The investment analysis below is our fourth in our ongoing series of guest write-ups, and is brought to you by friend of the blog Shaun Noll, CFA. Shaun is a member of the Distressed Debt Investors Club, a contributor to Sum Zero, and the founder and managing partner of Stirling Capital Management.
With a strategy and mission similar to our own, we think that Stirling Capital has carved out a “better way” for investors to protect and grow their wealth over time. As Shaun puts it, “Stirling Capital Management is a client centric performance oriented investment firm based in San Francisco. We are primarily conservative, deep value investors but we scour the globe for opportunity in any asset class with asymmetrical risk versus return characteristics. From an innovative fee structure to dynamic investment strategies, every aspect of the firm is designed to address the flaws of the traditional wealth management industry.” Nice
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Below is Shaun’s analysis on Envirostar (EVI, Financial), enjoy!
EVI: Envirorstar
Current Price: $1.15
Price Target: $1.90
EVI is a well run company with 60%+ of shares owned by management that has an absurd amount of cash on the balance sheet, no debt, and trades at a ridiculous valuation with a few likely catalysts.
EVI primarily distributes commercial and industrial laundry and dry cleaning equipment including a proprietary line of dry cleaning machines (98% of revenue) with a focus on environmentally friendly dry cleaning methods and equipment. There is even a “green” angle here for you environmentalists! Overall prospects for this business are not great but not terrible. Much of their dry cleaning products sales goes into hotels, hospitals etc, which is obviously very weak. They do have some good growth into international and latin America though, which is ~20% of their sales and growing. Not exactly the most “sexy” industry but keep reading!
Valuation for this company is ridiculous given ROE, ROIC, cash flow and balance sheet and there are some clear catalysts that could unlock value in the next year. Company has ~80% of market cap in cash, no debt, is fcf positive, insiders own >60% of shares, and company has respectable ROE, ROIC and EPS growth over last few years. Only way EVI is fairly valued at the current price is if you think it burns cash for an extended period of time and I think that is not likely.
The company used to pay out 50-100% of cash flow in dividend but cut the dividend when the economy really started coming unwound to be conservative. As a result they have been building cash on the balance sheet since and considering they were cash flow positive even in 2009 and cash flow approximates earnings they really don’t need to have much if any cash on the balance sheet considering the $2.2m revolver they have (has to be renewed annually in October).
Current market cap $7.24M and has $5.72M in cash on the balance sheet or ~79% of market cap despite no debt and great free cash flow. Also note they have an additional $2.3M in inventory you can discount at whatever you feel is appropriate. Note that cash + inventory (at balance sheet value) exceeds current market cap.
So strip out just the cash and the core company trades at ~2.5 P/E on my 2010 EPS (assumes net income declines) despite low teens ROIC, strong cash flow and high ROE while growing eps by ~10% a year since 2001. Even backing out customer deposits you still get a P/E on the core company of ~4x on 2010 EPS. Note that even in the depths of the collapse they actually were free cash flow positive the whole time and kept ROE and ROIC at respectable levels with decent profit margins.
I think there are a few likely outcomes:
1. Management takes the company private.
It makes no sense to me for a company this small to even be public. The costs of being public far outweigh the benefits and since insiders own 60% of shares the float is ridiculously small. If they do take the company private, I would imagine they pay out at least half the cash on the balance sheet sometime later this year in a one time dividend, giving us >$0.50 in cash in the process. Management could then use this cash they now have as equity in a very low leverage LBO that could be done with their line of credit or their own capital. Valuing the core company at 11 P/E (well below historical average) I get about $1.33 for the company. Add back the 0.50 we got in cash, gives us a total return of $1.92 using these conservative estimates. From today’s prices that is ~80% upside and makes a lot of sense from management’s perspective.
In the process mgmt could give themselves millions of dollars, take complete ownership of the company at low valuation, and save probably at least $350k annually (per CFO) in cost for being public and all the hassle. For a company with<$1M in net income that $350k in annual savings from being a private company is enormous.
NOTE: Management tried to take the company private earlier in 2009 with cash but the offer was too low and they withdrew it before a fairness opinion could be rendered. Commentary from CFO was that he would never let something like that happen again and was surprised that management even proposed it.
CFO justified cash on balance sheet by saying they are looking out for acquisitions but he also says they are not interested in acquisitions because it is hard to find quality companies in this industry at this size with reliable accounting. I get the idea he was just repeating the acquisition justification because it is the only real plausible argument for having this much cash on the balance sheet.
