Village Farms International (TSE:VFF)

VFF is a name I’ve run across in the past but didn’t spend much time analyzing until it hit my radar with disappointing results and a swift sell-off in May. Since that time, the stock has done nothing but go down – off over 50% in the last 3 months as the news just gets worse and worse. Suffice to say, we have a company with bad news in the short-term offset by solid operating results historically; a one-time act of God disaster severely impacting operations; and a stock price falling through the floor. Isn’t this the definition of a value stock? That’s where I started my analysis . . .

VFF bills itself as “a leading grower and marketer of branded, high-quality hydroponic greenhouse grown produce in North America.” Basically, the company grows tomatoes (and to a lesser extent cucumbers and bell peppers) on a large scale. When I say large, I really mean it – these aren’t your typical local flower farm greenhouses. VFF’s 8 facilities in British Columbia and Texas cover a staggering 262 acres. Go to Google Maps and search for Village Farms in towns like Fort Davis, TX or Marfa, TX to get a real appreciation for the size of these 40+ acre buildings.

The VFF story is an attractive one in terms of sustainability and long-term production growth. Greenhouse grown tomatoes yield over 50x per acre that of traditional field grown plants and use an estimated 85% less water (via water recycling). With growing demand for arable land and drinking water, the long-term trend seems to favor high impact growers such as VFF. On top of this, greenhouses can be located adjacent to key population areas and/or low cost energy sources - reducing food miles, carbon footprint, and meeting a growing “buy local” trend among North American consumers.

VFF also owns a propriety technology known as GATES (Greenhouse Advanced Technology Expert System) – a fully enclosed greenhouse technology capable of sustaining year round production at feasible cost and scale levels (as compared to traditional greenhouse production which goes “dark” for 3-4 months each year depending on location). GATES is so efficient that it is estimated to provide production levels 60% above traditional greenhouse systems. The company already has one greenhouse fully operational under GATES technology (Monahans, TX; 30 acres of tomatoes on-the-vine). Beyond the ability to expand its own production through greenhouse conversions or new builds (at considerable capital expenditures of course), VFF has the option to license GATES technology to competitors. To date, VFF has shown little interest in licensing GATES, but it remains an asset that doesn’t fully show up on the balance sheet.

Speaking of the balance sheet, what really sticks out on VFF is the valuation. At a recent close of $0.66, it trades at only 0.53x tangible book value ($1.25 as of 6/30/12). On top of the discount to TBV, the balance sheet likely understates the true replacement value of the greenhouses VFF owns.

We get a real time look at what the replacement value (using insured value as a proxy) of the greenhouses is due to recent damage on one of the facilities in Texas (see below). The damage resulted in receiving $18.7 million in insurance proceeds (with more pending/expected), but only a $3.9 million inventory write-down and an asset write off of $2.8 million – meaning the balance sheet had been undervaluing the greenhouse(s) in Marfa, TX by at least $12 million (assuming management has taken appropriate balance sheet write downs – a question I have not specifically addressed with them).

At stated balance sheet levels, to get a 10% return on our investment at the current share price, all we need is for VFF to earn an ROE of 5.3% (10% * 0.53x P/B). Last year, reported ROE was 14.8%. Also in calendar year 2011, VFF earned EBITDA of $15.5 million. At a current enterprise value of $104.983 million (38.873 million fully diluted shares outstanding at $0.66 per share plus $80.654 million in debt less $1.327 million in cash) we get an EV/EBITDA ratio of 6.8x – cheap for a growing enterprise.

Yet, as I noted above, things have not been going well for VFF. For the quarter ended March 31, 2012, VFF announced a 17% decrease in the average selling price of tomatoes year-over-year. The second quarter was no better, with management announcing that tomato prices were off 24% year-over-year. Intense pressure from field grown Mexican tomatoes (VFF management goes so far as to define the Mexican production as “dumping”) has been the primary culprit behind the weakness in tomato prices.

On top of this, a hail storm passed through Marfa, TX on May 31, 2012 severely damaging the 82 acre facility located there. Although insurance proceeds have been received (with the potential for further receipts) and one greenhouse (approx. 40 acres) has been repaired and is again operational, the fate of the remaining 42 acres in Marfa is up in the air.

