strength. It ended the September quarter with cash and securities of $2.3 billion versus $1.0 billion in gross debt. Share repurchases total $360 million year to date and $855 million over the past year. Fluor expects to complete its $1.0 billion buyback program by year-end.
7. Strategic Alliances & Innovative Design
Fluor-led consortia are building the lion’s share of new ethylene crackers in the U.S. Gulf, which will pay ongoing dividends as cheap and plentiful natural gas spurs successive rounds of petrochemical development.
Fluor’s new joint venture with China’s CNOOC is a strategic alliance that represents a step change in its cost-advantaged global fabrication and modular construction capabilities.
Fluor’s Nu-Scale modular nuclear power plant design represents a novel concept with intriguing long-term growth potential.
I enjoyed reading the transcript of Fluor’s Q3 2015 conference call. I believe David Seaton, Fluor Chairman & CEO, was very frank about his Company’s position.
“Since our last call, the global economy continues to be sluggish and commodity prices remain depressed. While commodity prices are showing signs of stability, there does not appear to be any near-term catalyst to drive prices up to where they were just a year-and-a-half-ago.
Lower commodity prices that impact our customers’ cash flow, and therefore, their ability to fund projects at the same pace. Nonetheless, we do expect customers to move forward with high-quality or otherwise necessary projects, especially those replacing depleting or deteriorating assets.
For example, oil and gas customers need to add production to replace their declining production base, as well as to meet the new regulatory demands.
Utility customers need to build new power plants to replace retiring generation capacity.
Infrastructure customers need to build new roads and replacing aging infrastructure. And the one area which we think is the most challenge to move forward at a rapid pace is LNG, where the spread between gas and other energy sources has narrowed significantly and there is a lot of new supply coming online.
Things are never as bad as the media would suggest nor as good as we would hope. Our focus is on the things we can control”.
Gotta love that sort of honesty!
Global Services is Fluor’s in-house unit which provides a wide array of solutions to support projects across Fluor groups all over the world. Capabilities within Global Services include site equipment and tool services, industrial fleet services, temporary staffing services, fabrication, construction and modularization services and supply chain solutions.
Global services effectively serves as a source of backup labor and expertise to a project’s main subcontractors. Labor shortages have been a limiting factor at energy and petchem projects in North America and elsewhere. I believe this gives Fluor a strategic competitive advantage.
10.Growing Project Backlog
Fluor’s project backlog is meaningfully larger, both in absolute terms and relative to annual revenue, than other large publicly traded competitors. For example, its $41.6 billion backlog at June 30 represents 1.9 times its fiscal 2014 revenue of $21.5 billion. This compares with a backlog of $18.8 billion (1.5 times 2014 revenue) for Jacobs Engineering and GBP 6.6 billion (1.7 times 2014 revenue) for AMEC Foster Wheeler.
Ok, now lets take a look at some key valuation metrics for Fluor.
Magic Formula Earnings Yield – 16.4%
Enterprise Multiple – 4.63
P/E – Price to Earnings – 10.73
P/B – Price to Book Value – 2.28
P/S – Price to Sales 0.38
So, there’s 11 good reasons to add Fluor Corporation to your value portfolio at a cheap price.
Crazy like a fox:
“There’s market capitulation and then there’s market carpet-bomb capitulation in coal,” said Byron King, editor of Agora Financial’s Outstanding Investments newsletter. “Coal is so far down the pits that it is hard to imagine the sector seeing daylight.”
Alpha Natural Resources Inc., which was one of the largest U.S. coal producers, filed for bankruptcy protection in August.
Last month Rio Tinto PLC RIO, -2.81% said it would sell its stake in a large Australian coal mine, the head of BHP Billiton Ltd.’s BHP, -3.72% coal business warned that depressed prices may continue to plague the industry for some time to come, and J.P. Morgan offered a downbeat outlook for coal prices.
And just this month, Moody’s Investors Service issued a weak forecast for the coal industry.Coal is also among the assets produced by Glencore PLC GLEN, -4.59% which has been suffering under the strain of staggering debts on the back of the wider slump in commodity prices.
