Value Library
The following is an excerpt from the ABC Perspective - April 2009 - Pg. 4-5
ABC Fund Value Favourites
CANAM GROUP INCORPORATED
ABC Funds’ unitholders should be familiar with the Canam Group story. Headquartered in Saint-Georges, Quebec, Canam Group designs, fabricates and markets construction products, such as steel decking and joists, composite flooring, bridges and steel building systems. The Company operates 12 plants with an annual production capacity of nearly 600,000 tonnes and employs more than 3,000 people in Canada, the U.S., India and Romania.
We originally purchased our shares of Canam Group through a secondary stock issue at $5.75 in March 2005. By late 2007, as infrastructure stocks became front page news, Canam was trading around $14.00 per share. Given the weakening economic outlook and full valuation of the stock price, we decided that it was time to take our money off the table. However, selling 3,000,000 shares took considerably longer to sell than to buy. In all it took almost six weeks to liquidate the ABC Funds’ holdings at $14.00 per share or better. Although Canam shares eventually hit a high of $15.98 four weeks later, the relative thinness of the stock and its full valuation necessitated an early exit. Nonetheless, we were extremely pleased with our investment and total return of about 120% over a 25 month holding period.
As the real estate crunch intensified and economic data deteriorated, shares of Canam Group began to sell off. As we entered 2008 the shares plummeted. They broke toward $10.00 in the January to March period, bottoming at a 52-week low of $9.40. Our interest was piqued. The Company and management were sound and Canam’s lower share price provided an excellent re-entry point. Yes, the shares were higher on an absolute basis than when we bought our original position. However, the multiples were almost identical to what we paid back in March 2005. Essentially we rebuilt a position in Canam Group at 1.3 times book value, 10 times trailing earnings and approximately 8.5 times forward earnings.
We were comfortable paying almost $6 per share lower than the stock’s 52-week high and roughly $4 per share lower than where we had sold our original stake. At the time, we thought that we were buying a dirt-cheap stock but, unfortunately, the bear market intensified. On October 7, the shares opened just below $6.50 and suddenly plunged to a low of $3.73 per share, a decline of approximately 40%. We were dumbfounded but quickly put a bid in and actually managed to purchase a few thousand shares at $3.75. The stock then bounced and closed the day at $5 per share. Over the next two days we saw several large blocks of stock change hands. It took us a few days to piece together the story but we finally discovered that a hedge fund was behind the volatile trading. This fund, perhaps facing redemptions, was forced to raise cash by dumping several million shares into the market, irrespective of price. It was frustrating to watch but at least we understood that the Company’s fundamentals were sound.
Today, we believe that Canam is an even more compelling investment than four years ago. The real corporate changes began in 2006 when Marcel Dutil, Canam’s founder, converted his Class “C” multiple voting shares into Class “A” subordinate voting shares. This nicely aligned the interests of all shareholders and leveled the playing field for investors. Marc Dutil, Marcel’s son, then began to take an active role in managing the day to day activities of the business. Since then, the financial results have demonstrated a shift in focus from revenue growth towards profit growth. All of these changes are positive from a fundamental valuation perspective.
We have also seen a tremendous improvement in the financial health of the Company. At the trough of the last infrastructure cycle in 2002/2003 Canam was unduly leveraged for a cyclical business. In 2002, net debt totaled $333 million on $256 million of equity for a net debt to equity ratio of 1.3 times. In 2003, although the total debt level fell on an absolute basis to $276 million, the net debt to equity ratio deteriorated to 1.4 times. Despite the present difficult economic environment, we believe that Canam did all it could to prepare for the current downturn. Net debt is presently $69.5 million, which implies a net debt-to-equity ratio of 0.17 times. Further, some of the current debt load was actually used to repurchase shares on the open market. As of January 21, 2009 the Company had bought back $26.3 million worth of shares over the past twelve months at an average price of $6.46 per share. This is accretive to earnings and book value, which currently stands at $9.06 per share.
In the near-term, upside to the story could come from two potential catalysts. Firstly, the Company should benefit from US and Canadian economic stimulus that focuses on infrastructure spending, especially bridge building. Remember that the Company recently acquired an American bridge manufacturer based in New Hampshire. This acquisition will enable Canam to take advantage of the significant repair and rebuilding of aging bridges in both Canada and the United States. Secondly, Canam could make one or more accretive acquisitions. The Company has the financial firepower to go out and buy businesses at trough valuations, which could be cents on the dollar for assets that have come under financial duress. If management can find quality assets that are simply overleveraged, we believe that Canam could pull the trigger on up to $150 million in acquisitions. This would support revenue and earnings through the downturn to the inevitable recovery. Eventually, investors will focus on fundamentals instead of liquidity and the shares should return to a more realistic valuation range.