This leads me to the three things keeping me out of this stock right now:

1. The balance sheet: debt to capital sits at 60%. For calendar year 2011, Times Interest Earned (TIE) was 3.1x, but the weakness in tomato pricing has caused TIE to go negative in recent quarters (net of the insurance proceeds in Q2). The weakness has so depressed operating earnings that VFF is nearly in violation of its debt covenants. Management was specifically asked about this on the recent quarterly conference call, and noted they were within all parameters currently – but didn’t go into detail on whether the covenants had been restructured or were in danger of being enforced.  If the market is right and the assets of VFF are not worth the balance sheet values but are rather worth $0.53 on the dollar (a case in which management should hope for further hail storms given the insurance proceeds they’ve received to date), then the debt/capital ratio would jump to nearly 77% - not much margin of safety.
2. Live by the government, die by the government. VFF is a leader in lobbying to regulate / legislate the “illegal dumping” of Mexican tomatoes into the U.S. Whether such lobbying is good/bad/indifferent, I’m not a fan when a company’s business plan requires government intervention to eliminate lower cost producers – in fact, it’s a red flag. With one stroke of the pen government intervention can create a competitive advantage, with another stroke of the pen it can completely destroy that competitive advantage (ok, I’ll admit that I’ve been burned by similar circumstances in the past and am cynical!).
3. The lack of a clear future operating strategy. As of today, even management doesn’t know (or at least isn’t saying) if they’ll rebuild the second greenhouse in Texas damaged by hail earlier this year. They may use further insurance proceeds to pay down debt, they may rebuild, or they may build a new GATES facility. The lack of clarity on the operating strategy – more than likely influenced by an already leveraged balance sheet with little room for additional borrowing – is a red flag that VFF may not have a sustainable competitive advantage in its current form (GATES may be a sustainable competitive advantage, but if management would need to issue (dilute) equity to realize the benefit, is it a real advantage in its current form?). 

Bottom line, I think VFF is extremely attractive in terms of historic earnings power, potential growth, and the value of assets on the balance sheet. In fact, it likely presents an asymmetric risk/reward payoff (downside of $0.66/share and upside of $2.00/share+). However, when the downside is a complete loss of capital, I’ll pass. Until we get some clarity on the future operating strategy of the company, until the impact of Mexican tomato production is better known, and until the balance sheet is stronger (or at least some combination of those three criteria), I’ll sit on the sideline.

Disclosure: No position in VFF but I reserve the right to implement one at any time.

Harvest Investor © 2012. 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.

Ceres Global Ag (CRP): 4th Quarter and Fiscal 2012 Update

A reader of my blog recently asked me to do a quick update on Ceres Global Ag now that full year 2012 (year ended 3/31/12) numbers are posted. Considering that there are only 4 of you out there that follow my blog (Mom . . . is that you?), I thought I should comply . . . especially since, as they noted, not many people seem to be following this stock. If any other blogs are following this stock, or if any of you have some research on the company, shoot me an email, I’d love to talk.

What follows are my brief notes on the 2012 financial statements and MD&A. I am still reading through the filings and going through all the details, but what follows are my initial reactions.

The Balance Sheet 

Looking at the balance sheet on a year-over-year basis, CRP saw a drop in current assets of $33.4 million (mainly accounted for by decreases in cash [-$17mm], investments [-$7.7mm], due from brokers [-$8.2mm], and inventories [-$2.8mm]). Where did all of these funds go?

• $15.3mm went to Property Plant and Equipment. 
• $13mm went to liability decreases, mainly: 
• $14.7mm of debt pay down (long-term debt, repurchase obligations, and bank indebtedness).
• $5.4mm is accounted for by a drop in equity. This further breaks down as: 
• $4.1mm in share buybacks. Because CRP is buying back shares below book value, it actually bought back $6.3mm worth of “book value” stock, with the difference ($2.1mm) being allocated back as retained earnings [in essence, CRP made money from buying back its own shares if you believe book value is a good proxy for economic value]. 
• A $1.3mm full year loss (net income of -$3.8mm plus a $2.5mm foreign exchange gain). 

All of this results in a book value (NAV) of $10.69 per share and a net current asset value (NCAV) of $5.22 per share. Compare both to yesterday’s (6/14/12) close of $5.66.

