Gencore: My Take on a ‘Net Net’
As an aside, I've seen mentions of Gencore in many different value communities online & from people who have contacted me personally about it over the past year or so. I realize this isn't an original idea, but I figure it's interesting to see my take on this company. Now that I think about it, though, the company is so simple that we all probably have the same exact reaction to Gencor. Nonetheless, I have not yet read anyone else's work on Gencore other than the fact they mentioned it to me. So this is all my work, and if there's anyone to laugh at for mistakes, just laugh at me.
Also, I've mentioned a few times (both in email to friends and on this website) that I have some good ideas that I'd be writing about shortly. This isn't one of them. I have those articles just about fully written but I'm not sharing on this blog until I've fully finished my research & initiated positions in the stocks. As far as I know, 2 of the 3 companies aren't followed by anyone online... so hopefully you'll enjoy once they get posted.
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I'm sure many of you have heard: Gencore is a net net! In the United States no less!! Graham must be turning over in his grave; this is something he probably wouldn't have expected in an age with instantaneously widespread information- via the internet- and it has traded below net liquidation value for a little while now. Not too bad!
However, this is not exactly the same scenario that you'd see with many of Graham's net nets. Back in his day, you could pick up a business for less than it's net working capital, and in terms of size, it was in pretty decent proportion to its operating business. Gencore is a different type of net net- buying them today is much more like purchasing a closed end fund below net liquidation value.
On Closed End Funds
It's been a very successful strategy to simply buy up closed end funds when they trade far below net liquidation value, wait until they sell at par, and unload them. Many would call it arbitrage. It's pretty darned close. So I'd tend to agree with them.
This is the case with Gencore today- they very closely resemble a closed ended fund below liquidation value. This is what their current balance sheet looks as of last check:
Current Assets: $106 MM
Total Assets: $114 MM
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Current Liabilities: $10 MM
Total Liabilities: $11 MM
Shareholder's Equity: $103 MM
There's one detail we need to adjust for, however. Gencore has $81 MM in investments (about 60% bonds, 40% equities):
Investments: $81 MM
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Net Current Assets: $25 MM
Net Total Assets: $33 MM
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Net Current Liabilities: $10 MM
Net Total Liabilities: $11 MM
Net Shareholder's Equity: $22 MM
Ah, that's much better. Now you can really get a sense of how big Gencore is as an operating business. While the balance sheet is overstated from the operating business' perspective (i.e. their asphalt plant & combustion system manufacturing business), you can still subtract it out to get the full picture.
From a valuation perspective, I'll simply separate the two assets (the operating business and the investment portfolio) and value each accordingly. Sum of parts analysis works just fine in this case.
Gencore's Operating Business
Gencore is an interesting little company. They make asphalt plants, combustion systems/industrial incinerators, and fluid heat transfer systems for customers who then make asphalt. This heavy equipment is all focused on one thing- the production & repair of highways. So they're very reliant on the federal government.
Gencore has been doing the same thing for a long time now. 1894 is when they first started making asphalt plants and they now have the largest base of asphalt production plants in the U.S. Throughout their annual report, they continually referenced being the lowest-cost producer, as well as possessing capabilities to produce the highest quality asphalt plants in the country. They've also worked with the U.S. to develop standards and it seems to me like a pretty nice setup. I don't know too many kids who grow up wanting to compete in the production of asphalt plants, so I think they're probably okay in terms of future competition.
The real value in this business comes when the federal government decides to open its pocket book & start repairing/updating our highways across the country. We've had some stimulus the last few years from both Obama & Bush, but they stabilized spending in the industry- it was far from a multi-year highway modernization plan. If you do see any mention of a multi-year highway plan, however, this is the first stock to buy! It pays to keep your eyes open.
I saw in one of Gencore's older annual reports that the U.S. has something between 4,000-5,000 asphalt plants, and also that Gencore clears something between $2-4 MM for each plant they sell. It looks to me like GENC's sales for the last decade were anywhere from 20-60 plants/year (although that may be far off). The last 2 years have been especially low for Gencore, but even at their earlier-decade sales figures, they won't be making much money. The business isn't a cash cow- it just stays pretty stable (although isn't always profitable) and reinvests excess cash flow into its investment portfolio.
One last note is that the business has gone into defensive mode. They allowed their balance sheet to shrink (in the form of inventories, accounts receivable, and all other working capital components), have laid off some workers, and are very focused on reducing SG&A. It's nice to see them waiting for a cyclical upswing in government spending (if it ever comes).