FORTRESS PAPER INCORPORATED
Fortress Paper (TSX: FTP) is an international producer of security and specialty papers and wallpaper base. The Company listed on the TSX on June 28, 2007, after purchasing the Landqart Mill and the Dresden Mill from Mercer International Incorporated. Mercer, a European softwood and kraft pulp producer that trades on the NASDAQ (MERC) and the TSX (MRI.u), divested the mills to focus on its pulp business. A Canadian entrepreneur, Chad Wasilenkoff, reviewed the assets, conducted due diligence and negotiated the transaction. Mr. Wasilenkoff then installed experienced European management, led by Dr. Alfonso Ciotola as Chief Operating Officer and Erich Sulser as Chief Financial Officer.
We believe that Fortress Paper is a net asset value story, where the replacement value of the two mills and the related equipment is well above the Company’s current market capitalization. The Landqart Mill, which produces security papers including paper currency, passports, visas, cheques, share certificates and lottery tickets, is situated in the town of Lanquart, 100 kilometres east of Zurich in the scenic Swiss Alps. The mill has been the sole provider of banknote paper for the Swiss currency since 1979 and is one of only nine authorized suppliers of various denominations of the Euro currency. After poring through the initial public offering prospectus we discovered that the fire insurance value of the property was CHF (Swiss Francs) 66.5 million for the building and CHF 163 million for the inventory and equipment. At the current exchange rate this totals approximately CAD $200 million. The Company’s Dresden Mill in Germany produces primarily non-woven wallpaper base that is sold to Eastern Europe and the former Soviet Union. Although global demand for wall paper is declining, these markets are experiencing growth, especially in the non-woven segment. The Dresden Mill is located in the town of Heidenau, 12 kilometres south of Dresden on the Elbe River. The mill has total capacity of 36,000 tonnes and a 12,000 tonne machine costs approximately EUR 30 million. Therefore the total replacement value of three 12,000 tonne machines is EUR 90 million or CAD $125 million. Additionally, the Dresden complex includes land, a hydroelectric plant and a water treatment facility, which were appraised at CAD $50 to CAD $100 million combined.
Putting all of the pieces together, we believe that the Company’s assets are worth between CAD $375 and CAD $425 million compared to the current market capitalization of only CAD $50 million. We are not suggesting that the stock should trade at replacement value, but we believe that a 75% discount to net asset value is excessive for assets that are both cash flow positive and profitable. Recently released 2008 financial statements indicated that annual sales grew from $145.3 million to $189.0 million, an increase of 30%. EBITDA almost doubled, advancing from $13.6 million to $25.0 million. Similarly, net income jumped from $5.3 million or $0.76 per share to $12.7 million or $1.24 per year in fiscal 2008. To be frank, these results are excellent given the current economic environment. Essentially, the stock now trades at approximately four times earnings and has an enterprise value to EBITDA multiple of less than two. At the current price of approximately $5.20 per share and a total market capitalization of approximately $50 million, the shares are very cheap. The discount to replacement value of the Landqart and Dresden mills, we believe, is excessive for a Company that is both cash flow positive and earning money.
At current trading multiples, the market has placed a forestry sector-type valuation on this Company. But we believe that the name “Fortress Paper” is a misnomer, which conjurers up negative connotations of cyclical commodities, small profit margins and a weak return on capital. However, Fortress is a high-technology company that uses proprietary techniques to incorporate features such as embedded watermarks, chemical taggants, security threads and even clear polymer windows in their products. Fortress also produces passports, visas, share certificates and identification cards that incorporate features such as holographic foil, radio frequency chips, antennas and machine-readable digital nanotechnology. These components allow for instantaneous verification of important documents. Fortress, moreover, operates in a highly specialized industry, with impressive research and development capabilities related to the development of the latest and most advanced anti-counterfeiting features. Therefore, we would suggest that it is more appropriate to use a high tech security multiple instead. Should a multiple re-rating occur and/or the Company is discovered by the market, we believe that the shares could trade at a significant premium to today’s valuation.
We believe that the market is only valuing the Company at approximately four times earnings and two times EBITDA for one key reason. Since the IPO, management has talked about making an acquisition to add bank note production capacity but have been unsuccessful thus far. Currently, bank note production is sold out and management has actually been politely turning down orders. Of particular importance, Fortress Paper has a clean balance sheet with $26.2 million of cash against $30.6 million of debt. With a net debt figure of $4.4 million, this provides Fortress with excellent opportunities. It is our view that an accretive acquisition could be an important catalyst to precipitate market recognition and a meaningful price appreciation.
Irwin A. Michael, CFA
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