I could tell you that this was all foreseen in my stellar analysis and that my decision to pass on CRP shares in November (due to lack of a margin of safety) was sheer brilliance, but I think I’d rather stick with the truth – dumb luck is a beautiful thing.
The 2nd quarter P&L numbers were ugly. Revenues were off significantly “as a result of lower overall facility utilization” due to “active delivery against future contracts in the spring wheat market.” Negative operating leverage (I see Wall Street analysts use this phrase all the time – must make you sound smarter than just saying “fixed costs”) turned the poor revenue showing into a bottom line loss. Although this is concerning, I remain optimistic that CRP (or Riverland more specifically) can garner EBIT per bushel of capacity of $0.29-0.37 long-term. If CRP converted itself to being a storage only company (no more merchandising or company owned inventory), it should be able to command $0.02/bu. per month in storage. With no cost of sales and the ability to cut SG&A costs to the bone, CRP should be able to earn $0.20/bu. in EBIT annually ($0.24 in revenue, $0.04 in SG&A which is roughly half of current) – just as a passive storage company. As an active merchandiser, I see no reason that the company can’t move back to $0.29-0.37 EBIT per bushel range over time.
Although I am optimistic about the long-term prospects of CRP, the income statement still doesn’t provide a margin of safety in my opinion. The balance sheet, however, is more intriguing. At this point I am more interested in CRP as a Benjamin Graham “Bargain Issue,” better known today as a “net-net” stock. A bargain issue is defined as a company that “sells for less than the company’s net working capital alone, after deducting all prior obligations.” In the case of CRP:
CRP (Data as of 9/30/11 unless noted) | |
Total Current Assets: | $240,034,011 |
- Derivatives* | $1,985,558 |
- Income taxes recoverable* | $1,612,766 |
- Total Liabilities | $151,317,348 |
Net Working Capital: | $85,228,003 |
Shares Outstanding: | 14,970,823 |
Net Working Capital per Share: | $5.69 |
Current Share Price (12/7/11): | $4.99 |
Upside to Net Working Capital: | 14.0% |
With the sell-off in CRP shares, the stock trades at a discount of $0.70 per share to its net working capital. This analysis assumes no value in the company's ~55 million bushels of storage capacity. In other words, CRP is effectively worth more dead than alive. The cash, inventory, and accounts receivable could be converted to cash, pay off all of the company's liabilities, and have enough remaining to give each shareholder $0.70/share and whatever the 14 elevators would bring in an open market sale ($2/share if the elevators could be sold for $0.55/bushel – roughly half of what CRP management feels is fair value for elevator capacity). In that sort of liquidation scenario, our $4.99 investment would return $2.70 in profit – a not too shabby return of ~55%.
Now before we all go out and buy Gordon Gekko shirts and become corporate raiders, I’m actually not advocating a liquidation of CRP. As I noted above, I think the company can return to profitability. As I am not in the business of going “active” on a company, I’m content to buy some shares and wait for the market to realize that CRP is trading for less than its net working capital. If anyone out there is an activist investor or if the folks at Front Street Capital (the hedge fund that manages CRP) want to talk about liquidating to realize value, I’m more than happy to coattail to a 55%+ return (I’m even open to taking a 10% finder’s fee for the outstanding investment banking advice I’m providing in this post).
Of course, this isn’t a firm net-net idea. We’re only trading at a 12% discount, well below the 1/3rd discount advocated by Benjamin Graham. Also, its an individual idea when net-net stocks typically work best as a basket investment – where you buy a portfolio of all available net-nets for diversification. Finally, CRP’s current assets are dominated by grain inventories. Inventories are the least liquid and hardest to value of all liquid assets.
However, given the long-term viability of CRP’s asset base (grain elevators), its historic profitability, and the fact that management owns 21% of outstanding shares, I’m open to initiating a position at these levels. Average in on weakness. Target $5.69 for an initial upside review point.
Anyone see gaps in my logic or reason to be more cautious on CRP shares?
