How to invest

Written by

Jae Jun

Darling International (DAR)

Darling International is a rendering company. A rendering company is one where it goes around collecting oil, waste and other animal by-products from meat processors, bakeries, grocery stores, butcher shops and restaurants to recycle it into things such as pet food, soap and bio fuel.

Why is it Cheap?

• Non-glamorous/dirty industry the business is in
• Very old company. Over 100 years in the business.
• Not cheap in my opinion
• Only national publicly traded company in the rendering business. No comps and therefore lack of coverage despite being over $1b in market cap.

Management

• Total executive compensation makes up 1% of revenue. Very good.
• A lot of insiders selling recently at $14 – $15
• Share count continues to increase. Lots of options to insiders. Not great.
• Insider ownership is only 2.53%. Feel it is better not to buy when insiders are selling.

Growth

• Can continue to grow by acquiring more contracts. There is a definite need for such a service and if DAR can efficiently expand its region, growth should come slowly and consistently.
• Acquisition of Griffin added a new business segment
• Growth could “possibly” could come from the joint venture with Valero in producing renewable diesel fuel but they are still several years away.
• The industry itself isn’t hot or growing, therefore overall growth will be limited to territories.

Strategic Advantage

• With the Griffin acquisition, it is now the biggest rendering company in the USA.
• DAR may have economies of scale but can’t be too certain because operations involve capital intensive costs that can’t be lowered even with big scale operations. You still need to go out to each store, factory or restaurant to collect the waste. There will always be fuel, labor and truck maintenance cost involved.
• Not a lot of competition due to nature of the industry. Not many entrepreneurs willing to start up a rendering company. No VC will fund them.

Competitors

• No comparable comp on the public market
• Final products compete with other commodities primarily corn, soybean oil and soybean meal. DAR’s product pricing depends on how these commodities are priced. If corn prices go down, they have to lower their price to compete. Riskiest part of their business as it is completely out of their control.

Risks

• Pricing pressure as mentioned above.
• Is the acquisition worth the price paid?
• Can DAR consolidate the acquisition properly?
• Relies on macro factors more than I thought. Such as commodity prices, energy prices because DAR uses a lot of natural gas to run boilers.
• “operating performance was challenged by extreme summer temperatures in the Midwest”. Is temperature a risk?
• A lot of FDA issues could arise based on how the animal feed is produced
• Fair amount of off balance sheet liabilities
• Underfunded pension plan + accrued liabilities

“As of October 1, 2011, the Company has an accrued liability of approximately $1.0 million representing the present value of scheduled withdrawal liability payments under this multiemployer plan”

Off balance sheet liabilities

Here are some sections from the 10-Q, 10-K.

“Company has commitments to purchase $27.8 million of commodity products consisting of approximately $19.9 million of finished products and approximately $7.9 million of natural gas and diesel fuel during the next twelve months, which are not included in liabilities on the Company’s balance sheet at October 1, 2011.”

“Company has committed to contribute approximately $93.2 million of the estimated aggregate costs for completion of the Facility in joint venture. Also has to pay 50% of everything overbudget.”

Expects to pay approximately $14.4 million in operating lease obligations during the next twelve months.

Total: $163m+ off balance sheet liabilities

Valuation

• Acquisition in Dec 2010 so prior numbers do not have the new revenue included.
• Looking at historical figures, DAR is not cheap at the moment.
• P/B in the 2.5 ~ 3 range
• P/FCF is greater than 20
• ROIC is average 11% over 10 years
• ROE average 18% over 10 years
• Balance sheet shows company to be capital intensive
• Debt from acquisition has been aggressively paid off but still remains
• Even assuming that DAR makes $100m in FCF, a discount rate of 15% gives a market implied growth rate of 17%. Too high.
• Based on last years EPS of $0.53, market implied growth is 20% using graham formula. EPS of $0.70 gives implied growth of 13%. Still too high.
• If I adjust numbers to include the acquisition and what I “think” it will be, reverse DCF gives growth rate of 10% and reverse Graham gives 5%. Debt is at 8% interest so their growth should be higher than this to cover leverage costs.
• All in all, looks fairly valued at current price of $13-14

Catalysts

• Griffin acquisitions makes big impact to business
• Macro tailwinds. If prices of corn goes up, DAR can increase their prices too. Energy price goes down, they will save money.
• Joint venture works out quicker than planned. (Don’t expect it though. Likely take minimum 3-5 years before anything happens.)

Conclusion

A dirty business off the radar on wall street. Business model is the type that value investors will enjoy, but whether management acts for shareholders is a concern. High capital business makes for slow growth in a slow industry.

Decent company overall but too much risk in the current stock price considering the growth expectations. Could easily keep running up as the acquisition proves to work itself out. If it drops to $10, then buy.

Verdict

• Management: B-
• Growth: B-
• Moat: B+
• Risk:B-
• Valuation: B
• Overall: B

Other Links

http://seekingalpha.com/article/99139-quick-take-darling-international-still-dirty-sexy-money

http://seekingalpha.com/article/317291-darling-international-inc-rendering-profits

http://seekingalpha.com/article/276290-darling-international-rendering-good-results

http://seekingalpha.com/article/287221-darling-international-strong-earnings-recent-acquisition-great-value-play

The Timken Company (TKR)

Written by

Jae Jun

Going through the list of Forbes Best Small Companies has become a tradition at Old School Value.