Some “key players are in bankruptcy or moving towards the courthouse,” said King. “it’s not a place for new money, that’s for sure.”
The coal market has suffered from what King referred to as two different “coup de graces.”
Prices for renewable energy, including wind and solar, has been falling and government subsidies make them a “formidable competitor,” said King.
“Then there’s low natural-gas prices, meaning that it is possible to fuel-switch to pipelines and gas turbines to generate electric power.”
But coal’s not dead yet.
Alliance Resource Partners, L.P. (ARLP) is aTulsa, Oklahoma-headquartered coal producer operating 10 underground mining complexes in Illinois, Indiana, Kentucky, Maryland, and West Virginia, and one of the cheapest stocks in the All Investable Screener.
Alliance Resource Partners (ARLP) is a deeply undervalued and overlooked company due to the perceived uncertainty in the coal industry. At the current price, it is a highly asymmetric bet, with negligible downside but huge potential upside.
Matthew Wolfer, an analyst at Boston-based Saibus Research, pointed out that “because of geography and delivery-ability…and current capacity, it is very hard to see coal’s share of total U.S. electricity generation going below around 30% over the course of the next 10 years.”
Most coal plants are several decades old so their capital costs are low, he said, suggesting that paying operational costs for an already existing coal plant could be much more appealing to a utility company than paying to have a new natural-gas plant built.
Natural gas isn’t the biggest threat to coal because there are infrastructure and capital costs involved, said Wolfer. “Competitive natural-gas prices have forced some of the older and less-efficient coal plants to be grandfathered in, but the ones that stand now are here to stay.”
Looking ahead, the coal market’s biggest worry will be environmental regulations, but it is tough to determine how tight the government will be on those issues in 30 or 40 years, he said.
“For the next decade or two, however, coal is going to be essential to delivering affordable electricity to U.S. families,” Wolfer said.
G. Willi-Food is a leading importer of food in Israel. It supplies a wide variety of food products from leading international brands. Willi-Food’s products are nationally distributed and delivered to thousand of customers throughout Israel. It distributes well-known brands like Del Monte or Gelato for example. The company also exports a wide range of kosher food around the world. Its customers are composed of large retailers and supermarket chains. In brief, it is possible to buy one of Israel’s leading food importers and exporters for free. As a deep-value investor the following quote of Benjamin Graham is particularly appropriate:
In the short run, the market is a voting machine, but in the long run, it is a weighing machine
G. Willi-Food is currently trading at a ridiculous price. Indeed, it is almost impossible to justify the current valuation in my opinion. The graph below shows the stock price variations over the last 10 years.
Back in the mid-twentieth century, the famous investor Benjamin Graham created a metric called the net current asset value (NCAV). It is calculated by subtracting the total liabilities from the current assets alone. In The Intelligent Investor, he explained in details the NCAV figure he used in his investment firm Graham & Newman. The paragraph below summarizes the concept behind this metric:
The idea here was to acquire as many issues as possible at a cost for each of less than their book value in terms of net-current-assets alone, giving no value to the plant account and other assets. Our purchases were made typically at two-thirds or less of such stripped-down asset value.
Based on the latest financial statement, G. Willi-Food had $98 million in current assets and $6 million in total liabilities. Consequently, it is possible to calculate a net current asset value (Current Assets – Total Liabilities) of $92 million. Ironically, the market capitalization is currently around $54 million. Indeed, the stock is trading at 58% of its net current asset value. So, the margin of safety is equal to 42%. Without a doubt, it is huge and largely above the minimum requirement of 33%.