Full Disclosure: Long CRP (TSE:CRP)
Harvest Investor © 2011. All rights reserved. The content and ideas contained in this blog represents only the opinions of the author. The content in no way constitutes investment advices, and should never be relied on in making an investment decision, ever. No content shall be construed as a recommendation to buy or sell any security or financial instrument, or to participate in any particular trading or investment strategy. The author may hold positions in the securities and companies mentioned on this site. Any position disclosed on this site may be modified or reversed without notice to you. The content herein is intended solely for the entertainment of the reader, and the author.
20 comments:
Thanks for the excellent analysis.
You know a liquidation sale might be the best exit. When Whitebox (a hedge fund) sold Riverland to Ceres, the president of Whitebox, Andrew Redleaf, went on record in the press saying he would never try to run an operating company again. He acknowledged he was a paper pusher and did not have the expertise to run an operating company. Perhaps Ceres management (essentially a group of fund managers) are asking themselves the same question – do we really have the skills to build an operating company? Especially given they run it part-time away from their day jobs at Front Street. If they aren’t asking themselves this question, they need look no further than their half-empty grain elevators for motivation. Or look at the perpetual huge discount to NAV.
Andrew Redleaf is a good hedge fund manager. One of the very few to short the subprime mortgage market. Front Street are good money managers. There is no shame in admitting running an operating company is not your strength.
Management takes a percentage fee based on an NAV of $11 per share. OK – show me the money!
Disclosure: no position long or short.
Anonymous #1: Thank you for the reply - great to get another perspective on these thinly traded microcaps. Also, I tend to agree with your outlook.
I do hope you are right that Front Street is reviewing its options - any company trading in net-net territory certainly should be.
If management or the Board are listening out there - a conference call or investor meeting would be great. That way you could detail strategy and explain why further acquisitions are better than stock buybacks and/or a spin-off. Why is it better to buy additional (open-market) elevator capacity at ~$1.00/bushel than it is to buyback your own stock at an implied NEGATIVE cost per bushel of capacity of ~$2.50 (assuming Riverland's elevators are sold at fire sale for $0.55/bu.)?
On second thought I would not hold out any hope for a liquidation.
This company is very tightly held and I would guess that a large portion of the shares are still held by those who bought it at the IPO (have you seen a more thinly traded stock?). The word coming down from management to investors is this still has huge upside. So for management to come back and say “hey we can get $9 to $10 a share right now” would make the very few recent buyers happy, but would not go over well with the majority who bought 4 years ago at $12.
Management seems to really dislike buying back shares.
For example, during the financial crisis Ceres stock traded for a while at about a 40% discount to NAV. At the time Ceres almost exclusively held publicly traded assets. People were indeed selling $20 bills for $12.
Ceres declined to buy back any shares. The word back was they would do better by buying other distressed companies than their own shares, keeping in line with the original plan to build an operating company. In fairness that is exactly what they were hired to do. But why take the risk in owning stock, as opposed to getting a guaranteed no risk immediate 60% return? Cynics implied buying shares reduces net assets and thus reduces management fees - I doubt that is the motivation.
Ultimately Ceres issued an NCIB, but even today they only use a small fraction of what is available. However I believe contributed surplus due to share repurchases exceeds all retained earnings for the history of the company on the balance sheet.
In terms of strategy, they seem committed to this market and growing the company via acquisitions. The belief is that the end of the Wheat Board will give them access to Canadian grain at better prices with less chance of inventory shortfalls. Somehow a minority interest in an 80 mile short line railway south of Regina plays into this plan.
So your analysis in my mind crystalized it.
If you buy based on the balance sheet and hope for either a liquidation or some plan to close the gap between share price and NAV it looks great.
If you buy based on the income statement and the projected earnings and a growth plan that consists of stapling together lots of Riverland equivalents side by side, it seems pretty thin.