Valuation
This is a pretty simple valuation- by far the most simple you'll see me perform:
Value of Investment Portfolio: $81 MM
Value of Operating Business: $11-20 MM*
TOTAL: $90-100 MM
I like to buy at a discount with an adequate margin of safety:
Discount: $55-65 MM
Current Market Cap: $68 MM
It seems Gencore is cheap enough for me to buy today, assuming no other problems. They have no debt, no serious longer-term obligations, and overall are in fantastic financial shape. I don't have any qualms in terms of bankruptcy risk or downside. The downside seems pretty limited. However, I have one last thing to say about risk in my last section to this article.
*The reason I have their operating business marked anywhere from $11-19 MM is simply 0.5-0.9 of book, I figure in this case the operating business is worth less than book value because it has posted operating losses (by my calculation) in 5 of the last 14 years. None of them were catastrophic either- all were pretty much within the same range. In any event, big swings in the value of the operating business (anywhere from $5-30 MM perhaps) doesn't make a huge impact on the ultimate valuation. The investments Gencore owns are clearly worth more than their operating business.
Fiscal Woes & The Human Factor
The two more obvious things I see as risks for this business are the fiscal woes of the federal government and the human factor behind their business.
As I said above, Gencore is heavily reliant on federal government spending on highways. Without it, asphalt isn't needed in nearly such a large supply, and Gencore's customers stop buying asphalt plants. If you haven't picked up a newspaper in the last 4 years, our government is having some serious trouble with its debt burden. And we're not alone- many governments in the world are having trouble with their debts. So, that leaves us in a predicament... With no money to spend at the federal level, we may not see any increases in infrastructure spending for awhile. And that is unfortunate because many people believe our highways aren't up to par these days. We could do with some updated roads. Just as with defense contractors, most businesses connected to highway construction (I'm thinking of the aggregate producers- Vulcan Materials, Martin Marietta- in particular) may have to wait awhile before they can shine again.
The other thing to consider- the people factor- does hold some importance here. The current Chair/CEO, EJ Elliott, has been with the company since 1965, is 81 years old, and effectively controls the company. He owns the B shares that trump your common stock every day in a proxy fight. So whatever he wants, he's likely to get. There hasn't been a dividend, as far as I can see, for quite some time, but that's not stopping him from selling all $81 MM in investments and paying it all out tomorrow. He also is capable of selling the whole company at a bad price. That's not to say that he'll do these things- but it's a real thing to consider. He's done well for Gencore through thick & thin these past 46 years. So I'm not terribly worried. But he does have to be on your radar.
In Closing
And that's all folks. Pretty simple. You're looking at $81 MM of securities, an operating business that could have a cyclical upswing the next time the federal government opens its pocketbook, and an 81-year old controlling stakeholder. Sounds like a closed-end fund to me.
Disclosure: I'll be long this stock starting tomorrow.**
**It's likely to be a very small position & held more in honor of Graham than anything else. I don't mind having another company to follow, and it'll be interesting to see if anything comes from this.
As I've said in previous posts, I'd much prefer to buy a business at a discount to its operating business (i.e. its earnings), but I still will buy something at a discount to its assets given the right opportunity. And I think this is a fairly decent opportunity. The cycle doesn't have to go in my favor to do well here- but it's a nice catalyst to unlock the value if it does happen. I just don't see it happening for awhile... mainly because of how long it may be before the government puts some money towards our roads. My faith & belief in the U.S. Federal Government's ability to allocate resources intelligently is similar to that of Santa. As I grow older, I believe in it less and less...
October 19th, 2011 - 11:55
I’d challenge your notion that you need to complete your research and buy in before posting anything on a blog. I’ve found that blogging about ideas gives me a chance to rethink ideas. In addition I get a lot of comments about angles I hadn’t considered initially. I’ve also never had it where I blogged about a stock and it wasn’t available to purchase at a similar price a few days to weeks later. Most of the time people who read ideas on blogs do their own research and consider the idea on their own. I would imagine someone doing an impulse buy is very rare unless you have the most bullet proof thesis, or are a big name investor.
I used to think in a similar manner as you, but in the course of my experience I’ve changed and write first before purchasing. The input I’ve received from others has been invaluable.
October 19th, 2011 - 12:36
My policy of not posting until I have a position isn’t to prevent impulse buyers from making mistakes. It’s about having the full story (or what I’m comfortable as enough of a story to invest) and writing it all out at once.
I also have a network of people I share ideas with- so it’s unfair to them to have given me proprietary ideas in the past & not expect similar treatment when I have an idea or two.
I still write it out for the feedback & other ways people see them (because, like you, I also find it quite valuable), but it’s just not worth it while I’m in the ‘discovery’ phase on a company. I like to solidify my thoughts & share it privately before sharing it publicly.
