ZCL Composites

ZCL.to has some qualities of a good value stock:

• Obscure name
• At or near 52 week low
• Near 5 year low
• Boring industry
• Headquartered here in Edmonton, making scuttlebutt easy

Here’s something to get your blood pumping…

That is a 10 year trading history of ZCL. From over $15 down to around $3 today. Yeah, I know. I was excited too.

I love when a former growth stock disappoints and falls off the map. Top it off with a global recession and an less than liquid shares, and you have the recipe for a deep value investment.

That’s really where the value in ZCL ends.

The two charts above show an average company that doesn’t really follow the economic cycle. That by itself isn’t really a worry. If the price is cheap enough, then you can buy almost any company.

There does look to be some mean reversion in margins going on. Though we are a long way from “average”.

My most aggressive fair value is for a return to historical profitability with revenue growth of 10%. This would give ZCL a DCF fair value of $4.50 or so. Current EPV and Graham fair value is $2.00-$3.00. Not enough margin of safety.

If we return to peak Ebitda of 19.3 million (nearly 4x what it is today), we still get a EV/Editda of 5.6x. That’s a lot of growth built in. That’s were the risk is in ZCL.

I would be interested if ZCL starts trading closer to tangible book or has some miraculous run in profitability coupled with a flat share price. Until then, I’ll wait patiently.

Dean

Sold Hartco.

I recently sold HCI.to.

The reasoning was that the company may have lots of cash, but I don’t see it getting back to shareholders.

The underlying business is OK. They can earn close to or slightly above their long term cost of capital.

Since the start of 2010 there has been at least $9 million on the balance sheet as cash. The CCC is quite short (around 30 days) and it seems that this number may be overstating what is actually needed. There are also some equity investments that one could add as excess to the valuation.

In that time the company has earned around $10 million in operating earnings. With a market cap of $45 million, this looks really cheap. But none of it has been returned to shareholders. No dividend, and no buyback. They did purchase an equity interest in a small marketing firm.

I like when you have a decent company with a ton of excess cash. I don’t mind when cash is plowed back into the business at a decent ROIC. HCI’s ROIC is around 11% over the last 5 years. Not great, but not too bad.

If you were to get the excess cash on the balance sheet returned, I would put fair value between $4.15 – $5.35 (based on 6x EV/EBITDA). Without getting any cash you get $2.95- $4.14.

All this is assuming that the company will implement the ERP successfully in the next 6 months and not spend the cash stupidly. There is some reason to be positive as last quarterly earnings were very strong.

I think there is too much risk that you either get no cash returned or it isn’t spent wisely.

I would look at HCI again closer to NCAV or $2.00, if it gets there.

Dean

McCoy Re-buy

Very similar to Flint Energy Services (FES.to), I have been buying shares of McCoy Corp. recently (MCB.to). I sold MCB late 2010, so this is my second kick at the can.

You can see from the chart that MCB has done a good job of taking advantage of the increased economic activity. Ebitda margins are near record and ROC is on its way up. The CCC is at an all-time low.

Why is this…

MCB has been deploying it capital intellegently. They recently (June 2011) announced that they would divest Rebel Metal Fabricators. Rebel manufactures and supplies vac and hydrovac systems to customers operating mainly in Western Canada. Earlier (February 2011) they announced another division sale, McCoy Parts and Services.

Apart these operations aren’t extremely meaningful. But together they show how important capital allocation is to management.

MCB had about $0.68/share in cash at quarter end. They recently announced they would issue a quarterly dividend of $0.03/share. Giving MCB a yield of 3.87%. I would expect the dividend to grow quickly going forward.

As you can see, MCB is trading near the valuation low of q4 2008 on an EV/Ebitda basis. Though we are at a larger premium to tangible book and EV/Revenue. You can see that the share price rebounded sharply and the stock appeared expensive on ttm EV/Ebitda basis. Now that those expected earnings have come in (quicker than I had expected), and shares are down 20% or so, the company is cheap enough to warrant purchase.

As long as we aren’t at peak cycle, I think MCB is worth picking up. Given the current economy and outlook, $4.50 doesn’t seem like a far stretch for fair value.   Upper limit fair value could be $6.00, but we’ll talk at $4.50 (if we get there).

Dean

Disclosure: The author is long MCB.to at time of writing.

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