AMERON INTERNATIONAL CORPORATION
Ameron International Corporation is a
multinational manufacturer of products and materials for the chemical,
industrial, energy, transportation and infrastructure markets. Among the
products that Ameron develops and markets are protective coatings and
finishes for oil and gas equipment as well as pipelines and fittings for
the transmission of water, petroleum and petrochemicals. The company also
supplies ready-mix concrete and other aggregates as well as producing
concrete and steel traffic lighting poles.
Having declined from a May 2002 peak
price of $78, Ameron shares currently sell at a 12% discount to expected
year-end book value of $59, under 8 times earnings per share of
approximately $7 and less than 5 times cash flow per share of about $12.
Ameron shares pay a dividend of $1.28 and currently yield over 2%. We
believe the dividend is secure given the firm's low debt level and high
cash flow generation. In addition, not one U.S. analyst officially covers
Ameron and therefore its story is not very well known. We also believe
that Ameron could very well be a takeover target given that management
owns less than 1% of the shares.
Notably, Ameron's Infrastructure Group
had higher year over year sales in the third quarter due to continued
strength of housing construction in the U.S. and military and road
construction in Hawaii. We believe this trend will continue as housing
starts and new home sales in the US remain strong while military spending
remains firm given the current geopolitical environment and recent
Republican victory in the U.S. mid-term elections. We expect the
macroeconomic and political risks currently associated with Ameron will
eventually subside and the Company's multiple will return to its
historical average of between 10 and 12 times earnings. A multiple
expansion combined with earnings growth presents compelling upside
potential for Ameron's shares. Downside risk in the stock is mitigated by
a well-financed dividend and a current tangible book value of over $54 a
share.
KINGSWAY FINANCIAL SERVICES INC.
Kingsway Financial is a Canadian-based
property and casualty insurance underwriter that does approximately 75% of
its business in the United States. The Company writes primarily
non-standard automobile insurance for drivers who fail to qualify for
standard coverage. Kingsway also writes commercial automobile, trucking,
property, motorcycle, taxi and other specialty policies.
In fiscal 2001, Kingsway wrote $1.065
billion in gross premiums, a 66% increase from fiscal 2000. Earnings per
fully diluted share increased 49% to $1.19 in 2001 compared to $0.80 the
previous year. Kingsway had a combined ratio (expenses and claims divided
by net premiums earned) of 99.1% in 2001, implying that the Company was
profitable even before investment gains, unlike many of its industry
peers.
Since the beginning of 2002, the shares
have been under pressure as investors became concerned with two issues.
First, Kingsway's available capital was becoming stretched after a period
of aggressive growth. However, the Company has recently issued $78 million
of unsecured senior debentures and has completed a private placement of
approximately US$15 million in trust preferred securities to strengthen
its balance sheet. Second, the Ontario auto business has been unprofitable
due to high levels of fraudulent claims, particularly in the GTA. However,
legislative changes and rate increases will have a positive impact on
profitability in 2003.
In October of this year, the stock
traded below its Q3 book value of $12.09 and at less than 10 times next
years' earnings, which represented a significant discount to the Company's
competitors. Given the Company's historical profitability, its pricing
discipline and the mitigating factors discussed above, we believed that
the shares were undervalued. Even after some recent price appreciation,
Kingsway should continue to do well in the coming year.
PRIME HOSPITALITY CORPORATION
Prime Hospitality Corp. is an owner,
manager and franchisor of hotels. It currently operates 240 hotels,
containing 30,460 rooms located in 33 states. Prime controls two hotel
brands, AmeriSuites, which are upscale all-suites hotels, and Wellesley
Inns & Suites, which are mid-price limited service hotels. The company
also operates a portfolio of upscale, full-service hotels under franchise
agreements with national hotel chains.
Prime Hospitality (PDQ) is in the midst
of transforming itself from a hotel owner/operator to a franchisor and
manager of hotel brands. The strategy is to sell the company's land and
hotels to independent owners. The Company will then receive a royalty fee
for supplying the brand names, advertising, and
supporting infrastructure. We believe that this strategy is good for a
number of reasons. First, by selling its land and hotels, PDQ is
unlocking the illiquid real estate value that is not fully reflected
in its stock price. Second, the company can use the proceeds to pay
down debt and repurchase shares. As a result of smaller interest
payments and fewer outstanding shares, earnings and cash flow per
share should improve. Finally, this strategy will allow the company to
focus entirely on its key strengths: managing and growing the
AmeriSuites and Wellesley brands.