Assuming the latter is the plan, I won’t be interested again until it goes below $4.50. Based roughly on your analysis I think that should be about the point where this grain elevator business net of all Ceres fees, and hiccups in inventories (like now), and delays in the Canadian deregulation, and delays in buying new assets, etc, could over the long term produce about a 10% return on a $4.50 investment with some margin of safety. If things go really well then there could be upside.
Despite my frustrations so far, Ceres managers are very smart and they seem to be committed to the project. It could still go well.
Just another point of interest in this discussion.
I have no basis for knowing if Ceres is involved one way or another, but the MF global collapse and missing $1.2B from segregated accounts was largely used to hedge grain prices for Minnesota farmers and grain elevator operators. Ceres does hedge their inventory. Whether Ceres used MF Global or not and if it is directly or indirectly affected I don't know.
Something to watch anyway.
http://www.agrinews.com/mf/global/actions/may/cost/farmers/elevators/millions/story-4087.html
BTW - you have Ceres ttm earnings at $.45. I think that is Riverland's earnings. I think Ceres ttm earnings are $.31 = $.30+.13+.02-.14
Anonymous #3: You are very right. The EPS numbers I stated are for Riverland Ag (per Ceres common share). I am making the correction in the post - thank you!
It looks like Ceres is getting hammered with a combination of their own bad Q2 results, a general market downturn, and tax loss selling. Getting close to a buy?
Do you have any other smallcaps you are watching right now?
Thanks
Hammered to say the least.
I'm buying shares of CRP on weakness, but only as a net current asset play - not on the income statement. There's risk of course - that management makes overpriced purchases, that losses continue to accelerate, or that Front Street (CRP's manager) continues to bleed off cash through its management fee, but at a growing discount to to net current assets, I'm averaging in. Continue to target $5.69 as upside review point.
As far as other smallcaps, I have a few on the radar / research list, but nothing that I feel is as cheap as CRP.
Thanks for the interest in my blog!
Who are you, Harvest Investor? Did I miss the "about the author" part of the blog?
These are excellent posts and comments. Overall, they seem a little tough on CRP as an investment in that I don't see anything else that is even close in value.
By the way, they told me flat out that they had no direct MF Global exposure. (I emailed them a query.)
Spoke too soon...I just went back and read the Inaugural Address.
I keep a similar "trading journal" on my wheat futures trading at tinbox-trading.blogspot.com .
The recent price drop in CRP made me nervous. Still rattled by the shocking news from MF Global, I have been too wary to add more CRP below $5. (I had an account at Penson until it went sub-$2)
I told CRP that they should release a statement regarding the 40% price move --if only to go on record as being unaware of any material changes in the company's business.
Another worry I have is their portfolio will probably get hit this quarter. For example at the end of last quarter they still held the recently IPO'd "Ecosynthetix" (ECO in Toronto) The IPO has not gone well as ECO warned on earnings last week and the stock crashed. I am guessing that all pre-IPO major shareholders are not allowed to sell for a period of time (usually six months.) If they haven't sold or hedged they stand to lose a few million more on top of whatever losses the half-empty grain elevators generate.
It looks like it will be a tough year regardless.
Tinbox - thanks for clearing up the MF Global confusion.
Tinbox - thank you for the kind words and for checking into MF Global and CRP's exposure. I completely agree that CRP should come out with a statement, or even better, host a conference call to discuss the company and strategy. I've even been toying with sending a letter direct to the BoD's, but haven't gone down that road (yet).
Anonymous - the investment portfolio is a very real risk - depending on how Front Street keeps converting it to cash, we may need to discount it's valuation in the net-net analysis - something to watch.
Earnings are due in a few days.
Do you care to make a prediction?
Thanks.
The rally has brought us to marginally above the NCAV ($5.69), so I'm anxious to see what happened to the balance sheet last quarter. As management puts more cash to work in long lived assets, NCAV will likely erode, so there's a risk there. Still, I'm willing to go into EPS long (even after a 40% jump off the Dec. 15 low) before I make a decision on whether to take profit or hold longer on improving fundamentals.
As far as the income statement is concerned - no predictions from me. Any number I threw out would be nothing more than a guess - and a bad one at that considering the source.