However, the accounts receivable and the inventory present a relatively important risk. In fact, I prefer to mark down the accounts receivable for doubtful accounts. Moreover, I prefer to apply a 50% reduction to the inventory value to reflect a rapid fire sale. Thereby, the net net working capital (NNWC) value is calculated with the following formula :
NNWC = Cash And Cash Equivalents + (0.75 x Accounts Receivable) + (0.5 x Total Inventory)
With $56 million in cash, $25 million in receivables and $12 million in inventory, it is possible to calculate a net net working capital value of $86.75 million. Again, the stock is currently at a huge discount. In this case, the margin of safety is acceptable at 37.75%. Thereby, it becomes increasingly difficult to justify the current valuation.
You don’t have to know a man’s exact weight to know that he is fat. It has to be obvious. The same concept is applicable with stocks. Consequently, I decided to calculate the net net cash value (NNC). In my mind, it is impossible to be more conservative than that. The NNC value is calculated by subtracting the total liabilities from the cash balance alone. Basically, if the market capitalization is below the NNC value, you are paying absolutely nothing for the entire business. With $56 million in cash and $6 million in total liabilities, the net net cash value is equal to $50 million.Based on a market capitalization of $54 million, you are paying only $4 million for the business itself. In other words, it is almost possible to buy G. Willi-Food for free.
Any serious investor should look at this situation. Furthermore, the company is cash flow positive. The risk of burning the entire cash balance is extremely low. On a trailing twelve months basis, it generates $4 million in operating cash flow. It is possible to conclude that G. Willi-Food is a decent business selling for a ridiculous price. The only risk inherent to WILC is widely diminished due to the positive operating cash flow and the low capital expenditures required to operate the business.
In conclusion, it is possible to buy a decent business for almost nothing. The risk / reward ratio is clearly asymmetric with a net net cash value of $50 million and a market capitalization of approximately $54 million. In my mind, it is impossible to justify rationally this valuation considering that the corporation is not burning through its cash balance. However, please do your own due diligence and consult your financial advisor before taking any decision. I am not a financial advisor. This article expresses my own opinion only.
The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned. The information in this document is believed to be accurate, but under no circumstances should a person act upon the information contain within. We do not recommend that anyone acts upon any investment information without first consulting an investment advisor as to the suitability of such investments for his specific situation.
Alliance Resource Partners is a producer and marketer of coal in the United States. The firm operates twelve underground mining complexes in Illinois, Indiana, Kentucky, Maryland and West Virginia. The mining operations are near major power plants. This favorable geographic location helps to minimize costs for customers. It is an important competitive advantage in my opinion. Despite the collapse in the coal price, Alliance Resource continues to generate strong cash flows.
In fact, coal is probably the most hated commodity at the moment. The coal shipped from the Australian port of Newcastle is selling around $55 per tonne. That is the lowest level since 2007. Clearly, many producers are feeling the pain and this is a good news. Walter Energy, Alpha Natural Resources and Patriot Coal went bankrupt in the past few months. Moreover, Arch Coal is almost game over with a market capitalization of $55 million and a huge debt load of $5 billion. The situation is similar for the giant Peabody Energy. In brief, the best cure for low coal prices is low coal prices. These bankruptcies are a good news.
Glencore, the world’s biggest exporter of coal, cut production by about 15% this year. Teck Resources, one of the Canada’s largest mining companies also reduced its output by a meaningful amount. These cuts are widespread in the coal industry. At the moment, the outlook for coal stock is disgusting. Coal companies are hated to death and this is the main reason why I like Alliance Resource Partners. In my opinion, it is an excellent contrarian opportunity.
Actually, its balance sheet is probably the most robust versus any other player in the industry. With current assets of $378 million and current liabilities of $229 million, it is possible to calculate a working capital of $149 million. This is reassuring. With an equity figure of $1,050 million and total liabilities of $1,280 million, the debt to equity ratio is 1.22. For example, Peabody Energy has a debt to equity ratio of 6.17. This metric is equal to 4.76 for Arch Coal. In brief, Alliance Resource Partners has a solid balance sheet and the bankruptcy risk is non-existent.