PDQ currently trades at a 50%
discount to its 2002 expected year-end book value. We anticipate that
this discount will narrow as the company continues to raise cash
through its franchising strategy while paying down debt and
repurchasing shares. We are confident that PDQ's CEO A.F. Petrocelli
will make choices that are in the best interest of shareholders since
he himself has a meaningful equity stake. We also expect that when
business travel improves, occupancy rates and REVPAR will lead to
increased room sales and thus higher franchising fees. With these
forces at work, we believe that significant upside potential exists
for PDQ stock in the next 12-18 months.
RIVERSIDE FOREST PRODUCTS
LIMITED
Riverside Forest Products, a B.C.
based producer of plywood, veneer and lumber, has faced strong,
diametrically opposing forces in 2002. Countervailing and anti-dumping
duties resulted in a combined tariff of 27% on Riverside's lumber
shipments to the United States. Sadly, the softwood lumber dispute has
persisted much longer than we had anticipated. However, the strength
of the North American housing market has created exceptional demand
for wood products.
Riverside's financial results for
fiscal 2002, ended September 30, are a testament to management's
efforts in what was an extremely difficult year. Total sales reached
$469 million compared to $461 in fiscal 2001, an increase of
approximately 2%. Sales of plywood and veneer accounted for 33% of
total sales or $161 million. Lumber products accounted for 54% of
total sales or $260 million, before the punitive duties on exports to
the United States. Earnings per share totaled $1.17 in 2002, an
increase of 30% from the $0.90 earned in fiscal 2001. Riverside was
able to report improving profits due to cost control, the reversal of
a provision for duties on shipments made before May 22, 2002 and lower
interest charges due to net debt reduction of almost $30 million.
At $10.50, Riverside Forest
Products is currently trading at only 0.5 times its book value of
$20.05 and 9 times fiscal 2002 earnings. Long-term debt to long-term
debt plus equity remains at a manageable 35%. As the return on
shareholders' equity improves from the 6% achieved in fiscal 2002, we
would expect the discount to book value to narrow. Until then, Gordon
Steele, President and CEO, is expected to continue to focus on
streamlining operations, managing cash and paying down debt in order
to position the Company for the future.
SHERMAG INC.
Over the course of the past two
years or so, the economy and the housing sector have shown a
pronounced disconnect. Economic malaise, especially in the United
States, has led to a period of monetary easing and record low interest
rates. This in turn has led to a surge in new and existing home sales.
Shermag, a Canadian furniture manufacturer, illustrates this dichotomy
quite nicely, because although the consumer has been hesitant to spend
freely, the strength of the housing sector has created good demand for
residential furniture.
For the first half of fiscal 2003,
Shermag reported gross revenue of $90.7 million, an increase of 20%
from $75.3 million last year. Despite a difficult pricing environment,
the Company has had good success with the independent furniture store
channel and with the new line of imported, traditionally styled
furniture. Operationally, management continues to do a great job.
Gross margins improved from 27.2% to 27.7% for the first half of the
fiscal year. Selling and administrative expenses as a percentage of
sales declined from 16.1% to 12.1%. Also, interest costs declined
significantly due to a reduction in net debt, which has fallen to just
$4 million from $13.6 million at the beginning of the year. Revenue
growth and margin improvement translated into fully diluted earnings
per share of $0.51 for the first six months of fiscal 2003 compared to
$0.16 last year.
We are extremely impressed with
Shermag's progress over the past year and a half. Jeff Casselman and
his team have done a great job turning around the Company's operations
amid a very difficult macro-environment. However, the stock has
declined from a high of $15 in May as investors became nervous about
the resiliency of the consumer and the sustainability of housing
demand. This correction seems to have played out and we now expect
that investors will focus on Shermag's ability to continue to show
good earnings growth.
Irwin A. Michael, CFA
