Buffett-Munger Screen: Chase Corp

Buffet-Munger Screen: Chase Corp

Overview

Chase Corp, founded in 1946, produces and supplies specialty industrial and construction materials that are intended to improve the safety and quality of its customer's products in the global telecom, utilities, electronic, and construction industries. Typical products and applications include specialty tapes, laminates, sealants, coatings, and electrical wiring and insulating materials. Products in its construction materials segment include protective pipe coating tapes and other protectants for valves, regulators, casings, joints, metals, concrete and wood. These products are mainly sold to oil companies, gas utilities, pipeline, and infrastructure development companies.

As a specialty maker of multiple forms of tapes and sealants, the company could easily be described as a "boring firm." For a boring firm, however, the company has been able to achieve exceptional growth, with sales compounding by 11% per year since 2004--which is actually pretty exciting.

The company is concentrated primarily in the U.S. with manufacturing, supply chain, and sales infrastructure targeted to serve a technically advanced client base. They have sales and manufacturing facilities in 5 States. CCF also has a sales and manufacturing presence in China and England. The company reports results for two segments--industrial materials and construction materials.

CCF experiences some seasonality in sales as demand in the construction market is often higher when temperatures are warmer (April through October) with less demand occurring when temperatures are colder (second fiscal quarter).

The company's key strategic focus is to achieve top and bottom line growth driven by sales in its existing product lines and sales from new product innovations and new product applications. The firm is seeking organic growth and will focus on strategic acquisitions that complement its existing business lines.

Perhaps what is most impressive about CCF has been its ability to continue to unlock value while selling largely commodity-type products. In addition, its future prospects remain bright with sales expected to grow as the construction sector rebounds following the housing crisis and recession. The company has demonstrated consistent earnings power--even on fairly tight margins--and its cash generating ability remains strong. It has also begun to divest itself from less profitable divisions.

Given the cyclical nature of its industry, it is important to note that while sales and earnings remain strong now, this could change if construction spending or spending in the energy sector slows. As long as raw material costs remain stable, the firm hedges its purchases and currency exposures effectively, and Chinese competition does not overwhelm the market, then the firm's cost structure looks reasonable.

Also, in part due to the commodity-type nature of its products, the shares should not be viewed from the perspective of a potential growth stock. CCF is a relatively small company and its stock could be punished badly if growth slows.

Purchase Considerations

• Recent and expected continued improvements in construction and energy spending will support sales.

• Good financial and cash-flows to support new acquisitions.

• Product quality is highly regarded.

• As of October 31, 2013, the backlog of customer orders believed to be firm was approximately $16,546,000.

• The company is consistently profitable.

• Shares are trading at reasonable multiples.

• The firm has strong untapped geographic markets outside the U.S.

• The firm is an attractive takeover target.

• The firm has a relatively low level of debt.

• Customers have shown loyalty to CCF due to risks of product/service failure in their own product/service lines.

Reasons for Caution

• Maintaining sales growth in the face of growing competition from China could prove tricky.

• The risk of future margin compression remains highly uncertain.

• Volatility in energy prices will translate into volatility in energy spending and, hence, volatility in CCF sales to energy customers.

• CCF is experiencing some inventory build-up; investors are well advised to continue to monitor CCF's inventory position.

• The company is more leveraged than it was 3 years ago.

• Non-existent share repurchase activity.

• CCF competes in a very competitive industry.

• Declining sales and earnings for such a small firm could quickly scare away share buyers.

Market-Based Price Multiple Valuation

As an initial step towards evaluating CCF, we have assembled the 15-yr historical record of the company’s Price/Sales, Price/Earnings, Price/Free Cash-Flow and Price/Book Value ratios as shown below. After reviewing the distributional properties of the multipliers around their respective means, we are confident about using multiplier values of 1.0, 13.0, 15.0, and 1.7 respectively. Based on our experiences with the industry, we believe that earnings and free cash-flows are particularly important predictors of company value. Consequently, instead of finding an equally weighted price average, we decided to apply the weights shown below for calculating a weighted average estimated price.

To do this, each expected multiplier was multiplied by the corresponding variable for the company’s expected average 10-yr forward sales, earnings, free cash-flows, and book value per share. We then decided to overweight earnings and free cash-flows and derived a fair value estimate for CCF of $29.66, which is just slightly below its current value.

Table: Historical Multipliers, Distributional Properties, Expected Multipliers, Multiplier Weights, and Average 10-Yr Forward Per Share Sales, Earnings, Free Cash-Flow and Book Value

Conclusion

CCF is a great company and a successful producer of specialty industrial and construction products. Our analysis of the company’s stock, based on a market-based price multiple valuation approach, suggest that CCF is valued at $29.66, which is slightly lower than its current valuation. However, this is definitely a company worth keeping your eye on! With continued revenue strength and a further push in earnings, this stock could quickly break-out. That being said, investors are cautioned against being overly emotional. This is a commodity-type firm that will likely experience increasing competitive pressures from China in the years ahead.