Monday, December 3, 2012

CMI Limited

I recently tweeted that I am examining 3 shares which I believe are undervalued.

The first of these is CMI Limited.


CMI operates two divisions, Electricals and TJM. 

Electricals revenue for FY 12 is $74m, returning EBIT of $21.5m.  TJM revenue for FY 12 is $40m, but EBIT is only $1m.

Electricals are facing headwinds due to declining coal sector investments in Qld, and also subdued industrial and housing activity.  

TJM has a lot of room to improve when performance is compared with ECB and ARP.  TJM is an established high quality brand with steady revenue, however the division is saddled with high costs due to the number of distribution centres, and management appears to be trying to contain costs by moving manufacturing to China.  ECB and ARP both generated EBIT margins in the mid teens, and if TJM can do just 10% EBIT, the EBIT from this division will go up 4x. I suspect that the TJM division is being dressed up for an eventual sale, and logical acquirers are AMA and ARP.

The problem with CMI has been management’s treatment of minorities over the last several years, culminating in litigation brought by Troy Harry last FY. With the death of long time owner Catalan, and succession to his daughter Leanne Catalan, the situation with management is still less than optimal, especially as management owns a controlling stake.  We suspect management’s actions account for the perennial share price underperformance, made worse by the previous unwieldy structure of having two classes of shares.  The structure has since been rationalised this FY following litigation brought by minority shareholders.  There is still some overhang of a big parcel of shares bought by Leanne allegedly in contravention of the provisions of the Corporations Act which was the subject of litigation at the Takeover Panel.  This matter is still subject to appeal, although I believe this is unlikely to matter in the big scheme of things.

Valuation
CMI has 38.2m shares on issue.  At AUD$1.70 cents, market cap is AUD$58m.   Operating cashflow is AUD$9.5m, giving P/Cashflow multiple of 6, and the multiple is slightly less than 7 if we include debt of about $8m.  Normalised EBIT is about $20m. A very conservative 5x EBIT puts CMI at AUD$100m. Current AUD$58 implies a 42% discount to a very conservative valuation. Even if EBIT drops by half to $10m, the EBIT multiple of 6 is still within conservative territory.

Earnings
Trailing PE (normalised without write-off based on NPAT of $14m) is 4.   Outlook given on 30 November 2012 appears to indicate that Electricals is holding and TJM is improving.  Market cap of AUD$58m allows an earnings deterioration by 50% to $7m,  and even then, the PE is still a lowly 8.  This provides a degree of margin of safety

Balance Sheet
As at June 2012, CMI has $8m in bank debt.  This is more than covered by operating cashflow of $9m. There are $16m in franking credits. There is also an impairment provision for a third party loan of $17m which has been written off to zero, but which I am confident will result in some recovery. There is a personal guarantee for $2.5m for this loan which CMI is now pursuing.  Working capital is about $37m which is about 1/3 of sales, and I expect there is some room for improvement here to boost the balance sheet.

Disclosure: The author owns shares in CMI.

Disclaimer: the content of this post is not to be relied on as financial advice.  It contains my personal opinion only, plus facts that I cannot verify to be accurate.  Do your own research and seek financial advice where appropriate. I have made many mistakes in the past, and will continue to do so in the future.



3 comments:

Gaby Berger said...

Hi, That is a very good analysis. AS we have similar views, I would like to set up a correspondence with you. See:

GabyBergerEquities.blogspot.com.au

Gaby Berger said...

Would like to discuss CMI with you. See me at
GabyBergerEquities.blogspot.com.au

Gaby Berger said...

Please contact me at GabyBergerEquities.blogspot.com.au