The Income Statement 

I already delivered the punchline above – CRP lost $3.8mm in fiscal 2012. This works out to -$0.25 per share.

Despite a positive tone in the annual report and MD&A, as well as what seems a loss of “only” $0.02 a share in the quarter, this is masking what was truly a horrendous 4Q. Without factoring in finance income of $2.2mm, we see a gross margin of 2% on the operating business. Compare this with 21.5% in 3Q12 and 11.8% in 2Q12. Is this some sort of capitulation? Management is certainly building it up as that as they cite a host of positive catalysts in fiscal 2013 with the removal of the Canadian Wheat Board (an untapped production source for Riverland’s grain terminals), a return to contango in key futures markets (easier for merchandisers to extract storage profits), and a strong start to the northern U.S. and Canadian small grain belts (Riverland lives and dies on inventory turnover – witness 2012’s low capacity utilization and ensuing poor financial performance).

Management is also – for the first time that I’ve seen – making a big deal about Stewart Southern Railway. This is an 81 mile (interestingly, a Canadian company talking about distance in miles, not kilometers?) short-line in south eastern Saskatchewan that runs from Stoughton to Regina. CRP holds a 25% interest in SSR. The line is benefitting from an oil boom in the area, as well as a lack of pipelines to carry the oil – making rail the best logistical alternative. As I mentioned last quarter – I continue to view CRP’s rail interest as a nice call option for the company.

The Statement of Cash Flows

Cash Flow from Operations grew by $15.8mm, but most of this ($13.1MM) came from changes in non-cash working capital accounts. If we want to think about Owner’s Earnings, this first step is taking net income and adding back depreciation/amortization. This would be -$1.1mm (-$0.08/share for fiscal 2012).

Cash Flow from Investing was -$9.7mm, but the most interesting part of CFI was the $16.4mm capex spend. The overwhelming majority of this ($12.8mm) went into buildings and silos/elevators. $3mm went into land. I’m a little disappointed that management didn’t give at least some color on where these funds went (we know they purchased the Manitowoc facility and have been doing some needed updates on other facilities) – making it difficult to determine just what is “maintenance capex.”

Without a good estimate of maintenance capex, it’s tough to determine a good owner’s earnings number. For my analysis, I’m going to assume that depreciation/amortization is equal to maintenance capex, so net income is a good proxy for owner’s earnings is a good proxy for free cash flow.

Cash Flow from Financing was -$23.1mm. The biggest issue here was the swap of repo obligation into long-term debt, the general paydown of debt, and the share repurchases.

Bottom line

There was very little we didn’t already know / expect in the annual financials of CRP. We knew it was going to be a bad year (well, maybe we didn’t know how horrendous the 4Q would be). We were fairly positive that NCAV would continue to erode as management invested those assets lower on the balance sheet (PP&E).

What came as a surprise, at least to me, was how much stock management bought back in fiscal 2012 (they spent $4.1mm – equivalent to an almost 5% net payout yield at today’s price) and how upbeat they are for the short-term. They are certainly hanging their hats on the break-up of the CWB, as well as specifically pointing out the return to contango on the futures market and the strong early growing prospects for northern tier production areas.

At a premium of only ~8% to NCAV, with the potential for increasing market penetration (CWB break-up), strong growing conditions, recent industry consolidation (Glencore for Viterra, Marubeni for Gavillon [Marubeni already owns Columbia Grain]), and a still healthy balance sheet, I continue to like the long-term prospects for CRP at these levels. I am maintaining my position, and will become more accumulation minded on any pullbacks below NCAV.

One last item – still the biggest issue facing CRP, in my humble opinion, is the dual management structure. A low margin business in a commodity industry cannot sustain the SG&A expense of maintaining two management teams (Riverland Ag and Front Street Capital). This is a key factor to watch going forward.

Full Disclosure:  Long CRP


Harvest Investor © 2012. 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.

George Risk Industries: Better Late Than Never

(Editor’s Note: I wrote this post several months ago before I began accumulating shares.  Apparently I’m not the only blogger who has been sniffing around RSKIA as Whopper Investments beat me to the punch with a very well done post on May 25th. Enjoy!)