2. They payout 65% of current cash balance and reinstate the old dividend
Assuming they payout cash at the low end of their historical pay out rate of 50-100%. If they pay out 50% of 2011 cash flow that would give us a yield of >5%, allow them to hold and compound the rest of their cash at ~12% and payout 65% of current cash holdings. So we would get the majority of our cost basis back in cash and be left with ownership of a small but well run company with 60%+ inside ownership at a<3 P/E and 5%+ dividend yield. This probably gives us at least 50% return depending on how the core company is valued post payout.
3. Nothing. If nothing happens at least they will be building cash on the balance sheet and compounding returns at 10%+ and the company is well run so I am happy to wait. I’d rather have capital invested in this idea than sitting in cash. I believe that at some point that cash will be paid out or put to work somehow given management ownership and incentive to do something good for shareholders (them). Given stabilization in their end markets something probably happens sooner than later.
NOTE: They probably have at least one or two quarters soon where cash flow is actually negative due to working capital growth but after they get working capital back up to normal levels it seems likely to me they will pay out a large piece of that cash. If the stock tanks on that quarter of negative cash flow, it is likely a great buying opportunity.
Update: Most recent quarter had negative free cash flow due to negative CFO from growth in AR. Top line declines are concerning but cost control held net income to a decent level, although net income was below my initial estimates. I would like to repeat that as long as this company does not start having negative net income for consecutive quarters then the investment thesis will likely work out. All we need is for this company to continue generating FCF and we should be safe. CFO says they are open to a buyout also, but his sense is that it would need to be >$2 for mgmt to take it seriously. They would need to grow net income probably at least 20% for anyone to take the company at that price (although just eliminating public company costs would increase net income ~60%).
Downside. Primarily just liquidity as they have basically no bankruptcy risk, no litigation outstanding or union issues, no pension liabilities, nothing off balance sheet. But if the market implodes again it could trade down to ~$0.85. In 2009 it traded down to $.80 but EVI has also grown cash on the balance sheet by 20% since then so I would be very surprised if the stock traded down to less $.85 and if it did I would sell my kidneys to buy more.
Risks. The Steiner family owns an enormous amount of EVI shares. The Steiners lowball takeout attempt last year worries me that they aren’t the most shareholder friendly. This company also rents property from the Steiners with guaranteed increases. The cost is not huge but they get 3% guaranteed increases which obviously don’t make sense in the current real estate market. The history on this though is that EVI rented this property from the Steiners (the founders) before the company went public and it just didn’t make sense to change this relationship given that the rents are not excessive
However, management salary is high but they don’t pay themselves a ridiculous salary, which they could. EVI has no plans or arrangements with any officers which provide for the payment of retirement benefits, or benefits that would be paid primarily following retirement, other than the Company’s 401k which is a deferred compensation plan under which the company matches employee contributions up to 2% of an eligible employee’s yearly compensation.
Also, the company has no arrangements that pay any company executive following or in connection with resignation, other termination of employment or change in control of the company. The company’s five directors each receive a modest fee of $5,000 per annum. The chairman receives $10,000 per annum and is an independent officer.
If not for the huge inside ownership in these shares I would be much less bullish on this stock. The real estate deal bothers me but given other signs of management honesty, I think there is low risk of management doing something shady or destructive for shareholders. Some insider dealings are pretty common in micro cap land.
Another potential risk is just the volatility of a stock this small and illiquid. If we get another market melt down this stock could easily fall 50% for no fundamental reason. Investors should only own this stock if they are comfortable with that and can afford to have at least a 2 year time frame. The way I think about this is “would I be comfortable buying this company if it was private and I could not sell for 2-3 years?” For me, if someone proposed selling me a free cash flow positive company with no debt for less than the value of inventory and cash on hand that came with motivated management team, I would jump all over that.
Summary: So you essentially have 25% downside and 70%+ upside using relatively conservative estimates, for a 2.5x return/risk ratio with very little risk of permanent loss of capital. Impossible to know exactly what could happen but it seems under almost any scenario the company is under valued. Stock could do anything in the short term but over the next year or two I have a hard time coming up with any scenario that has less than a 40% return. Given market environment and limited downside this looks pretty compelling to me. I am a buyer at anything<$1.20. If the company starts having multiple quarters of negative net income indicating likely extended cash burn or if management shows me reason not to trust them, then I will likely exit the investment.
