SAXON ENERGY SERVICES
Saxon Energy Services Incorporated (TSX:SES)
is an international oil and gas drilling and services
company. The Company originally had a focus on Latin
America, with operations in Ecuador, Venezuela, Colombia and
Peru. However, the recent acquisition of Drillers Technology
created a more balanced operating base. Of Saxon’s 37
drilling rigs and 16 workover rigs, 60% of its fleet is now
based in South America and 40% in North America.
As deep-value investors, it is usually
difficult for us to purchase energy services stocks due to
premium valuations. However, we were able to add two
companies to our portfolios during the current cycle. The
cheapest stock we could find was Drillers Technology, which
was depressed due to an elevated debt load and history of
inconsistent operating performance. However, we did our work
and determined that the debt was manageable and that the
operations were beginning to show an improvement. The second
cheapest stock we could find was Saxon Energy Services,
which was cheap due to its international exposure. However,
we believed that the market’s relative discount on the stock
due to geographic or political risk was too great. Imagine
our surprise on October 4, 2005 when Saxon Energy announced
a takeover offer for Drillers Technology.
We think the deal was a win/win for
shareholders of both companies for several reasons. Although
we received a premium on our shares of Drillers Technology,
Saxon did not overpay for the assets; Saxon issued shares to
pay for the acquisition and at the same time solved
Drillers’ debt issues. The merger created a balanced
operations base, which reduced the geographic and political
risks. Finally, the addition of Dale Tremblay, Michael
McNulty and Tim Braun from Precision Drilling provided
greater depth to the management team. This will enable the
company to take advantage of international and domestic
growth opportunities.
We have valued Saxon Energy Services
based on a net asset value approach. Using precedent
transactions and estimated replacement value, we believe
that between US$5 million and US$6 million per rig is an
appropriate measure to use. Based on this range, Saxon has a
net asset value between $4.00 and $4.60CDN per share. But
the shares were cheap on another metric; we calculated that
the stock traded at roughly 3 times its 2006 estimated cash
flow. On balance, we concluded that Saxon was cheap both
relative to its peers and on an absolute basis. We believe
that Saxon’s strategic expansion plans and lower political
risk should become more fairly reflected in its share price
in 2006.
JOHN B. SANFILIPPO
John B. Sanfilippo & Sons (NASDAQ:JBSS)
is one of the leading processors and marketers of tree nuts
and peanuts in the United States. Based in Elk Grove,
Illinois, the company sells all major nut types consumed in
the U.S. including peanuts, pecans, cashews, walnuts and
almonds. Through various acquisitions including the purchase
of the H.H. Evon Nut Company in 1974 and Fisher Nut in 1994,
JBSS has grown to be the second largest nut company in the
United States. It is estimated that JBSS has a market share
of 10% in a very fragmented market.
JBSS remained a private company until
1992, when it issued stock to the public at $12 a share.
Post IPO, JBSS shares failed to gain traction. It wasn’t
until 2002 that investors began to take notice. Due to the
widely successful marketing of high protein/low carbohydrate
diets such as Atkins and South Beach, Americans began
consuming peanuts, cashews and almonds like never before. In
2003, JBSS earned $1.61 per share, which was twice the
amount it earned in 2002. In 2004, earnings subsequently
reached $2.32 per share. Investors were watching as JBSS’s
stock rocketed through $50 a share, reaching an all time
high of $54.90 in December 2003. By the end of 2004,
however, it had become apparent that interest in Atkins and
South Beach had waned. To make matters worse, tree nut
prices, the company’s largest cost, were soaring. Earnings
fell to just $1.35 in 2005 and shares of JBSS eventually
fell below $20 a share. For the first quarter of fiscal
2006, JBSS reported its first loss since 1999. With that
announcement in late October 2005, JBSS’s stock plummeted
22% or over $4 that day, closing at $13.44 per share.
Today, with its shares trading at
$12.30, JBSS appears to be a bargain. The stock is trading
at a 33% discount to its book value of $18.42 and at
approximately eight times next year’s estimated earnings of
$1.65 per share. Book value is likely understated given that
JBSS owns quite a bit of real estate, most of which was
purchased in the 1980’s and early 1990s. The company is
planning to consolidate its operations by building a new
larger central facility. Given the expected short payback of
the project, the cost savings could be materially accretive
to earnings in a couple of years. As far as tree costs are
concerned, management expects prices to fall as newly
planted crops are harvested in the coming years. Finally,
given the company’s low stock price, the costs and time
required complying with Sarbanes Oxley, and the favourable
prospects for the company, the Sanfilippo family could take
the company private. If it did, we feel it would be worth
considerably more than what the stock is presently trading
for in the market.
Irwin A. Michael, CFA