Furthermore, the firm is profitable quarter after quarter despite the record low coal price. On a trailing twelve months basis, the firm generated $510 million in operating income. Based on an enterprise value of $2,416 million, the acquirer’s multiple is equal to 4.74. Without a doubt, it is very low. I want to mention that the firm generated $438.12 million in free cash flow over the last twelve months. It is important to remember that prices are at a record low-level. With a market capitalization of $1,600 million, the free cash flow yield is equal to 27.38%. Likewise, the firm pays a quarterly dividend of $0.675. According to the actual stock price of $21.71, the dividend yield is 12.4%. At the first look, it seems unsustainable. However, the payout ratio is manageable at 88%.
Finally, a discounted cash flow analysis corroborates my entire thesis. I used a worst case scenario. Indeed, an annual growth rate and a terminal growth rate of 0% is almost impossible. One day, coal prices will rebound in my opinion. It is the nature of any commodities. According to many financial websites, the beta of Alliance Resource Partners is around 0.9. To be conservative, I used a beta between 2 and 2.5. The complete input table is illustrated below.
According to my model, the intrinsic value of Alliance Resource Partners is between $35.13 and $37.98. Currently, the stock is trading around $22. Every metric looks cheap. The price to earnings ratio is equal to 5.5 and the EV/EBITDA ratio is extremely low at 3.10. The graph below illustrates the intrinsic value distribution based on 5,000 different scenarios.
In conclusion, Alliance Resource Partners is a diamond in the rough. The coal industry is ugly and disgusting, but ARLP is definitely worth a look at the current price. With its healthy balance sheet, the firm is well positioned to weather the current crisis in the coal industry. Due to record low coal prices, the downside seems limited. Indeed, stocks are not cheap and popular at the same time.
I am an undergraduate student, not a professional. Please take this factor into consideration. Despite the bearish tone of my article, please do your own due diligence and consult your financial advisor before taking any action. I am not a financial advisor. This article expresses my own opinion only. The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned. The information in this document is believed to be accurate, but under no circumstances should a person act upon the information contained within. We do not recommend that anyone acts upon any investment information without first consulting an investment advisor as to the suitability of such investments for his specific situation.
Companies with a negative enterprise value are elusive beasts, highly sought after by deep value investors, but little understood outside that world.
Value investing is about finding and buying a bargain, a dollar selling for 70 cents or less. One of the most tantalizing apparent bargains offered by the stock market is the negative enterprise value (EV) stock: a stock that is trading for less than the net cash on the company’s balance sheet.1 Buying a negative EV stock seems like a no-lose proposition: Imagine a house selling for $1 million with a safe in the basement that contains $1.2 million in cash. Why would anyone offer up such a deal? If you find one, should you take it, or write it off as too good to be true?
To answer this question, I investigated the performance of all negative EV stocks trading in the United States between 30 March 1972 and 28 September 2012. I started with balance sheet data from Standard & Poor’s Compustat database and merged these data with price data from the database maintained by the Center for Research in Security Prices (CRSP). I then calculated historical enterprise values for every company every month, as well as matching forward 12-month returns. For example, Microsoft’s enterprise value on 31 August 2011 was $182 billion, and MSFT’s 12-month forward return from 31 August 2011 to 31 August 2012 was 19%. This is a total time-weighted return, including dividends and price appreciation. The enterprise value is based on Microsoft’s 2011 Q4 report, which was released on 21 July 2011, making it 41 days old on 31 August 2011. The merging process ensures that all fundamental data have been published to the market at least five days before they are used in EV calculations so as to minimize look-ahead bias. After this math was done, I filtered the dataset to include only negative EV stocks.
I found 2,613 stocks that at one point or another traded at a negative enterprise value between 1972 and 2012 (Microsoft, unfortunately, was not among them). The list has one entry per stock-month. That is, a stock that has traded at a negative enterprise value three months in a row will appear on the list three times. Each time is a different investment opportunity with its own forward 12-month return. The average stock spent 10.17 months (not necessarily consecutive) in negative EV territory. Thus, the list shows a total of 26,569 opportunities to invest in negative EV stocks.
