Recently, I’ve been on the lookout for micro-caps w/ Mario Gabelli present as an activist, as I’ve seen several situations where he got involved and caused quick and serious value realization for shareholders (CIBY was just one example that I missed out on).
So I was quite interested when I saw this letter from him to the board of Starett (NYSE:SCX) requesting they eliminate their poison pill so he could acquire more than the 15% of the company he already owns. And, after diving into the company, I do agree with him- Starett is quite undervalued… but it’s also comes with a good deal of risk!!!
But we’ll get there. Let’s start with an overview of the company.
Starett makes tools for measurement. They’ve been an industry leader for close to 150 years (131 years according to their 10K, but what’s a decade or two between friends?)- that’s stability! Their products are also pretty easy to find if you want to check them out- here’s an amazon page with an overview of plenty of their products. And their products are pretty highly reviewed- this product review gets includes the quote
As a finish carpenter for the last twenty years and a comitted tool junkie I am always looking for the next tool that will make my life easier. A friend recommended this tool for doing crown molding so I thought why not? I am finding that his advise is well taken. It works great and I find myself using it for more applications that I anticipated, and it has earned a place on my tool beltWhat I really like about these products after browsing through them is that there is almost no risk of obsolescence. Carpenters, plumbers, etc. will always need tools like these to perform their jobs.
So enough with the qualitative; let’s hit the quantitative.
Actually, before we do that, I’d be remiss if I didn’t point you to Saj’s write up on the company a few years ago, as he covers many of the points I’m going to discuss! See here, here, and here.
At today’s price of ~$11.75, the company trades for a market cap of $80m. This is against book value per share of ~$22, tangible book per share over $20, and NCAV per share (net current assets less all liabilities) of ~$8.20.
Honestly, those numbers alone are pretty attractive. But there’s reason to believe book value significantly understates the value of SCX’s assets. Check out this note from their last 10-Q
That’s a LIFO reserve of $27m, or $4 per share! That’s huge on a stock price under $12.
Now it is true that realizing that LIFO gain would take liquidating the inventory and likely incur taxes to boot… but it doesn’t change the fact that their are a lot of assets sitting hidden on the balance sheet!
There are also other things to like about SCX- the balance sheet is relatively strong despite more leverage than I’d like (I know that sounds weird for a net-net, but we’ll talk about it in a second!), and the company has shown an ability to make pretty decent returns during more normal economic times (most of their products are tied to construction and housing, so they’re very levered to the economy).
However, there are also some concerns.
First, the company has more leverage than I’d normally like. The company has about $30m in debt. Granted, that’s a drop in the hat compared to how big their tangible assets are, but it given this is a somewhat cyclical business it will be cause for concern if times continue to be rough. Also of note- $15m is a term loan on what I view to be very favorable rates (10 year, 4.5% interest rate, monthly principal and interest payments).
There’s also a pension and post-retirement plan that is, in total, underfunded by $23m. While that doesn’t sound huge, the total benefit obligation is over $130m (combining the pension obligation w/ healthcare obligation). I can’t find the traditional table w/ the sensitivity to discount rates, but it looks like the company is using ~5.5%. If you decreased the a little bit, you could be talking a significant increase in the liability. They’re forecasting pension payments of $6.5-7.0m each year for the next five years, so while all of this may sounds small and nitpicky… I think it is a real concern (of course, it is true that much of those payments will be covered by plan assets and returns- but if their plan doesn’t meet their expected return of 8%….)
Second, insider ownsership is shockingly low considering the current CEO bears the same last name as the company. Check this ot.
The CEO makes ~$500k and has accrued about $1m in pension/ post retirement benefits. His equity stake is worth ~$900k. What do you think he’s more concerned with: increasing shareholder value or growing at all costs to increase annual raises??? That said, I will admit his salary is quite small compared to the revenue size of the company, so give him credit on that count.
Speaking of name, the company has a dual class structure and a poison pill in place. It seems like they’re trying to make it impossible to be bought out!
So those are the negatives (as I see them). Quite honestly though, I think they’re out-weighed by the positives. I’m not alone in that- check out the list of investors with major stakes
Those are three serious value / quant value funds. And Gamco has only upped its stake in the company since then.
Currently, I’m not long SCX. I simply don’t have any cash available to invest. But I do think it’s undervalued, and as cash frees up in my portfolio I wouldn’t be surprised to take a position in it.