CMI update

I purchased CMI base on the premises set out in this blog post.

On 19 February 2013, CMI's share price jumped as ASIC sold the overhang parcel for $2.65. The resulting market capitalisation of CMI reached $100m.  being what I estimated to be conservative fair value.

Consequently, I began to prepare to sell. The share price has reached a conservative fair value and more importantly, I was unwilling to stay the long haul with the current management. As I have explained previously, management competency and integrity at these relatively small companies can have a major effect on shareholder value.

On 20 February 2013, we found out that Acorn Capital has emerged with slightly less than 10% holding in CMI. I have great respect for the managers at Acorn Capital, and accordingly, I was prepared to wait until the half yearly result is published and hence deferred my sale decision.

On 27 February 2013, CMI published its half yearly results.  My overall impression was as if management has fallen asleep on the wheels. No doubt Mr Colin Ryan had other more pressing matters to attend to, notably his prosecution by authorities in New Zealand on charges of misleading conduct. Just to backtrack a little, CMI's announcements on 18 and 20 February 2013 did nothing to allay my deep mistrust of this board. If anything, my fears were actually accentuated by the contents of these announcements.

Looking at the results, accounts receivables and inventories continued to increase. CMI has enough inventories for 10 months worth of sales. This is an inefficient use of capital. The tax bill was higher due to an overprovision of $581k in the previous period which ate into cashflow. Only half of debt repaid. Electrical is still making good margins, but margins are decreasing. TJM still making losses of $600k despite a revenue increase, and taking up over $29m of assets. This division should be sold.  

What took the cake was that recently appointed director Stephen Lonie mysteriously resigned without any reason.  

On 27 and 28th Feb 2013, all CMI shares in the incubation fund was sold at $2.65. The gain is 59.6% in slightly under 3 months. Quite a fortuitous windfall considering the circumstances.

As a matter of disclosure, I still own a small holding of CMI in my family account. Unless circumstances change, this holding will also be sold if the share price approaches $2.65 again.

Obviously, this will continue to be on my watchlist. No doubt there are some lessons to be learned here, primarily as to whether assessment of management should be a strict filter, or whether this factor can be balanced off against a deeply undervalued share price.

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.

Another angle on FGE plus tidbit on CMI

Clough Limited (CLO) is another mining services company listed on the ASX and exposed to the oil and gas sector. On 11 December 2012, CLO announced that it had renewed a $200m debt facility.  How is this relevant to FGE?

CLO is the biggest shareholder of FGE, holding roughly 36% of shares in FGE.  As at June 2012, CLO had $146m cash on its balance sheet. The last substantial shareholder notice published by FGE in May 2012 showed that CLO added a further 3% in compliance with the creep provisions of the Corporations Act. 

In 2012, CLO made $42m in profits and is currently trading at PE 15. FGE has $130m cash as at June 2012, and has had a good half with NPBT forecasted at $50m. If CLO takes $100m of its cash, combined with $130m of FGE cash, totalling $230m, it could afford to take over FGE for up to $360m. The current market cap for FGE is $335m. Alternatively, CLO could just use $200m from its debt facility to do the same thing, and after the takeover, repay the debt in full with FGE’s cash plus a bit of its own. With CLO’s huge blocking and controlling stake, a rival bidder is very unlikely.

An acquisition by CLO will be immediately and significantly PE accretive without any synergistic costs savings. In fact, CLO’s earnings would more than double, and its margins will increase by about 50% with FGE in its fold, and this can be done with minimal dilution.

All these are pretty obvious, so what am I missing?

My best guess from CLO’s perspective is that there is no hurry since CLO has a large blocking stake which renders the possibility of a rival bidder vanishingly small. CLO can take advantage of lower prices using the creep provisions. In the current environment for mining services, it is also prudent for CLO to preserve its cash rather than making any bold moves. CLO’s largest South African shareholder is probably loath to risk contributing more capital to CLO and prefers CLO to keep a clean healthy balance sheet.

A takeover by CLO has been long anticipated and speculated by the market, at much higher prices for FGE than the present.  These speculations have intensified with recent management changes at FGE, and the recent exercise of options by outgoing management at prices up to $5.60 perhaps indicate that they do not see any potential upside beyond $5.60 for FGE due to the potential for a takeover at prices below that.

It will be interesting days ahead for FGE.

Lastly, a little tidbit on CMI, with the newest director, Stephen Lonie, spending over $120,000 of his own money buying up 65000 shares in recent days.

Disclosure: The author owns shares in FGE and 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.

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.

Activity Update

Mulling over my activity over the last 7 days since my last blog post, I am reminded of John Arnold’s famous quote:

“War is sometimes described as long periods of boredom punctuated by short moments of excitement. History is often similar, if rather safer.”

I would tentatively venture that investing is similar.  After all, history is a record of the endeavours of humankind. Business is but one small facet of these endeavours. Logically, the same process should apply. My investing is characterised by a never-ending search for ideas, many of which are discarded.  Looking back over my notes, good ideas that are investable are rare, about one every 3 months where I am concerned.

Here is a summary of what I have been up to over the last 7 days, gleaned from my journal.

14 November 2012

Thinking about businesses with longevity, a long compounding trajectory. Growth rates should be moderate, should not be rapidly changing.  Compounding machines.  Need to learn more about financial history, especially businesses that have been around and unchanged for a long time.  Very few businesses can stand the ravages of time and competition.  Banking and law are two examples. BHP is another. Needless to say, adaptability is crucial.

Continued going through list of shares.

15 November 2012

ABS data shows MV vehicle sales for Oct down 2.8% from Sept, and SUV down 3%. Data conflicts with FCAI figures published at the start of the month.  Investigated cause for difference.

Continued going through list of shares.

16 November 2012

Looking closely at CMI Ltd. TJM has a good brand, but management is stuffing up via wrong business model. Electricals facing some serious headwinds.

19 November 2012

Boom in shale gas- LNG transport- shipping.

Finished treasure hunt project for industrials.

20 November 2012

TGA results out- NCML continues to drag- lesson= large acquisitions seldom work. Cashflow strong. Rentals steady. Arrears/impairments down. Cashfirst and TEF looking promising. TEF being funded entirely by debt.  Market did not like result. Dividend lifted. No long term reason to sell but unsure of whether to add more.

FFI- catching up with news. Chairman's presentation and latest leasing deal are positive news as value is unlocked from the land parcel.  Attempting to do a revised valuation.

21 November 2012

Considering the implications of the US becoming energy independent, and the many projects in the pipeline for LNG.  A long tailwind. Thinking of industries that will benefit from declining input costs of LNG. There are 4 obvious candidates on the ASX that my non-creative mind can think of.

LYL management gave an unusual downward guidance over next 2 years.  Mining services slowing down rapidly. Hats off to a management with impeccable integrity.

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.