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The company seems to finance the growth of the new operations and investment portfolio from the transportation business as well as debentures, a unique and different approach from the typical reinsurance arm operations skillful investors seem to operate.
The company has done fairly well on a 10-year consolidated basis.
· Long-term debt has been consistently paid down while shares have been bought back at an annual rate of roughly 4%, the most recent three-year average being 13.8%. (The company repurchased 370,402 shares during the 2012 year.)
· EPS has remained fairly stagnant over the last decade while book value has grown at an annual rate of 10%.
· Operating earnings, margins and revenues have all been growing, adjusted for the cyclicality of the transportation and investment business.
· I believe a fair estimate for the normalized operating income to be in the range of 4% to 5% of revenues.
· Normalized ROIC of 10% to 12%.
· Retained earnings had a very large draw down in 2008, including the losses of paid-up capital, the retained business earnings have grown at a rate of 5% to 6% over the ten year period
There has been heavy insider buying in the most recent three-month period from $4.60 to $5.73 per share leading to over 2.3% ownership between two people, Charles Pellerin and Michael Rapps. The dividend is also fairly safe, (based on present metrics of just over a 27% payout) although the dividend policy was abandoned in the recession (Aug. 31, 2008), it has grown by over 60% since being re-implemented in 2012.
The Business and Competition
There is a large amount of competition in the transportation business (that is where the focus of my attention is as it derives the largest portion of revenues and cash flow, currently). The (transportation) competition Clarke faces is most likely to be from indirect large capital-based logistical business like FedEx and UPS, railroad companies and small boutique delivery services. The direct competition within Canada to Clarke may be viewed as Contrans Group, Trimac Transportation, Transforce and Wheels Group, of which the largest (based on market capitalization) is Transforce.
Another large portion of the business is the commercial tanks and home heating segment. Emera (Nova Scotia Power is a wholly owned subsidiary) and Bullfrog Power, as well as countless boutique operations owned privately are the competitors in the space Clarke should be aware of. The "Other" segment consists of real estate used primarily in the freight transportation segment, together with the company’s IT services, human resource and treasury functions and private investments in associates. The results of the pension plans are also reflected in the other segment, as well as the interest payable on the 2013 debentures.
Operations and Competitive Advantage
The company's accounting policy seems conservative, revenues are recognized when they are received, marked-to-market securities portfolio is in existence and a first in first out inventory policy in place. The competitive advantage almost entirely lies in the management’s capability at identifying opportunities and allocating capital efficiently. The geographic advantage also has a strong presence in Clarke’s business model and as Eastern Canada continues to grow they will likely prosper.
The operations are more easily identified on a segmented basis, with the growth of the commercial tank and home heating business leading over the last few years. At this point I will refer you to note 24 of the (2012) 10-K to view the segmented information in more detail.
The four largest investments that Clarke is currently holding in their portfolio are as follows for the period ending Dec. 31, 2012. (A summary of the investee performance is provided in more detail by management in the 2012 annual report and recent 10-Qs.)
1. Royal Host (owning 30.10% of total outstanding shares)
Royal Host’s core businesses are hotel ownership and franchising. Royal Host owns 23 hotels (comprising 2,957 rooms), and franchised 91 locations (including 13 owned by Royal Host) under the Travelodge and Thriftlodge banners.
2. Bonnett’s (owning 24.91% of the total outstanding shares)
Bonnett's is a trusted name in downhole operations. Their core service areas are wireline, swabbing, production and testing, as well as oilfield rental, fishing and pipe recovery in the Western Canada Sedimentary Basin.
3. TerraVest (owning 32.09% of the total outstanding shares)
TerraVest is one of the largest providers of wellhead processing equipment for the natural gas industry in western Canada and a market leader in providing well servicing for the oil and natural gas sector in south western Saskatchewan.
4. Supremex (owning 45.20% of the total outstanding shares)
Supremex is Canada's largest manufacturer and marketer of envelopes, labels and related mailing products. They provide stock and custom manufactured envelopes and mail packaging products to Canadian and US customers.
Balance Sheet and Profitability
In the latest quarter the debt to equity ratio was 1.2 with moderate leverage applied to the capital structure. The increase in the current portion of liabilities is attributable to debentures due Dec. 31, 2013.
· Current ratio of 2.43.
· Acid ratio of 2.09.
· Cash and cash equivalents: $75.54 million or 4.50 per share.
· Book value per share: $5.75.
· Dividend yield of 6.55% at a payout ratio of just over 27%.
As the success continues in the investment side of the business combined with double-digit growth in the commercial tank and heating business, I would expect the share buybacks to continue and the dividend to be raised consistently.
Value and Price
At $6 PPS the market capitalization is $100 million with 16.57 million shares outstanding. Using quick conservative estimates to discount the cash flow I find the following. Using a discount rate of 10%, a cash flow growth rate of 4.5% over the next five years, using 4% there after, leads to an intrinsic value of roughly $11.50 per share for Clarke Inc. From the current price, that would indicate almost 100% upside or a margin of safety close to 50%. My belief is that Clarke should trade at a more appropriate multiple of 10x to 11x trailing 12-month earnings, which would also lead to a present valuation of $8 to $9 per share. Currently offering a 13% earnings yield, combined with a 6.5% dividend is just shy of 20% expected yield.
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Clarke Inc. seems to also be considerably cheap on a FCF yield basis and generic GuruFocus.com-projected DCF. My calculations were a little more conservative.
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Currently trading just above book value, the growth of the business or the future investment prospects of management are not included in the price, exactly what bargain hunters like myself would like to find in an investment.
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About the author:I am working towards the CPA & CFA designations, and would love to manage an investment partnership in the future. I am a self taught investor through Warren Buffett, Charlie Munger, Ben Graham, Peter Lynch, Joel Greenblatt, David Einhorn, Seth Klarman, Howard Marks, Phillip Fisher and Thornton O'Glove. My focus is a bottoms up Value-GARP strategy with a mix of top down contrarianism.
"When you find yourself on the side of the majority, it is time to pause and reflect." - Mark Twain