Hi - can you clarify your comment about the company "putting more cash to work in long lived assets?"
My worry was there would not be enough time after earnings are published to capture recent profits, so I am out for now. The stock price I think is very soft right now.
I'll make a "wild guess":
($2M) bottom line loss on Riverland operations (after Cere Mgmnt fees etc.)
($2M) bottom line loss on the investment portfolio.
$1.2M gain on share purchase through NCIB.
($2.6M) decline in net assets due to foreign currency translation ($US to $CDN)(not reflected in EPS but is in NAV)
EPS = -$.19
NAV per share = 11.07 -.31 = $10.76
My comment on cash being converted to long-lived assets was about management investing cash (and proceeds from the investment portfolio) into grain elevators and other property, plant, and equipment. This is a stated goal of management's, and as it takes place the net current asset value of the stock will likely fall as current assets (cash, marketable securities) move down the balance sheet to long-term assets. Although it's not necessarily a bad thing (if the long-lived assets can earn a sufficient return on capital), the liquidity of the assets changes, and anyone investing based on asset value needs to consider the consequences.
Basically it comes down to the question of whether the business is better served by returning the cash to shareholders or if management is skilled in finding profitable net present value investments and deploying the cash internally. Reversion to mean ROA for the average North American company (which CRP has not been earning) should be a tailwind to the company given its low P/B valuation. Hopefully the quarterly report gives us some more info with which to build our outlook.
Thank you for the reply.
I don't think we will see anything substantial on new investments in elevators since Ceres typically announces these as they happen. They may still be investing in upgrading the existing facilities which would drain cash.
The value of the cash and marketable assets stockpile will be very interesting. I think we have in the last two quarters seen it fall from $60M to $48M with the purchase of one new facility for $9M. With operations losses, portfolio losses,internal investments (facility upgrades) and share repurchases the stockpile could fall substantially this quarter - even as low as $40M.
With a depleted stockpile, and a discounted share price, management will be limited in closing cash+stock deals for new facilities. They may have no option to add more of these facilities despite a strong balance sheet.
Which as you point out is not necessarily bad.
$5.90 - good luck.
FYI - earnings are out and posted on Ceres new website.
A little better than I expected, but still a lot of reading to do.
EPS = -$.11 (versus wild guess of -$.19)
NAV = $10.83 (versus guess of $10.76) - down approx $.24
Cash and securities = $45.2M (down from $48) - holding onto cash much better than I expected.
Riverland made a small profit (before Ceres corporate overhead.) Operations appears to have done a little better than expected.
The portfolio took a $2M loss due to the Ecosynthetix crash as predicted. BUT a big ($5M) loss on Ecosynthetix was offset by a large gain of $3M in the fair value of the rest of the portfolio. This is a huge gain on what is now a very small portfolio, and no mention of where the gain came from. Would be interesting to ask anyway.
They bought back a predicted number of shares (about 25% of NCIB annual amount)
NAV took a slight additional loss due to foreign exchange as expected.
There is a casual reference in the MD&A to a late quarter property purchase, but no details, or the amount. (related to increase in PP&E)
I will be really interested in your revised Net-Net analysis whenever you have a chance.
Thanks again for your analysis of this interesting company.
Without an abnormally very high gross margin generated through "trading gains" and the $3M gain on the fair value of the unsold assets in the portfolio it would have been a very UGLY quarter.
They dodged it somehow.
Spike,
It would be easier to follow the CRP story if you put up a new post as opposed to posting new information in the comments section..
As a grain trader, I expected worse on the Riverland operations since inventory levels of Hard Spring Wheat and Oats have been very low generally--using the carrying costs on the CBOT futures as a guide.
tinbox:
I am currently planning to put up a new CRP post addressing the quarterly report and the changes in NCAV. However, I haven't changed my investment position or thesis, so there isn't a lot for me to post yet. As I work my way through the report, I'll probably clean up my notes and put them up as some sort of post in the coming weeks.
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