Note- as I’ve done several times (most recently with McRae (MRINA)), I’m writing this post in advance (writing on March 20, 2012). As I prep to release this on May 24, I’ve accumulated a decent chunk of shares, and would happily buy more if the price would come down further.
The thesis for RSKIA is incredibly simple: the company trades for a huge discount to what any private buyer would consider paying for them.
RSKIA has two sources of value: a huge investment / excess cash portfolio, and the core business. Once you add the two of them up, it becomes clear just how undervalued the stock is at today’s levels.
Let’s start with the investments, because they’re much easier to value. The company has ~$25m in excess cash and investments, split about 40%/30%/30% between munis, cash, and stocks. With 5.1m shares outstanding, this represents ~$4.90 in cash and investments per share.
So at any price below $6, you are paying $1.10 per share (or less!) for RSKIA’s core business. As you will see, that price implies a value of less than 2x EBIT for a business with consistently outstanding ROIC that throws off gobs of cash.
Let’s start with the ROIC. In the past twelve months, RSKIA has earned over $2.7m in EBIT. They’ve done this with less than $4m in invested capital. That implies a pre-tax ROIC of almost 70%! This is no anomaly- ROIC has consistently been outstanding, and even in their worst year on record (FY 2010), ROIC was above average.
So now let’s look at what you’re paying for a company that can consistently earn out of this world ROIC. Here’s RSKIA’s EBIT for the past six years (from FY 2006-2011): $4.1m, $3.7m, $2.9m, $2.7m, $1.1m, $1.8m. That’s an average of $2.7m in EBIT, with a low of $1.1m and a high of $4.1m. They’ve only reported the first nine months of fiscal 2012, but EBIT has grown from $1.1m last year to $2.1m in the most recent nine months. Trailing twelve month EBIT comes in right at their average, $2.7m.
RSKIA has 5.1m shares outstanding. Applying that to their EBIT numbers, the lowest they’ve earned in the past six years is $0.216 per share in 2010. The highest is $0.804 in 2006, and their average and trailing numbers come in at $0.529 ebit per share.
If I assume a 35% tax rate (which seems fair, and is about what they’ve paid in the past), their average net income comes in at $0.34 per share. Given the business’s consistentcy and high ROIC, I’d guess it deserves at least a market multiple. I’ll use 16x (the current market multiple) as the high end and 10x earnings as a bear case (for a business to be worth less than 10x earning, it would generally have to be in pretty clear secular decline). Note that w/ our 35% tax rate, these multiples translate into 10.4x and 6.5x EBIT, respectively. Quite conservative.
Assuming those multiple, the business is worth $3.40 on the low end and $5.44 on the high end. If we applied the same multiples to RSKIA’s lowest EBIT figure ($0.216 per share in 2010), we’d end up w/ a business value of $1.40 on the low end and $2.25 on the high end.
So, using quite conservative assumptions, and adding back their $4.90 per share in cash, we end up w/ an IV of $8.30 to $10.34. Even if we took their absolute worst earnings and applied them as normalized, we’d get an IV of $6.30 to $7.15.
But none of that is exactly revolutionary info. You could have easily found by checking their morningstar summary page out. What I think makes them really interesting is a few key lines buried in their most recent 10-Q in their results of operations section:
Remember, the quarter ended Jan. 31- so the price increases were only in place for one month (1/3 of the quarter). Provided the increases stick (and it seems like they have), and volume remains relatively flat, this price increase means revenues and, more importantly, margins/profits are both going up this year. It also shows that the company has some pricing power.
Even though the majority of the Company's products are tied to the housing market, the increase in sales is a result of the Company focusing on gaining market share in the industry. The Company is accomplishing this by having excellent customer service and being willing to make many customized parts. Cost of goods sold was 48.26% of net sales for the quarter ended January 31, 2012 and 50.41% for the same quarter last year. Year-to-date cost of goods sold percentages were 49.1% for the current nine months and 53.75% for the corresponding nine months last year. Management continues to keep labor and other manufacturing expenses down and strives to stay in the desired cost of goods sold percentage range of 45 to 50%. Also, management raised prices at January 1, 2012. The price increase helps in-crease the gross profit
The bit about gaining market share is interesting as well. RSKIA is tied to the housing market- if their revenue / profit gains are coming completely through pricing power and market gains, imagine what’s going to happen to profits and revenues when the housing market finally turns!
There’s plenty more to like about RSKIA (as well as some things not to like!), but I think I’m going to leave the article on that thought. Beware that the stock is very illiquid w/ a large bid-ask spread, so be sure to use limit orders and exercise patience!
Disclosure- Long RSKIA