I am always on the lookout for investment opportunities that conform to Benjamin Graham's deep-value criteria.
Graham is widely considered to be the father of value investing. He developed strategies for finding undervalued securities based on analyzing balance sheets. One technique he used for finding deep value stocks was called net-net investing, which values a company based solely on its net current assets.
The idea behind this method was that if an investor can buy a security for less than the value of its current assets, long-term assets are effectively free. Therefore, there should be a wide margin of safety between value and price, which should yield good investment returns.
The formula Graham used was: Net-Net Working Capital = Cash And Cash Equivalents + Short Term Investments + (0.75 * Net Receivables) + (0.5 * Inventory) - Total Liabilities
One company that recently appeared on my radar that is trading close to net-net working capital is the construction company Tutor Perini (TPC, Financial).
Tutor describes itself as "a leading civil, building and specialty construction company offering diversified general contracting and design-build services to private clients and public agencies throughout the world." Its legacy stretches back to 1894.
However, the business has fallen on hard times over the past few years. Revenue and profit growth have stagnated, and the firm has had trouble collecting debts from clients.
This has lead to an unusual situation with the shares. The stock is currently dealing close to net-net working capital value, according to my figures, and there's a value-unlocking catalyst on the horizon.
Net-net value
At the end of September, Tutor had cash and short-term investments of $281 million, receivables of $3.2 billion and $162 million of other current assets (there was no inventory). Total liabilities were $3 billion at the end of September. This yields a net-net working capital value of around -$150 million.
So the stock does not meet Graham's criteria just yet, but the $594 million company also has $900 million of long term assets. Adding these in appears to give a substantial margin of safety.
Deep value stocks can remain cheap for years if there is no catalyst to unlock value. It seems as if there is with Tutor, which is why I think this business could be worth further investigation.
Management is working through the company's backlog of receivables to unlock cash. It seems to be making good progress. In its third-quarter earnings report, Tutor declared that it generated "a new quarterly record $222.9 million of operating cash for the third quarter of 2019 compared to $27.6 million for the same quarter last year."
The report goes on to state that this cash is coming from "collections associated with certain dispute resolutions, as well as from the Company's continued focus on improved working capital management."
Further, management said that "Operating cash flow is expected to be solid in the fourth quarter and in 2020, as the company expects construction activities to increase significantly and several of its larger projects to generate higher revenue and earnings."
The bottom line
All in all, it looks as if 2020 could be a successful year for the group, with plenty of free cash flow as well. This could be the catalyst that is required to unlock the value on the balance sheet. Improved earnings and collections of receivables would enhance the quality of Tutor's balance sheet and allow it to reduce debt.
Wall Street analysts have the stock trading at a forward price-earnings ratio of just 5 and a price to free cash flow ratio of 6.6. It might be worth keeping an eye on this construction business as it pushes forward with its plans in 2020.
Disclosure: The author owns no stocks mentioned.
Read more here:
- Buffett: Benjamin Graham 'Wasn't as Interested in Business as I Am'
- A Look Back at Warren Buffett's $37 Billion Derivitave Deal
- Learning From Charlie Munger's Investment Approach
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