Dominion Homes is the largest public homebuilding company in both
central Ohio and Louisville, Kentucky. The company has been building
homes in Ohio for over fifty years and has been a public company since
1994. Dominion markets to first time and move-up homebuyers. These
homes range in price from $100,000 to $350,000 and in size from 1,000
to 3,500 square feet. The company traces its roots to 1952 when
Douglas Borror built his first home in Columbus, Ohio. Mr. Borror
remains the single largest shareholder of Dominion owning 3.9 million
shares or 47.5% of the company.
Shares of Dominion Homes reached an all time high of $40.28 in March
2004 and have since declined to the $16-$17 range. Higher mortgage
rates in 2004 and 2005 are undoubtedly having a cooling effect on
housing demand while higher real estate and raw material costs have
begun to impact the Company’s margins. However, given that shares of
Dominion Homes currently trade at a 27% discount to its book value of
$22.96, we feel the share price is already discounting the cyclical
nature of the business and is now fundamentally inexpensive.
On
February 10th 2005 Dominion Homes reported fourth quarter
and year-end financial results. Sales were $542 million on the
delivery of 2,837 homes while net income was $20.2 million, or $2.47
per share. This implies a price to earnings ratio for Dominion of less
than seven times 2004 earnings. While earnings, admittedly, will be
lower in 2005, free cash flow for the year could be substantial. As
orders decline, so should its working capital requirements as the
company reduces its land purchases while simultaneously drawing down
its inventory of completed homes. Management can use the funds to
initiate a dividend, repurchase shares, or even fund a going private
transaction.
Lastly, we believe that consolidation among the homebuilders is likely
to continue. The industry remains relatively fragmented with the top
ten home manufacturers accounting for only 21% of sales in the U.S.
Company balance sheets will soon be awash with cash and as a result,
we could begin to see an increase in merger and acquisition activity.
If this were to occur, we feel Dominion Homes could be a prime
takeover candidate given its small size, large real estate holdings
and attractive share price.
NORSKE SKOG CANADA LIMITED
Norske Skog Canada Limited, known as NorskeCanada, produces groundwood
specialty papers, including newsprint, containerboard and pulp.
Originally known as Fletcher Challenge Canada, the predecessor company
was acquired in July 2000 by Norske Skogindustrier of Norway who then
renamed the subsidiary Norske Skog Canada. In August 2001,
NorskeCanada acquired Pacifica Papers and created the corporate entity
that we see today.
NorskeCanada is a deep cyclical stock that is sensitive to demand from
printers and publishers. Over the past few years, a slowdown in
advertising spending created excess capacity across the industry,
depressed prices and forced the Company to take downtime. Despite the
difficult environment, earnings have shown an improving trend over the
past three years. In 2002, the Company reported a loss of $0.64 per
share, in 2003 a loss of $0.41 per share and in 2004 a loss of $0.13
per share. In the fourth quarter of 2004, NorskeCanada reported a
loss of only $0.06 per share, in line with expectations.
Rather than focus on the losses per share, we prefer to track
NorskeCanada’s cash flow situation. The Company is generating
positive cash flow, due to a low cost fibre base and several
profitability and efficiency improvement initiatives. For 2004, the
Company generated $88.9 million of cash from operations, or $64.5
million of cash after changes in non-cash working capital. In the
fourth quarter of 2004, the Company generated $34.5 million of cash
from operations, or $49.6 million after changes in non-cash working
capital. With capital expenditures of $20 million, free cash flow was
$14.5 million. We believe the positive cash flow indicates that a
return to profitability is finally imminent.
NorskeCanada is currently trading at only 0.8 times
its book value of $4.86. Liquidity and financial flexibility is
adequate, with a net debt to net capitalization of 43%, which is much
better than the Company’s peers. Further, NorskeCanada has a $350
million revolving operating facility that is undrawn. We believe that
cash from operations and the revolving operating facility are
sufficient to meet the Company’s capital expenditure needs and debt
obligations comfortably. Putting the pieces together, NorskeCanada
likely bottomed at the $3.50 level over the past few months. We look
for pulp and paper prices to strengthen throughout the spring and
summer months and the shares of NorskeCanada should follow.
Irwin A. Michael, CFA
