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A pinksheet net-net gem - McRae Industries $MRINA
Posted by: whopper investments (IP Logged)
Date: March 20, 2012 07:36AM

I’ve been beating my quest through the pink sheet stocks over your heads lately, and I’ve definitely found a couple of interesting stocks (including ELXS and JLMC). So far, however, I haven’t found anything that had everything lined up just right to make me invest in it.

That is, I hadn’t found anything until now.

***Note- as I’ve done several times, I’m writing this ahead of time (Feb. 28) and placing a bid for the stock (at $13.16). If my bid goes through or the stock runs up, I will post my article in the future.**** Update- the stock ran up, and I never got an order filled. Sad.

The company is McRae Industries (MRINA, see their financials here).

McRae sells boots. We could go into a further breakdown of what they do, but there’s honestly no need. As you might expect of a company in the boot industry, McRae is pretty much a commodity company with commodity company like returns. ROE has averaged ~8-9% over the past 10 years, with them turning a slight loss in FY 2009 (note that their FY ends at the end of July) but modest profitability in every other year.

Honestly, that’s the big downside here- no one is ever going to mistake McRae for Nike or Under Armour. These guys are never going to create value by investing at a higher rate than their cost of capital. This isn’t the stock for a “wonderful business at a reasonable price” investor- of course, I don’t think I’ve mentioned anything that would begin to qualify for that category in the past three months, so why would you expect it to be?!?!

Now that we’ve got the negatives out of the way, let’s move on to the positives. Because there are plenty.

First, price.

At McRae’s current price of ~$13.05, they’re selling for a big discount to both NCAV value ($14.80) and book value ($19.55), as well as just 8.2x trailing earnings. Most of their book value consists of accounts receivable, cash, and inventory. Given the inventory is boots, even in a liquidation scenario I don’t think there’d be too big of a mark down on their assets. In other words, you’re likely buying into McRae at a discount to their liquidation value.

Second, I like that book value is growing.


There are two big fears with net-nets.

First, that you’re investing in a melting ice cube- you buy in at a discount to NCAV, but the company is losing so much money that the discount disappears.

Second, that you buy into a “dead money” stock where the company trades at a big discount to book but the book value basically stays flat for years and years due to constant break even results. The company ends up getting taken out at book value, but you make a terrible annualized return because the company’s value never grew.

The first problem is a much bigger risk than the second, because it would result in serious and rapid impairments of capital, but obviously the second scenario would be terrible as well.

I don’t think either is a risk with McRae. The company is profitable and has been profitable consistently. More importantly, they’ve shown a good ability to compound wealth. At the end of FY2001, they had a book value of $27.4m w/ 2.77m share outstanding, for a book value of under $9.90. At the end of FY 2011, they had a book value of over $47m w/ 2.48m shares outstanding, for a book value of just under $19.00. In addition, they paid cumulative dividends over $3 per share over that time frame.

If we assume those dividends were reinvested at a 0% rate of return, and that book value equals IV, then the company basically grew IV at 8.5% per year. Again, are they creating vast sums of wealth? No… but neither are they destroying it! They are basically investing at their cost of capital. There’s nothing wrong with that!

So the company has shown that they can increase book value and they’ve shown a willingness to return excess cash to shareholders through dividends and share repurchases. To me, that takes capital allocation mismanagement, another of the big risks with net-nets, off the table.

Speaking of management, they seem excellent here. New info is hard to come by, but reviewing their last proxies from 2005 (before they delisted and moved to the pinks) shows management owns 35%+ of the company, takes a very reasonable salary with limited bonuses, and generally seems to treat their fellow shareholders as partners in the business. This could have changed since they went private, but everything here speaks to management running a tight ship and only doing well when shareholders do well. In addition, management has shown a willingness to sell under-performing businesses, something quite rare in the corporate world today.

So that basics of the investment in MRINA is this- the company should be worth tangible book value, maybe a slight premium to it. They are trading for a huge discount to tangible book value. Thus, you’re investing with a very nice margin of safety.

So there’s clearly asset safety here. But is there upside?

In a word, yes. I think there’s pretty significant upside.

To illustrate, let’s do a very, very quick, conservative, and simple example.

Say you can invest at $14 per share. Further, let’s assume the company stops paying a dividend and compounds book value per share at 8% for share for the next five years (these are very, very conservative assumptions. The company has compounded book value faster than this over the past five years while paying a dividend! In addition, if the company continues to repurchase shares below BV, this alone would drive growth in BV per share). If they do this, the company’s BV per share would come out to ~$28.75 in five years.

Assuming they then sold out for book value, your annualized return would come out to 15.5%.

Not bad for a low risk investment in a “boring” industry.

Disclsoure- None as I write this article. May be long MRINA when it posts.

Stocks Discussed: ELXS, JLMC, MRINA,
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