Be cautious,
Shaun Noll, CFA for aboveaverageodds
Founder and Portfolio Manager
Stirling Capital Management
[email protected]
phone: 707-495-8353
With a strategy and mission similar to our own, we think that Stirling Capital has carved out a “better way” for investors to protect and grow their wealth over time. As Shaun puts it, “Stirling Capital Management is a client centric performance oriented investment firm based in San Francisco. We are primarily conservative, deep value investors but we scour the globe for opportunity in any asset class with asymmetrical risk versus return characteristics. From an innovative fee structure to dynamic investment strategies, every aspect of the firm is designed to address the flaws of the traditional wealth management industry.” Nice
.Below is Shaun’s analysis on Envirostar (EVI, Financial), enjoy!
EVI: Envirorstar
Current Price: $1.15
Price Target: $1.90
EVI is a well run company with 60%+ of shares owned by management that has an absurd amount of cash on the balance sheet, no debt, and trades at a ridiculous valuation with a few likely catalysts.
EVI primarily distributes commercial and industrial laundry and dry cleaning equipment including a proprietary line of dry cleaning machines (98% of revenue) with a focus on environmentally friendly dry cleaning methods and equipment. There is even a “green” angle here for you environmentalists! Overall prospects for this business are not great but not terrible. Much of their dry cleaning products sales goes into hotels, hospitals etc, which is obviously very weak. They do have some good growth into international and latin America though, which is ~20% of their sales and growing. Not exactly the most “sexy” industry but keep reading!
Valuation for this company is ridiculous given ROE, ROIC, cash flow and balance sheet and there are some clear catalysts that could unlock value in the next year. Company has ~80% of market cap in cash, no debt, is fcf positive, insiders own >60% of shares, and company has respectable ROE, ROIC and EPS growth over last few years. Only way EVI is fairly valued at the current price is if you think it burns cash for an extended period of time and I think that is not likely.
The company used to pay out 50-100% of cash flow in dividend but cut the dividend when the economy really started coming unwound to be conservative. As a result they have been building cash on the balance sheet since and considering they were cash flow positive even in 2009 and cash flow approximates earnings they really don’t need to have much if any cash on the balance sheet considering the $2.2m revolver they have (has to be renewed annually in October).
Current market cap $7.24M and has $5.72M in cash on the balance sheet or ~79% of market cap despite no debt and great free cash flow. Also note they have an additional $2.3M in inventory you can discount at whatever you feel is appropriate. Note that cash + inventory (at balance sheet value) exceeds current market cap.
So strip out just the cash and the core company trades at ~2.5 P/E on my 2010 EPS (assumes net income declines) despite low teens ROIC, strong cash flow and high ROE while growing eps by ~10% a year since 2001. Even backing out customer deposits you still get a P/E on the core company of ~4x on 2010 EPS. Note that even in the depths of the collapse they actually were free cash flow positive the whole time and kept ROE and ROIC at respectable levels with decent profit margins.
I think there are a few likely outcomes:
1. Management takes the company private.
It makes no sense to me for a company this small to even be public. The costs of being public far outweigh the benefits and since insiders own 60% of shares the float is ridiculously small. If they do take the company private, I would imagine they pay out at least half the cash on the balance sheet sometime later this year in a one time dividend, giving us >$0.50 in cash in the process. Management could then use this cash they now have as equity in a very low leverage LBO that could be done with their line of credit or their own capital. Valuing the core company at 11 P/E (well below historical average) I get about $1.33 for the company. Add back the 0.50 we got in cash, gives us a total return of $1.92 using these conservative estimates. From today’s prices that is ~80% upside and makes a lot of sense from management’s perspective.
In the process mgmt could give themselves millions of dollars, take complete ownership of the company at low valuation, and save probably at least $350k annually (per CFO) in cost for being public and all the hassle. For a company with<$1M in net income that $350k in annual savings from being a private company is enormous.
NOTE: Management tried to take the company private earlier in 2009 with cash but the offer was too low and they withdrew it before a fairness opinion could be rendered. Commentary from CFO was that he would never let something like that happen again and was surprised that management even proposed it.
CFO justified cash on balance sheet by saying they are looking out for acquisitions but he also says they are not interested in acquisitions because it is hard to find quality companies in this industry at this size with reliable accounting. I get the idea he was just repeating the acquisition justification because it is the only real plausible argument for having this much cash on the balance sheet.
