The situation goes something like this: a company has two segments and is currently earning $2 per share.However, one division is earning $3.50 and the other division is losing $1.50 per share. The company’s stock is trading for $20, or a 10x P/E.
By selling that money losing division off, suddenly the company is earning $3.50 per share and the stock looks ridiculously cheap at $20. Plus, management has a ton of excess cash from selling thatmoney losing division of, and can now use it to buy back cheap shares. A double whammy, if you will.
Well, I think Kreisler (KRSL) presents an opportunity that is somewhat like the situation Greenblatt mentions…. except in Kreisler’s case, the money losing operation has already been sold and we can already see the effects on the financials.
Per their old 10-Ks, Kreisler
manufactures precision metal components and assemblies for use in military and commercial aircraft engines and industrial gas turbines. Kreisler Industrial’s products primarily include tube and manifold assemblies of multiple sizes and configurations and are typically manufactured in accordance with customer designs and specificationsSo that’s what they do. Here’s the story of what makes them so interesting as far as I can put it together. Note that the company went private in 2009, and while they have continued to report financials ,their level of disclosure / color in their financials noticeably decreased after going private, which makes the story more difficult to put together. So please spot check my work if you’re interested in the company.
Kreisler enjoyed a life of pretty steady earnings. I went all the way back to the 2006 income statement, and what I find is a company that enjoy consistently strong (but not outrageous) profits and enjoys strong ROIC. Operating profit was $1.8m in 2006 and over $3m in 2007-2008. The company was enjoying such strong profits, in fact, that they decided to open up a plant in Poland that would provide “machined components” to the company’s main New Jersey plant.
Sounds great, right? Well, the financial crisis happened, and earnings fell off a cliff. The company earned only $400k in 2009 and lost $1m in 2010 and $550k in 2011.
So we have a cyclical that made strong profits in the up cycle and got clobbered during the downturn. Move along, nothing to see here, right?
I don’t think so. You see, Kreisler sold the Polish sub at the end of fiscal 2012 for basically nothing (well, not nothing. They got $10. Not $10m or $10k. $10 american dollars). Not only did they get nothing for the Polish division, but they wrote off $5.3m in intercompany debt. This is for a company that had a book value under $20m before the write off. Ouch.
But selling the Polish division off revealed something- the core business was still profitable!!!! Per the most recent annual report, the Polish sub lost $1.6m in 2012 and $1.2m in 2011. After adjusting for that, Kreisler’s “core” business earned $560k in 2011 and $3.7m in 2012.
Now we’re talking. If we assume the Polish business lost a similar amount in 2010 and 2009 as it did in 2012 and 2011… well then, we can see that the core business has stayed profitable throughout the downturn! And with that information, we’re no longer talking about a cyclical, we’re talking about a business with some economic sensitivity but a proven ability to generate profits in even the worst environment!
There are other goodies. Kreisler has a strong balance sheet- $2.2m in cash vs no debt, current assets outnumber total liabilities more than 4:1, and an untapped credit line that they just renewed to provide them liquidity if they need any. And while there are some related parties red flags, if the information from their last proxy before going private is still reliable, management pay is reasonable and their interests should be well aligned w/ shareholders given their 40% equity stake. Related to that equity stake, and perhaps my favorite stat in this whole article- Kreisler hasn’t issued a single new share since 2007. That means current shareholders can feel confident that their ownership stake won’t be getting diluted as the company continues to turn profits
So, with all those positives we’re really not paying much for Kreisler. Trailing EBIT, after adjusting for the disposal, comes in at $3.7m. I’ve got their enterprise value around $11m and their market cap at about $13m. So we’re paying somewhere between 3-4x profits for KRSL.
Are the some negatives? Sure. I mentioned the related party flags early, and the company gets ~65% of sales from two customers.
But I think those are all outweighed by the current cheapness.
I’m not currently long shares- I think I have some (slightly) better idea, and I need to get more comfy with the business and story before I can consider going on. But take a look at this one, because it’s interesting and I’d love to hear your thoughts.
Disclosure- no currently, but who knows in the future?