I have to admit that I anchor on prices. Missed opportunities weigh on my mind and my analysis. I see what I could have paid for a stock 6, 12, or 18 months ago, and it clouds my “value” judgment. It must not be a good value if the stock is now up 50%, 100% or even 200%, right? This is a dangerous habit for long-term value creation, and one I try to keep in check, but what can I say – I’m cheap!

For this post, I’m suppressing that tendency and pressing forward with an analysis of George Risk Industries (RSKIA). Sure, you could have bought RSKIA for less than $4.00 in 2009 or less than $5.00 in 2010, but it’s still a good opportunity (in my humble opinion) at today’s $6.00 quote.

I’ll try to be brief in this post – for one reason RSKIA is a fairly simple business. For another, there’s been a fair amount of ink spilled on the subject of RSKIA by other, more talented value investors (not all of whom agree with my analysis):

January 21, 2010 piece at The Rational Walk
July 30, 201 piece at The Rational Walk
February 5, 2011 piece by Geoff Gannon (see the second half of the article)
August 2, 2011 piece at Oddball Stocks

RSKIA makes electronics products such as computer keyboards, push button switches, burglar alarm components and systems, pool alarms, thermostats, EZ Duct wire covers, and water sensors. Security products comprise the overwhelming majority of sales (~88%). Although George Risk has over 4,000 customers, 1 distributor (a subsidiary of Honeywell) accounts for nearly 42% of total sales. To get a feel for just what it is RSKIA manufactures, check out the company’s website – they build some cool gadgets (www.grisk.com).

A couple of quick tidbits about George Risk industries. Management typically pays 1 dividend per year (last year ex-date of 9/28/11), which at $0.23/share comes to a yield of 3.8%. Management is also actively searching for “lost” shareholders of the stock to repurchase shares. I think this indicates how closely held and how long some of these shares have been sitting out there – George Risk management is actually out there calling people who forgot they own those stock certificates locked up in their safe deposit boxes. Through this and other efforts, management has repurchased 10,855 shares in the last 12 months (~0.2% of outstanding – not exactly burning up the certificates, but not bad considering avg. daily volume is somewhere around 300 shares).

Although the dividend and the buybacks are interesting, the crux of RSKIA is in its profitability and cash balances. As of most recent quarter end (1/31/12, 3Q12) the company had cash and marketable securities of $4.94 per share. This puts a value on the operating business of just $1.06/share ($6.00 market price less $4.94 in cash – we can quibble over how much cash the company needs to operate, but I’m assuming $0 for this analysis).

Last year, RSKIA had EPS of $0.40. However, much of that came from earnings on investments (the interest, gains, and dividend income on the cash and marketable securities). If we net out this non-core income, the firm generated EBIT of $1,7650,000. At an assumed tax rate of 35%, this equates to EPS of $0.23. At an operating business value of $1.06, this equates to a P/E ratio of 4.6x. An earnings yield of 21.7% (inverted P/E = E/P = earnings yield) is nothing to scoff at.

Over the last 3 years - which include the worst downturn in the U.S. housing market since the Great Depression, a rough time for a company that makes electronic and security products targeted at residential real estate – George Risk Industries has had an average, adjusted core ROE of 16.1% (netting out the investment income and assuming a 35% tax rate). At quarter end 1/31/12, netting out cash, RSKIA had a book value of $0.80 per share. A 16.1% ROE equates to “normalized” EPS of $0.13/share. I say “normalized,” but I may go so far as to say “depressed” given the housing environment of the last 3 years. At $1.06 in residual value, RSKIA is priced at 8.2x earnings, or an earnings yield of 12.2%.

I could spend lots of time laying out the case for RSKIA, but it would all be repetitive of what I’ve just shown – net of cash/securities, RSKIA looks remarkably cheap.

This isn’t to say there aren’t risks - Ken Risk in fact (I know . . . a pun on the name risk . . . but come on, it was right there, I had to throw it in). Mr. Risk is the CEO, the son of the company’s founder, and the owner of slightly more than 58% of outstanding shares. He and his management team have shown little interest in returning the nearly $25 million in cash and securities to us as shareholders. Many analysts will cite this as a lack of catalyst – or even a weakness of the company. Management could squander this asset, do a silly acquisition, or invest poorly. All of that’s true, but do we really think the Risk family is going to intentionally squander an asset they’ve been building since 1967? At the end of the day, I find myself asking “so what” if they don’t immediately monetize the cash and investments?