The average return across all 26,569 opportunities was 50.4%. That is, if you had diligently watched the market over the last 40 years and invested $1,000 into each negative EV stock each month, your average investment would be worth $1,504 after holding that investment for one year, not including trading costs, taxes, and so on. Not bad!
As it turns out, this strategy works much better for individual than larger institutional investors because most of the investment opportunities are in micro-cap stocks with limited liquidity:
Only about 3% of the investment opportunities are in stocks with a market capitalization of half a billion dollars or more. These opportunities have come up with some regularity and have usually provided attractive returns but have on occasion lost a great deal as well:
In summary, negative EV stocks have offered attractive returns over the past 40 years and may be well worth a look, provided you can stand the volatility.
Alon defines enterprise value is defined (EV) as follows:
- EV =
Common equity at market value (this line item is also known as “market cap”)
+ Preferred equity at market value
+ Minority interest at market value, if any
+ Debt at market value
+ Unfunded pension liabilities and other debt-deemed provisions
– Associate company at market value, if any
– Cash and cash-equivalents.
A negative EV stock is one where the cash exceeds all other factors in the equation. In practice, “cash” may be defined to include marketable securities. In that case, the marketable securities themselves may be over- or undervalued.
Payment Data Systems, Inc. (NASDAQ:PYDS) is an unusual, undervalued small cap company. It is not as undervalued as it appears at first glance, and its unusual business makes it difficult to assess, but there is value here. At $2.90, the company has a market capitalization of $35 million. Its $65 million in net cash put its enterprise value at -$30 million. With positive operating earnings of $2 million over the last twelve months, the company trades on an acquirer’s multiple of -12.6x. It also trades on a PE of 6.2, and has generated free cash flow / EV of -14 percent (positive free cash flow of $4.2m on a negative EV of -$30 million). The net cash position here is a little misleading because PYDS carries a current liability called “Customer deposits payable” in the amount of $61 million that balances the $65 million in net cash. Adjusting for the Customer deposits payable liability, PYDS’s net cash position shrinks to $4 million, its enterprise value swells to $31 million, and its acquirer’s multiple blows out to 15x, which makes it too expensive to feature in the top 30 in the Small and Micro Screener. One interesting note: If I test the screen backing out all current liabilities from net cash to eliminate companies like PYDS, the screen underperforms the usual acquirer’s multiple screen by almost 2 percent per year (1.71 percent per year, to be precise). Clearly, cash on the balance sheet–even cash balanced by a current liability–has value. That’s the case here, even if PYDS has some other problems.
Payment Data Systems, Inc.was founded in 1998 and is headquartered in San Antonio, Texas. It provides integrated electronic payment processing services to merchants and businesses in the United States. The company offers various types of automated clearing house (ACH) processing, and credit, prepaid card, and debit card-based processing services. Its ACH processing services include Represented Check, a consumer non-sufficient funds check that is represented for payment electronically rather than through the paper check collection system; and Accounts Receivable Check Conversion, a consumer paper check payment, which is converted into an e-check. The company also offers merchant account services for the processing of card-based transactions through the VISA, MasterCard, American Express, Discover, and JCB networks, including online terminal services accessed through a Website or retail services accessed through a physical terminal. In addition, it provides a proprietary Web-based customer service application that allows companies to process one-time and recurring payments through e-checks or credit cards; and an Interactive Voice Response telephone system to companies, which accept payments directly from consumers over the telephone using e-checks or credit cards. Further, the company creates, manages, and processes prepaid card programs for corporate clients to issue prepaid cards to their customer base or employees; and issues general purpose reloadable cards to consumers as an alternative to a traditional bank account. Additionally, it operates billx.com, a consumer Website that provides bill payment services; and offers iRemote Pay, a mobile payment application designed for merchant customers for a remote wireless point-of-sale application to accept credit cards, debit cards, ACH, and cash payments. The company markets and sells its products and services directly, as well as through non-exclusive resellers.