October 26th, 2011 - 00:19
I dug into Gencore a bit further after reading your post. I think the margin of safety is an illusion with them, here is my post: http://oddballstocks.blogspot.com/2011/10/gencore-selling-below-net-cash-but-is.html
October 27th, 2011 - 00:09
Very impressive article. I’m already sold out & appreciate the digging you’ve done- the problem I tend to run into is for cheap stocks like Gencore, where I may want a position but it’s going to be quite small, I don’t bother digging like this at this stage.
I’m still at the point in my learning that I want 1-3 hours per company of exposure, get a good sense as to what they’re all about, and get a good approximation of intrinsic value assuming they’re telling the truth.
For my big ideas, such as Noble Corp. or Aeropostale, I tend to dig very diligently (closer to 20-50 hours). That’s just tough on a 1-2% position when you have less than $50k to invest. We’re talking positions <$1,000. For 40-50 hours it’s not worth it to me.
Maybe I just shouldn’t buy small positions….
October 27th, 2011 - 09:45
I agree, but I don’t think you have to dig that far. I probably put in three hours or less for that post and didn’t have to dig in deep.
I think the main issue is the approach, here’s in essence what I do:
1) Identify the bull case (otherwise why would I be interested), this could be selling at EV/EBIT 3x or how ROIC low P/FCF, net-net etc
2) Identify the problem with the stock why it’s selling cheap. This is usually quite apparent a lawsuit, recent loss. This is often spelled out by the company in the 10-k risk factors.
3) I next look to kill the idea, the company is obviously cheap, and even a return to average will give me a good return. This is where I look for fraud, any red flags, check the cash flow, check the durability of assets etc.
The first two steps are usually very simple and quick, and often with a cheap company the third step is equally quick. As I noted in my post I want to find companies selling cheap with a problem that looks big, massive and scary but in reality won’t have much affect on the business.
The trick with investing is probabilities, I agree with your assessment on return on research. I’d argue that with $50k even your big ideas aren’t worth 50 hours of research. After about 10-20 hours you hit diminishing returns. If you can identify a cheap company, know why it’s cheap, know you have a large margin of safety you have a good investment. I would argue digging into the nitty gritty to understand some obscure aspect of the business actually harms the investment because you become emotionally invested in an idea.
Consider the math, say you own 10 companies at $5k a pop a very focused portfolio. If you put 40 hours into each you’re at 400 hours. If your portfolio returns 30% your hourly return is $37.50 an hour. Not terrible but I think getting 30% a year returns is probably unrealistic sustained. If you only get 15% in a year now your return is $18.75. And quite honestly at that point you’re better off working at Costco because the $18/hr at Costco is guaranteed and has no risk whereas with your portfolio you could find amazing companies and you’re still at the whim of the market.
For me I will do smaller positions, my goal is to make sure I cover all of the bases quickly and then diversify. I have some concentrated positions I know more about, but for net-net’s there is strength in numbers. If I miss something big and have a blowup it won’t sink my portfolio. I also don’t have to sink a ton of time into these situations either.
I don’t know if you’ve ever read Security Analysis (I would recommend it), but the most important factor in investing is to buy with a margin of safety (a true one). If you can identify it, make sure it’s solid you’ll be fine.
Best of luck, I’ve enjoyed reading your blog as you discover investing and work to refine your technique. Like anything in life you get better with practice and maturity.
November 10th, 2011 - 13:23
Nate, you’re absolutely right.
I posted about it- sorry I hadn’t gotten back sooner.
I appreciate the help, commentary, and pointing out the mistake. Very helpful to hear from you.
Look forward to working together more in the future. I’ll start following you much more closely & have some commentary on your latest investment ideas… it
I’ve read Security Analysis a few times, alongside a large slew of investment books, and feel like I’ve gotten what I can from them at this stage. I’ll likely go back in a year or two to help refine my technique, but for now I’m in this business learning stage & staying there.
As for my size in relation to position size, it’s important that I treat my concentrated positions as worth spending 20-40 hours on. Without it, I have no discipline & no real direction. If you can understand most everything about a company, it really gives you a leg up for the analysis. So, when I’m older & have more time, I know I’ll have the luxury to spend those kind of hours on all the stocks I research. Regardless of this idea of hourly pay (which shouldn’t matter if I’m continuing to grow & consider taking outside investors), I’ll be rewarded within the next 10-15 years for that time I spent. Once you get the ball rolling it won’t stop.
Thanks for reaching out with the insightful commentary. I’d be sending you a check if I had the money haha.