With a stable operating company generating consistent ROE, I’m happy to go along for the ride and be a claimholder for whenever and however management decides to monetize the on-balance sheet cash/securities. If, in the meantime, you can find me $4.94 in cash with an operating business attached that generates an average ROE of 16% (through a generational market downturn) and that sells for less than $6.00/share, let’s talk. No seriously, let’s talk. I mean it; operators are standing by, because just like George Risk Industries, that is a business worth looking at.

Full Disclosure: Long George Risk Industries (RSKIA). If, after conducting your own due diligence, you decide to buy shares of RSKIA, watch the bid/ask spread - share volume is sporadic and very low. Proceed at your own caution!

Harvest Investor © 2012. 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.

Fresh Del Monte Produce (FDP): Value Investment or Banana Republic?

I’ll start this post off with a disclosure. I am and have been a shareholder of FDP for a couple of years. It is a position that confounds me – although I haven’t lost money, I have suffered opportunity cost when I consider other forgone ideas (for some reason, the old Wall Street saying “never confuse brains with a bull market” is coming to mind right now). Although I’m not one to be impatient with a quality value investment, I do want to review my thesis and make sure FDP is a long-term value and not a value-trap.

Background
FDP is arguably the worldwide leader in fresh produce. The company’s vertically integrated operations include company owned farms (primarily in Central and South America, Africa, and the Philippines), port facilities, a fleet of refrigerated vessels and trucks, and distribution centers.

FDP’s two primary products, accounting for a combined 61% of 2011 sales, are bananas and gold pineapples. Management claims to be the #1 marketer of fresh pineapples worldwide and the #3 marketer of bananas worldwide. Other products in the company’s basket include melons, tomatoes, grapes, apples, pears, peaches, plums, nectarines, cherries, citrus, avocados, blueberries, and kiwi, along with prepared food products such as juices, beverages, and snacks.

Bananas – the slippery peel
The problem with bananas is that they are low margin. There is little barrier to entry to growing bananas as they have a short growing cycle, limited capital investment is needed, and they can be grown year round in tropical locations. Competition can easily enter the market when supply is tight, and exit when there is a glut. Other fruits require more capital investment and time to grow – creating a competitive advantage for large, committed producers. Pineapples, for instance, have an 18 month growing cycle, require re-cultivation after one to two harvests, and require higher levels of capital investment as well as greater agricultural expertise.

Now the lower margins on bananas are not an outright negative for FDP – everybody has known about this anomaly for a long time. And there are benefits to growing bananas. The product diversification and high volume of bananas (Wal-Mart sells more bananas annually than any other single item) creates a great revenue stream for the company. The problem comes when bananas become a larger portion of sales.

As the chart above shows, banana sales have climbed from 35.6% of sales in 2007 to 46.1% in 2011. Although there has been some reshuffle in the company’s other divisions (i.e. an Argentine grain operation was sold), bananas gain has been a loss to Other Fresh Produce and Prepared Foods. Other Fresh Produce dropped from 48% of sales in 2007 to 44.1% last year. Prepared Foods dropped from 12.8% in 2007 to 9.9% last year. This is a big deal when we look at the average gross margins on all three divisions from 2007-2011: Bananas 5.6%; Other Fresh Produce 11.7%; Prepared Foods 13.9%.

Book Value, Margins, and ROE
The drop in margins has created a direct assault on one of the biggest value propositions of FDP: it trades at 0.75x book value. The assets on the balance sheet (at historic cost less depreciation) are worth more than the stock. However, as the company’s melon business (part of “Other Fresh Produce”) drops from 7.5% of sales in 2007 to 3.4% last year, management has to start “rationalizing” its melon assets. I love that word “rationalizing.” Basically a nice way of saying these assets aren’t worth what we bought them for, so we’re going to write them off – poof! In that case, your book value is going to drop.

If we view FDP as an asset play – basically valuing it as a liquidation – this would be very concerning. Book value might not be representative of what the assets are really worth, and our whole investment thesis would be out the window. However, FDP is a going concern – people are going to continue to eat fresh fruit (hopefully they start eating more!). So, more important than the asset values on the balance sheet is the earnings power of the company.