PYDS appears to have some problems on the safety front. Its F Score at 6/8 indicates that it is fundamentally strong, but its Z score and M score indicate something potentially amiss. PYDS’s Z score at -0.26 indicates financial distress. In this instance it’s PYDS’s unusual financials fooling the Z score indicators. Its main problem is its huge retained losses– -$49 million–on total assets of $71 million. But PYDS is net cash (even accounting for the Customer deposit liability) and generating free cash flow, so I don’t think it’s actually financially distressed. If anything, the net operating losses (NOLs) are a benefit, offering a large shield against future tax. PYDS’s other problem is its M score, which at -0.03, indicates the presence of earnings manipulation. Its main issues are gross profits slipping year-on-year on increased revenue, asset quality deteriorating and slowing depreciation relative to PP&E year-on-year. Again, this is PYDS’s unusual financials tripping up the metric. The large net cash position and balancing customer deposit liability relative to the other assets makes the company very sensitive to movements in this relationship. For example, companies sometimes slow the rate of depreciation to boost earnings. For PYDS, depreciation actually increased fivefold from $39K to $199K, but PP&E increased 25-fold year-on-year from $132K to $3.2 million, which makes the metric look ugly, but isn’t out-of-the-ordinary for a rapidly growing business with depreciation lagging asset growth. PYDS is an unusual business with unusual financials, and these odd relationships are flagged by the Z and M scores. Examining the metrics in detail shows that it is the unusual business and financials themselves, rather than manipulation or distress, that raises the flag.
Value, growth, contrarian, growth at reasonable price Nitin Gulati has an interesting take on PYDS:
Traditionally, there have been five major stakeholders in the payment ecosystems: cardholders, merchants, acquiring banks, association networks, and issuing banks. The “merchant” receives the payment from the “cardholder” (customer) swiping the card at the point of sale (customer-present), the bank that the merchant uses to provide processing services (“acquiring bank”), the bank that issued the card to the customer (“issuing bank”) and association networks such as Visa (NYSE:V), MasterCard (NYSE:MA), American Express (NYSE:AXP). On one side are bankcard issuers and their customers who hold consumer payment cards, and use their credit, debit, and prepaid cards to make purchases at merchants. On the other side, merchant banks or, as is many times the case, their merchant acquiring or processing partners who process consumer card payments into payment card networks on behalf of merchants.
Together, merchant acquirers and processors serve as the communications and transactions link between the merchants and the card issuers. Every card issuer deals with at least one payment processor, and every merchant that accepts cards has a relationship with a merchant acquirer. Without them, the payment system as we know it would not exist.
Figure 1 : Taken from KPMG “Card Payments in Asia-pacific study”
Over the past five years, revenue has grown by 33 percent, from $3.2 million to $13.4 million at the end of FY14, driven primarily by adding merchant accounts. Merchant accounts have grown from 482 in 2009 to 795 at the end of FY14, with one customer accounting for 11% of total sales. The company hit a roadblock in 2013, as lower ACH transaction volumes and pre-paid card volumes were down, resulting in reduced overall revenue. PYDS acquired Akimbo Financial for $3.0 million in December last year, with speedy and successful integration now contributing to the top-line.
For the recently completed 2nd quarter, PYDS’s top-line revenue grew 4% to $3.42 million, against the backdrop of higher transaction volume in credit card, debit card, and ACH processing. Gross profit grew 5% y/y while operating income declined primarily due to charges associated with listing the company on NASDAQ, and including two independent directors to the board of directors. Credit card dollars processed during Q2 were up 9% y/y while the transactions processed were up 6% y/y. Cash flow from operations excluding customer deposits was $1.3 million. Total dollars processed for the Q2 exceeded $806 million and is the second highest in the history of the company for any previous quarter.
However, the company expects revenue growth to accelerate in Q3 and Q4 of 2015, with further growth in Q1 and Q2 of 2016. Specifically, the Company is targeting 10-20% quarterly growth in revenue beginning in 2016. The Company expects its 2015 gross margins to be 35-40%, more in line with how it started this year and net profit margin (before tax) to be 10-15% for the year ending December 31, 2015. The Company also expects to see revenue growth in 2015 with the growth accelerating in 2016.
