Value Library

The following is an excerpt from the ABC Perspective - October 2011 - Pg. 4-5

ABC Fund Value Favourites

Flexsteel Industries

Flexsteel Industries (FLXS-Q) is one of the oldest and largest manufacturers, importers and marketers of residential and commercial upholstered and wooden furniture products in the United States.  The company is headquarted in Dubuque, Iowa, and its wholly-owned subsidiary – DMI Furniture, Inc. is based in Louisville, Kentucky. Flexsteel’s brands include Wynwood, Homestyles and DMI Commercial Office Furniture. At June 30th, 2011, the company had 1,300 employees.

Although Flexsteel is presently operating in a challenging macro environment, we believe the company’s shares are extraordinarily cheap on numerous metrics.  For example, while FLXS generated fiscal 2011 revenue of $339 million, its current market capitalization is approximately $92 million – or 27% of sales. We also note that Flexsteel is presently trading below its working capital position, which at June 30th, 2011 totaled $100 million ($15.00/share). FLXS shareholders also receive a $0.40 per share annualized dividend (paid quarterly), which at current levels equates to a 2.8% yield.

From an operational perspective, management has in recent history demonstrated an ability to persevere through challenging market conditions.  For example, in fiscal 2009, Flexsteel implemented a number of cost saving initiatives, including a 30% reduction in headcount, consolidation of its manufacturing operations, and minimizing capital expenditures.  In fiscal 2010, the company immediately benefited from this strategy, reporting a higher gross margin and reduced selling, general, and administrative expenses.

Flexsteel’s improved financial performance continued through fiscal 2011. As outlined above, the company generated consolidated net sales of $339 million, representing a 4% year-over-year increase.  From a profitability standpoint, the company reported a 2011 gross margin of 22.8%, which was flat year-over-year.  However, the gross margin includes a $0.6 million inventory writedown relating to a facility closing.  Excluding this charge, we estimate that the 2011 gross margin would have been approximately 23%. While FLXS’ reported 2011 EPS decreased to $1.50 per share compared to $1.61 in 2010, excluding one-time charges, we estimate 2011 EPS would have increased to $1.64 per share.

On a segmented basis, Flexsteel’s residential business, which accounts for approximately 70-75% of annual revenue, has benefited from its involvement with RTA furniture, which Flexsteel markets to online retailers such as Target.com and JCPenney.com. In addition, management also believes that recent growth in residential sales could reflect increases in market share. Within the commercial segment (25-30% of annual revenue), management indicated that its motorhome and towable business have recovered sooner than expected, while sales of senior living products should benefit from the retiring baby boomer population.  Indeed, higher quality furnishings can attract more affluent baby boomers to a particular senior living development.

In fiscal 2012, Flexsteel expects to invest $15 million in capital expenditures. This includes approximately $12 million to construct, furnish and equip a corporate office building in Dubuque, Iowa, with the balance spent on delivery and manufacturing equipment.  In our view, the company is well-capitalized to fund its 2012 capital expenditures, with $17.9 million in cash ($2.32/share) and no long-term debt.

From a strategic standpoint, given Flexsteel’s strong financial position and discounted share price, we believe there are a number of initiatives that management could consider to enhance shareholder value. This could include repurchasing its shares under a normal course issuer bid, increasing the dividend, or possibly a going-private transaction.  It is worth noting current President and CEO Ronald J. Klosterman, who had been with the company for the past 40 years, recently announced his plans to retire.

Despite the fact that FLXS just earned $1.50 per share in the 2011 fiscal year, at current levels, the market appears to be pricing in the most pessimistic of all scenarios.  On a P/E basis, FLXS is trading at just 9.5x 2010 EPS and a 25% discount to its tangible book value of $19.16 per share.  As outlined above, the company is also trading at a discount to its annual 2011 revenue and working capital position at June 30th 2011.

Flint Energy Services

Flint Energy Services (FES-T) is an integrated construction and production service provider to the energy and resource industries.  The company plans, fabricates, transports, builds, and maintains customer projects from well tie-ins to the complete construction of major infrastructure projects. Flint has approximately 9,000 employees and operates more than 65 locations across Canada and the United States.

September 2011 was an active month for Flint Energy. On September 28th, the company was awarded a major oil sands project located in Fort McMurray, Alberta valued at approximately $430 million.  FES will be responsible for the construction of two major silos of work within the central plant facility.  Work will commence in the first quarter of 2012 through mid-2014, and the project will employ over 1,500 employees.  Post this announcement, Flint Energy’s backlog for its Facility Infrastructure segment increased to $740 million, providing good revenue visibility for 2012 and 2013.

In addition, on October 1st, Flint Energy completed the $160 million acquisition of Carson Energy Services, which is one of Saskatchewan's largest private energy services companies. Carson Energy provides a wide range of services, including pipeline construction, fabrication, civil and facility construction, and has more than 900 employees in 14 locations.

From a financial perspective, Carson Energy is expected to contribute $220 million and $40 million in annual revenue and EBITDA, respectively.  The purchase price equates to approximately 4x EV/EBITDA, and while it is not significantly accretive to FES’s valuation at present, management has identified operational synergies that will leverage Carson Energy’s platform and expand Flint Energy’s existing services. In addition, the company positions FES as one of the largest service providers in the Bakken Resource basin.  Note that FES currently has a presence in the United States’ portion of the Bakken with various locations in North Dakota.

Like many energy services companies, FES shares have recently come under significant downward pressure. In our view, the share price decline represents a significant disconnect to the fundamentals of Flint Energy’s existing operations.  For example, while the company’s Q2/2011 results were impacted by non-recurring charges, including non-reimbursable bidding costs and loan prepayment charges, revenue within the Oilfield Services Division, which accounts for 20% of revenue, nearly doubled year-over-year due to increased levels of drilling in both Canada and the United States. Moreover, management expects that further increases in drilling activity will contribute to a strong second half of the year.  For example, while Canadian drilling activity in the first half of 2011 increased 12% to 5,400 wells compared to 2010, second half drilling is forecast to rise 17% to 8,800 wells.

In connection with its Q2/2011 results, management also indicated that it anticipates much stronger activity for its Production Services segment in both Canada and the United States for the second half of the year. The division, which accounts for approximately 60% of Flint’s revenue, has been awarded a number of pipeline construction contracts in northeast BC, as well as the eastern United States. Finally, as noted above, following a major oil sands contract win, the Facility Infrastructure division has substantial revenue visibility, with a $740 million backlog.

We continue to own Flint Energy in all five of our ABC Funds. While the recent share price decline could indeed test the patience of many investors, we believe the valuation gap will eventually close.  To put this into perspective, FES shares traded as high as $20 in late February of this year.  Since then, the stock has retreated more than 50%, despite a bullish outlook with respect to revenue, margins, and earnings.

For example, based on consensus analyst estimates, Flint Energy is forecast to generate more than $2.0 billion in revenue in 2012 compared to $1.6 billion in 2011. Furthermore, gross margin is expected to increase to 18.0% in 2012 compared to 17.2% this year as the company executes higher margin contracts.  Given the higher level of profitability, analysts forecast FES will generate EBITDA of $206 million in 2012 – a 60% year-over-year increase.

Irwin A. Michael, CFA