The shift toward bananas has resulted in lower margins overall. The gross profit margin has dropped from 10.8% in 2007 (admittedly a peak year for margins) to 8.9% today. This has weighed on shares in recent quarters/years. But, the news isn’t all bad.

Over the past 10 years, the gross margin on bananas has averaged 5.1%. Other fresh produce has averaged 11.9% (I’m knocking out the “outlier” margins in 2002 and 2003 of 24.5% and 17.8%). Prepared foods have averaged 14.5%. If we assume last year’s sales levels can be maintained (46% Bananas, 44% Other Fresh Produce, and 10% Prepared Food), we get a weighted average normalized gross margin of 9.0% (basically right in line with last year’s 8.9%). SG&A along with interest and taxes have historically dropped gross margins by 5.5% to get to a normalized net margin of 3.5% (management initiated a wide reaching restructuring program in the 4Q11 to try and further improve net margins).

If management can maintain asset turnover at its 10y average of 1.55x, and leverage stays at today’s 1.5x (arguably low, see below), we get a normalized ROE of 8.1%. Jump leverage up to its historic average of 1.8x, and we get a normalized ROE of 9.8%. (ROE = Return on Equity = Asset Turnover [sales/assets] x Net Margin [net income/sales] x Leverage [assets/equity])

At 0.75x book value, for every $1 we invest, we earn $0.108 in normalized income [$0.081 / 0.75]. That’s a 10.8% return on our investment. At these types of valuations, as long as management can maintain sales, turnover, and margins, we are buying a 10%+ return investment. If they can actually grow revenues and/or improve fundamental metrics, we stand to see significant gain. Of course, the opposite is also true, but that’s where the balance sheet comes in.

The Balance Sheet
FDP has the strongest balance sheet in the industry. Debt to Capital is a very manageable 11%. Compare that to Dole (67%) and Chiquita (42%). Management also maintains a very healthy 2.4x current ratio and a 1.1x quick ratio as of most recent year end. In other words, no one on the industry is better positioned to handle stress, opportunity, or turmoil than FDP.

FDP: Banana Republic?
Finally, I would be remiss if I didn’t talk about management. Management is both a concern and a potential asset for FDP. There is some concern that CEO Mohammad Abu-Ghazaleh, whose family controls 34% of outstanding shares, and his Chief Operating Officer Hani El-Naffy, run FDP as their own Banana Republic. If you go out and Google FDP, you’ll likely find reference to a 1996 lawsuit over the purchase of the company by the Abu-Ghazaleh family from the Mexican government and whether a bribe was paid to hasten the process / lower the price – the lawsuit was ultimately dismissed.

On one hand, management is invested right beside us as shareholders. On the other hand, they are less than forthcoming on the details. This year’s annual letter was a whole ½ page – not exactly “long” on the details. On one hand I like that management thumbs its nose at Wall Street and focuses on running the business (you can almost hear management’s disdain for the analyst questions on the quarterly conference call). On the other hand, some outline of long-term strategy (I have no interest in quarter to quarter EPS targets) and where management sees the business going would be helpful.

Although management is less than forthcoming on details, they are major shareholders, have been committed to this for decades, espouse a focus on long-term value creation, continue to seek out new markets (leveraging management’s history in the Middle East) and new products (there was a reference on the 4Q call to a new pineapple variety in the next 2-3 years), and have recently reinstituted a dividend, which is now yielding 1.8%.

Conclusion
Although I personally don’t care for the taste of bananas, I continue to like Fresh Del Monte Produce. At current price to book and normalized return on equity levels, FDP is attractive. At this valuation, FDP stands to provide a healthy return even without growth and/or ROE expansion. If industry dynamics should improve, I feel we are getting a free call option on the improvement. With the backing of a solid balance sheet, it continues to be a part of my portfolio – an investment that I’ve increased on recent weakness. A warning for those looking for a quick buck however –most everything I just said could have applied as far back as 2008. Fairly warned be thee, says I.

Full Disclosure: Long Fresh Del Monte Produce (FDP)

Harvest Investor © 2012. 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.

Ceres Global Ag (CRP): 3rd Quarter Update

CRP reported 3rd quarter earnings (quarter ended 12/31/11) on February 9, 2012. Although I don’t want this blog to get bogged down with continual updates on CRP, I did want to give a brief update on what’s happening and my current investment thesis on the company.

