Thursday, April 16, 2015

Buhler Industries (TSE:BUI): Inventorying this Net-Net

I have to admit, Buhler Industries (TSE:BUI) calls to me like a siren’s song.  What can I say, I have a weakness for net-net stocks.  And in many ways, BUI is my ideal net-net:
  • It’s in an industry I (sort of) understand: Farm Equipment Manufacturing.
  • It has a long history of profitability: EPS have been positive in every single fiscal year going back to at least 1993.
  • Its foray into 4WD tractors has been initially successful based on reviews of its Versatile DeltaTrack models.
  • Best of all, it trades at a discount to net current asset value (NCAV). As of December 31, 2014, NCAV was $5.56 per share, compared to the current quote of $5.20.
A historically profitable company trading at a discount to liquidation value - a rare find in this market.

Now, admittedly, there are issues surrounding BUI that give one pause, not the least of which is the ownership structure:
  • Despite having a market cap of C$130,000,000, BUI has a very low float.
    • In 2007, Combine Factory Rostselmash Ltd, a Russian manufacturer of combines, bought 80% of Buhler. The company remains headquartered and operated in Canada (with some U.S. manufacturing facilities), but the new owners have provided a potential growth avenue into Russia and Eastern Europe through co-marketing with Rostselmash.
  • John Buhler (the retired CEO, current Board member and namesake of the company) still owns 14.5% of outstanding shares as of the most recent proxy. 
  • The company’s deferred profit sharing plan owns another ~1%.
All told, BUI has a float of only ~4.5% of shares outstanding. This is 1,125,000 shares, or less than C$6 million at current prices. To say we would be minority shareholders in this stock seems like an understatement. 

While these issues certainly play into any purchase analysis, more concerning to me is the growing imbalance between revenues and inventories. In fact, many short sellers will use slowing sales and continued additions to inventory as a textbook screen for short ideas.

Now, arguably, some of this growing disparity is likely priced into shares considering they are trading for slightly less than NCAV. Yet, when we compare BUI’s numbers to peers, it is staggering how large its stockpiles of inventory and accounts receivable have become:

Among peers it has (usually by a wide margin):
  • The longest receivables collection period
  • The most days inventory on hand
  • The highest inventory per employee
  • And, despite a slowing ag economy, saw both its accounts receivables and inventory grow over the past twelve months.
In other words, I have some doubt that BUI could liquidate itself for NCAV. Additionally, BUI is having trouble converting working capital assets into cash (it has virtually no cash on hand), as evidenced by the receivables aging trends shown below:

As the above table from the 2014 annual report (year ended 9/30/14) shows, there has been a dramatic spike not just in accounts receivable, but particularly in the accounts receivable delinquent. In total, 17.2% of receivables are past due, with 10.1% of the total over 30 days delinquent. Comparatively, 6.4% of receivables were past due at the end of fiscal 2013, and a more manageable 3.5% were over 30 days delinquent.

Finally, due to balance sheet leverage, the margin of safety associated with this net-net could quickly disappear. Current Assets / Total Liabilities come to only 1.89 as of Dec. 31, 2014.  Although not a hard and fast rule, I use the rule of thumb that a net-net should have CA/TL of  at least 2.0 to lessen the impact of financial leverage on my margin of safety.  At a reading of 1.89, even a small receivables write-off and/or inventory discount could significantly impact Buhler's book value and NCAV:

So all this leads me to the question: what is Buhler Industries worth?

Over the past 10 years, BUI has averaged annual EPS of $0.43. Assign a 13x multiple to this (not sure why I chose 13, but it seems right given minority shareholder status) and we get an intrinsic value of $5.59.

Backing into valuation a slightly different way, over the last decade ROE has averaged 9.0%. To get a 10% annual return on a 9.0% ROE stock we should pay 0.9x book value.  Again, assume we take a discount for minority status, and we could in theory pay 0.8x book value for shares. At a recent book value of $7.79, this comes to $6.23 (and assumes there will be NO write-downs in accounts receivable or inventory, which I’d be surprised to see happen).

If we feel intrinsic value is somewhere between $5.50 and $6.00 per share, and since I like to buy at a discount, I’m not going to get too interested in Buhler until I see a price in the low $4 range (and even then, I’ll still need to get comfortable with my standing as a minority shareholder and who is the marginal buyer of BUI).

Ironically, a price in the low $4's would be pretty close to the old Benjamin Graham rule of buying a net-net at 2/3rds of NCAV.  So all that work I just did in the preceding paragraphs could be summed up by a very simple quantitative rule developed over 80 years ago.  Maybe there's a lesson for me there?

Full Disclosure: I own a handful of BUI shares (mainly for tracking purposes). I do not consider BUI a position in my portfolio.

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