PYDS reported transaction processing volume of $309 million, equating to an annual rate of $3.7 billion in processing dollars. Using management’s guidance, Revenue projection of $15.5-$16.5 million for FY 15 seems reasonable, which translates into processing revenue of 5 bps per transacted dollar. With the industry average cost of processing a payment at about five to eight bps per transacted dollar, according to McKinsey estimates, it certainly is an impressive feat for a company this size.
PYDS is fulfilling the needs of the customers, which often remain ignored by the larger players in space, and by preserving their cost base low enough PYDS can produce profits from serving such low volume customers. By successfully leveraging customer relationships and fulfilling customer requirements with post-sales support, PYDS is quickly expanding its merchant account base upwards. Also, by integrating certain proprietary infrastructure components, it builds a customized electronic payment service tailored to customer’s specific needs, and captures cross-selling opportunities between merchant business and pre-paid business, which as we stated earlier remains underestimated.
Some color on the NOLs
Besides adding more merchants in its customer base and acquiring Akimbo, we note for 2014 PYDS’s tax expense (benefit) was ($1.48 million) , primarily the result of PYDS recognizing deferred tax benefit of $1.62 million , net of alternative minimum tax and Texas margin tax. PYDS has net operating loss carryforwards of about $40.8 million, which expire beginning in the year 2020, despite being profitable for FY14 with a total net income of$3.8 million. The company has recorded a valuation allowance reserve of $12.2 million, that we figured, was most likely created due to PYDS’s history of operating losses limiting any visibility on when if some or the entire deferred tax asset will be realized. However, PYDS has been profitable for three out of the past four years; we think it has accumulated sufficient objectively verifiable evidence to reverse this valuation charge. We believe, this reversal will significantly boost PYDS FCF for the next five years.
Basically, if PYDS were to maintain its profitability at the same levels as trailing twelve months ($3.9 million) for the next five years, we estimate PYDS can generate FCF north of $3.5 -$4.0 million per year comfortably, after factoring in its NOL’s. Readers should note that this back of envelope estimate doesn’t factor any margin improvement opportunity.
Given PYDS’s low coverage and the catalysts that abound in the name, we are going to shun relative valuation techniques, and instead purely focus on its valuation in its pure absolute terms.
Below is the table, which succinctly illustrates, PYDS’s earnings power near $3.75 million, which we strongly believe can comfortably grow to near $6 million by FY19. An under the radar business that yields FCF north of 10 %, not bad in our opinion, considering we embrace a owner mindset with a long term focus.
Kindly note, in these projections, we have not yet incorporated any benefits PYDS can incur if Federal Reserve elects to lift the federal funds rate.
|Revenue Growth Rate||16.0%||13.3%||10.5%||7.8%||5.0%|
|Revenues , millions||$ 13.40||$ 15.54||$ 17.60||$ 19.45||$ 20.96||$ 22.01|
|– Capital Expenditures||0.03||0.06||0.07||0.08||0.08||0.09|
|FCFF||$ 3.73||$ 4.36||$ 4.98||$ 5.54||$ 5.82|
|PV FCF||$ 3.38||$ 3.57||$ 3.69||$ 3.72||$ 3.53|
|Sum on PV FCF||$ 17.89|
|Terminal Value||$ 42.81|
|Sum of Operating Assets||$ 60.70|
|Value of Cash||$ 3.25|
|Value of Firm||$ 63.95|
|Value of Equity Options||$ 2.00|
|Value of Equity||$ 61.95|
|Number of Shares||12|
|Value per share||$ 5.2|
Here, we have a business with a clean balance sheet, no debt overhang unlike its larger peers, with a clear visibility to future earnings power, positioned to benefit from interest rate hikes, remains insulated from the vagaries of exchange rate fluctuations, and yet trades at a considerable discount to its true value. We believe, PYDS shares are currently undervalued by a wide margin and are worth at least $5.20 per share.