3rd quarter numbers were, as expected, ugly. The low capacity utilization management had prepped us for last quarter translated into top line sales of only $22.6 million – the lowest in the six quarters CRP has owned Riverland Ag. Although there were underlying positives, such as “trading” gains that helped boost the gross margin to 21.5% (including this quarter, gross margin has averaged 14.3% in the six quarters since CRP purchased Riverland Ag), the bottom line remained negative with a loss of $0.11 per share.

More important to our investment thesis – the Net Current Asset Value (NCAV) of CRP dropped from $5.69 per share last quarter to $5.29 on 12/31/11. The biggest influences on this drop were an $8.4 million decline in “Due from brokers” (perhaps a result of the trading gains noted above?), a $5.0 million drop in Portfolio Investments (partially attributable to a $3.3 million mark-down due to “Change in fair value of investments”), and a $1.4 million drop in Accounts Receivable. An increase in cash and a decline in total liabilities (paydowns of debt and payables) were insufficient to offset these current asset declines.

Since my last CRP update, when the stock was trading at $5.00 (right before it dropped as low as $4.20), the stock has rallied back above NCAV to $5.90/share:

In effect, CRP is no longer offering “free money.” We now have to assume at least some value in the Property Plant and Equipment to justify the current share price. Specifically, we need to assume $0.61/share in long-term asset value to justify the current price ($5.90 – $5.29). With 55 million bushels of storage capacity and 14.691 million shares outstanding, this equates to $0.16 per bushel of storage capacity. Last fall, CRP management communicated to me that they feel elevator storage capacity is worth ~$1.10/bushel and they cited purchases by Bunge and Gavilon to justify this level. Are the elevators of Riverland worth $1.10/bu? I honestly don’t know.

I am more familiar with the country elevator system (Riverland has a mix, but the company’s focus seems to be on end-market and transport terminals). In the country elevator system, we are in the midst of an “upgrade” cycle. Older terminals are being refurbished, repurposed, or even abandoned as elevator companies move toward the economic advantages of shuttle loaders (elevator’s capable of loading 100-110 railcars within 15 to 18 hours). Of the 9 Riverland Ag facilitates listed on the BNSF.com website, only one – the 10.85 million bushel WB Duluth Storage facility – is shuttle capable. Will the same upgrade cycle hurt end-market and transport facilities? Or, is this phenomenon specific to country elevators, where it is easier to relocate a facility and you are more captive to rail shipments? I honestly don’t know.

What I do know is that today, even with the recent recovery in price (back above the NCAV), the gap between CRP’s share price and book value remains wide at nearly 50%:

At this level of discount, to earn a 10% return on our investment we need CRP to generate an ROE of just 5.4% (0.54 P/B x 10%). This equates to annual EPS of $0.58 ($10.83 book value x 5.4% ROE). Put in terms of profit per bushel of storage capacity, Riverland would need to earn $0.155 per bushel of capacity. Is this doable? Yes. Will CRP be able to accomplish the feat? Time will tell.

For now, I remain invested and am willing to give management the benefit of the doubt. Management owns in aggregate ~22% of the outstanding shares, which should give them plenty of incentive to be good stewards of our (their) capital.

With the stock trading at just 54% of book value (albeit a likely inflated book value), revenue and capacity utilization coming off very low levels, an inverted Minneapolis wheat futures, and even a small equity option through the Stewart Southern Railway, I’m willing to hold CRP for the interim.

For a good write-up on when to sell a net-net, see Geoff Gannon’s recent article “How Long Should You Hold a Net-Net?”

Full Disclosure: Long CRP

Harvest Investor © 2012. 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.

McRae Industries (MRINA)

• A nanocap equity (Definition: a market cap below $50 million). 
• A pink sheet stock that deregistered from SEC reporting back in 2005. 
• A dual class structure controlled (presumably) by the founding family. 
• Management that has yet to respond to information inquiries. 

Now that I’ve made sure no one is still reading this post, we can get started.

McRae Industries (MRINA) is a small North Carolina company that manufactures boots – western (cowboy) boots, work boots, and military boots. It sells its products under the Dan Post, Laredo, Dingo, John Deere, Johnny Popper, and McRae name brands. Annual sales over the last 5 years have averaged just shy of $70 million.