2. They payout 65% of current cash balance and reinstate the old dividend
Assuming they payout cash at the low end of their historical pay out rate of 50-100%. If they pay out 50% of 2011 cash flow that would give us a yield of >5%, allow them to hold and compound the rest of their cash at ~12% and payout 65% of current cash holdings. So we would get the majority of our cost basis back in cash and be left with ownership of a small but well run company with 60%+ inside ownership at a<3 P/E and 5%+ dividend yield. This probably gives us at least 50% return depending on how the core company is valued post payout.
3. Nothing. If nothing happens at least they will be building cash on the balance sheet and compounding returns at 10%+ and the company is well run so I am happy to wait. I’d rather have capital invested in this idea than sitting in cash. I believe that at some point that cash will be paid out or put to work somehow given management ownership and incentive to do something good for shareholders (them). Given stabilization in their end markets something probably happens sooner than later.
NOTE: They probably have at least one or two quarters soon where cash flow is actually negative due to working capital growth but after they get working capital back up to normal levels it seems likely to me they will pay out a large piece of that cash. If the stock tanks on that quarter of negative cash flow, it is likely a great buying opportunity.
Update: Most recent quarter had negative free cash flow due to negative CFO from growth in AR. Top line declines are concerning but cost control held net income to a decent level, although net income was below my initial estimates. I would like to repeat that as long as this company does not start having negative net income for consecutive quarters then the investment thesis will likely work out. All we need is for this company to continue generating FCF and we should be safe. CFO says they are open to a buyout also, but his sense is that it would need to be >$2 for mgmt to take it seriously. They would need to grow net income probably at least 20% for anyone to take the company at that price (although just eliminating public company costs would increase net income ~60%).
Downside. Primarily just liquidity as they have basically no bankruptcy risk, no litigation outstanding or union issues, no pension liabilities, nothing off balance sheet. But if the market implodes again it could trade down to ~$0.85. In 2009 it traded down to $.80 but EVI has also grown cash on the balance sheet by 20% since then so I would be very surprised if the stock traded down to less $.85 and if it did I would sell my kidneys to buy more.
Risks. The Steiner family owns an enormous amount of EVI shares. The Steiners lowball takeout attempt last year worries me that they aren’t the most shareholder friendly. This company also rents property from the Steiners with guaranteed increases. The cost is not huge but they get 3% guaranteed increases which obviously don’t make sense in the current real estate market. The history on this though is that EVI rented this property from the Steiners (the founders) before the company went public and it just didn’t make sense to change this relationship given that the rents are not excessive
However, management salary is high but they don’t pay themselves a ridiculous salary, which they could. EVI has no plans or arrangements with any officers which provide for the payment of retirement benefits, or benefits that would be paid primarily following retirement, other than the Company’s 401k which is a deferred compensation plan under which the company matches employee contributions up to 2% of an eligible employee’s yearly compensation.
Also, the company has no arrangements that pay any company executive following or in connection with resignation, other termination of employment or change in control of the company. The company’s five directors each receive a modest fee of $5,000 per annum. The chairman receives $10,000 per annum and is an independent officer.
If not for the huge inside ownership in these shares I would be much less bullish on this stock. The real estate deal bothers me but given other signs of management honesty, I think there is low risk of management doing something shady or destructive for shareholders. Some insider dealings are pretty common in micro cap land.
Another potential risk is just the volatility of a stock this small and illiquid. If we get another market melt down this stock could easily fall 50% for no fundamental reason. Investors should only own this stock if they are comfortable with that and can afford to have at least a 2 year time frame. The way I think about this is “would I be comfortable buying this company if it was private and I could not sell for 2-3 years?” For me, if someone proposed selling me a free cash flow positive company with no debt for less than the value of inventory and cash on hand that came with motivated management team, I would jump all over that.
Summary: So you essentially have 25% downside and 70%+ upside using relatively conservative estimates, for a 2.5x return/risk ratio with very little risk of permanent loss of capital. Impossible to know exactly what could happen but it seems under almost any scenario the company is under valued. Stock could do anything in the short term but over the next year or two I have a hard time coming up with any scenario that has less than a 40% return. Given market environment and limited downside this looks pretty compelling to me. I am a buyer at anything<$1.20. If the company starts having multiple quarters of negative net income indicating likely extended cash burn or if management shows me reason not to trust them, then I will likely exit the investment.
Be cautious,
Shaun Noll, CFA for aboveaverageodds
Founder and Portfolio Manager
Stirling Capital Management
[email protected]
phone: 707-495-8353