Now the above listed bullet points probably should have scared me off (and still might), but one overriding point peaked my interest – MRINA is one of those rare net-net stocks.  Even more uncommon these days, it is a profitable net-net.

As of October 29, 2011 MRINA reported liquid current assets (cash, accounts receivable, and inventory) of $42.416 million. This compares with total liabilities of $6.216 million for net current assets of $36.2 million. With total shares outstanding (A & B class) of 2.467 million, we get a net current asset value of $14.67. Closing price today (1/24/12) was $12.80 for a net current value upside of ~15%.

Over the past 5 years, MRINA has posted EPS numbers of (fiscal year ends last week of July):

Year	EPS
2007	$1.75
2008	$2.27
2009	$0.11
2010	$1.47
2011	$1.84

This equates to 5 year average EPS of $1.49. Keep in mind that this period includes one of the worst economic downturns since the Great Depression and saw only the second operating loss McRae in over 25 years (2009 reported an operating loss despite adjustments keeping EPS positive). On a price-to-earnings basis, this is a current P/E ratio of 8.6x, and earnings yield of 11.6%, and a Return-on-Equity of 7.6%. 

Cash Conversion	Jul-11	Jul-10	Aug-09	Aug-08	Jul-07
Reported Net Income	$3,829	$2,952	($514)	$5,041	$3,818
Cash From Operations	$2,234	$770	($1,075)	$5,420	$2,470
CFO/NI Conversion	58.3%	26.1%	n/a	107.5%	64.7%
Free Cash Flow
CFO - CapEx.	$1,412	$401	($3,131)	$5,232	$2,048
Net Income + Depr./Amm. - CapEx.	$3,636	$3,151	($2,006)	$5,338	$3,971
Free-Cash-Flow Yield
Shares Outstanding:	2,467
Current Price:	$12.80
Market Cap	$31,578
FCF Yield	CFO - CapEx		NI + D/A - CapEx
1 Year Avg. FCF	4.5%		11.5%
3 Year Avg. FCF	-1.4%		5.0%
5 Year Avg. FCF	3.8%		8.9%

(*all values in $,000’s unless otherwise noted)

One concerning item, however, is free-cash-flow (FCF). If we look at the statement of cash flows, MRINA’s Cash From Operations (CFO) has been substantially less than Net Income in 4 of the last 5 years. Depending on how you think of FCF, this may be a manageable risk since most of the drag on CFO has been additional working capital requirements. Does MRINA require additional working capital to maintain its competitive position and unit volume, or is this just balance sheet rebuilding after major inventory liquidation in 2009? Is the inventory build mainly in the military business, which MRINA cites in its 2011 annual report as “highly competitive as a result of troop draw-downs in Iraq and Afghanistan and the U.S. Government’s excess inventory of several styles of combat boots”?   Before I get a comfort level with MRINA more clarity on inventory will be an area of focus.

Still, I remain intrigued with this company. An 8.6x 5yr average price-to-earnings ratio, a 2.8% dividend yield, an invested and controlling family, and best of all – trading firmly in net-net territory. A few questions for management:

1. Can we get detailed financial information for 10+ years? 
2. Can you explain the dual class structure, class rights, and disclose who the primary owners of both A & B classes are? 
3. Sub question: Have any of the controlling shareholders announced share liquidation plans? What were the most recent insider transactions? 
4. Can you provide some segment level detail on inventory? Is the growth in inventory mainly military, western, or work boots? 
5. Can you talk about the operating loss in 2009 and how that adjusted to an EPS profit? Are the adjustments all related to the sale of Compsee or were there other events? 
6. What is management’s stance on the net-net status of the stock? Is there any plan to pursue value enhancing strategies (i.e. asset sales, additional share buybacks, etc.)? 
7. On the Statement of Cash Flows, there is a “Purchase of land for investment” line-item. Can you explain this investment? Is this property for future growth? Is it strictly for investment? 

I will keep you posted as I move forward with my MRINA research.

Disclosure: No current position, but reserve the right to initiate one at any time (if I can find the shares – MRINA trades extremely low volume).

Harvest Investor © 2012. 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.