Previously I announced that I was going through the 2009 list of 200 best small companies to get more ideas and to revisit many of the companies that I looked at. You can see the original 2009 best small companies series from here.

2 years after my first run, 20 companies have been eliminated from the list. Most of them were bought out or went private. There were a few I deleted because they were just plain awful and not even worth putting in the list. From a percentage perspective, roughly 7.5% of the companies were bought out or taken private. You would have been rewarded with some concrete gains if you held some.

The Process

Because I had so many companies to go through, I had to keep the process simple and quick.

I either liked it or disliked it within 5 minutes of looking at the financial statements and most of my favorite financial ratios. I didn’t have time to decipher what the hidden assets were or break down the components of the business operations.

At first, the method was uneven and inconsistent and it is likely reflected in the comments for each stock, but as I continued, it got simpler and clearer.

Here is how I went through the companies.

• I used my stock valuation spreadsheets to value stocks. No time to calculate everything by hand when you are going through 200 stocks.
• Start going through the financial statements in reverse. From the cash flow statement to balance sheet to income statement.
• (if you want to build confidence in interpreting financial statements, start with this series. Income statement analysis. Balance sheet analysis. Cash flow statement analysis.)
• Review the financial statements in percentage form. That way you get a better picture of the state of the company.
• Then look at historical 10 year trends of the best investing ratios.
• Value the stock based on low, mid and high expectations to get a range of values. DCF valuation, Graham formula, EPV and absolute PE methods were mainly used.
• Each company was then given a rank of 1,2 or 3 based on current price to calculated intrinsic value and quantitative fundamentals of the business.

Data Explanations

Like I said, it got easier as the list went on because once I found a pattern of things to look for, I could do it much quicker compared to the beginning.

You can download the spreadsheet as well as the pdf of my results but let me explain the meaning of the headings.

• Date of completion for this project is Nov 21, 2011
• % Price change: The price change in % on Nov 21, 2011
• Price in 2009: The price of the company when I first reviewed it in 2009
• Current price: Price as of Nov 21, 2011
• 2011/2009 Price: Dividing the current price to the 2009 price to see how much the stock price moved from the 2009 value.
• Added Price: The trading stock price when I got around to analyzing that particular company and added it to the list.
• Price Diff%: The difference in price from the time I analyzed and added it to the list.
• Low – High Value: Intrinsic value range calculated with the stock valuation tools.
• Low – Mid Sale%: The % value between the trading stock price and the calculated intrinsic value.
• Price (1,2,3): Rank given to the company based on intrinsic value and stock price.
• Biz (1,2,3): The quality of the business based on quantitative data.

Quality Companies Worthy of Mention

(Comments may be a couple of weeks old based on the time I analyzed each one)

Here is a list of companies I found to be particularly interesting and worthy of studying in more detail.

NPK - Accounting is very straight. Easy to understand. Business has greatly improved since 2006-2007. Getting towards high operating efficiency. Did well even in recession and current year. Good margins. Large increase in receivables and inventory from 2006-2007 looks to have been solved now. Solvent with no short term or long term debt. Retained earnings and shareholders equity has increased for 10 straight years. Annual dividend of 8%??? Valuation looks excellent.

CMTL - Made money in recession and revenue growth is still impressive at 30% last year. Most likely due to an acquisition in 2009-2010. Increase in growth has led to inefficiency showing margin decrease. Net margin has taken a big drop. If company can get back up to upper range of margins, intrinsic value will be much higher. Share count has increased. Warning is that revenue grew 30% but receivables grew 70% in 2010. Even with 15% discount rate and 10% growth off conservative FCF, valuation is compelling. 5year CROIC is 12% and 5 year FCF/Sales is 13%. Cash converting cow. NCAV of $16.7 and NNWC of $14.5. Meaning business is being priced for about $10.

NVEC - Makes devices that use spintronics, a nanotechnology for transmitting data. Small company with FCF growth every year. See what’s listed under sale of assets. Not much cash. Hasn’t had much cash in its history of operations. Shares are not diluted. Company has grown significantly since the beginning. Returns on capital are excellent at > 19%. Not cheap in terms of multiples. EPV is 2x net repro suggesting that a moat does exist.

HITT - Makes integrated circuits, modules and other RF parts. Excellent growth on the top and bottom line. FCF growth is most impressive. Huge margins considering the industry. Must have an excellent moat. Watch the receivables growth. Lots of cash, no debt, no intangibles. First small acquisition in 10 years. Amazingly good fundamentals. ROE at 20%. CROIC at 15%.

FDS - Provides financial fundamental data and financial tools. Very profitable business. Huge margins. No debt, plenty of FCF. Latest ROE, ROIC, CROIC is ASTRONIMCAL at > 30%. If it ever comes down, buy buy buy. Definitely a moat.

RAVN - Industrial manufacturer. Positive FCF for 10 years, no debt, no stock issuance, very small acquisitions (if you can call it that), plenty of cash, healthy balance sheet. Very low SG&A. Wonderful. Currently at its peak in margins. Stock price has gone up a lot to reflect the strong business. Industrial manufacturer with ROE, CROIC in 25% range since 2005? Definitely can continue to grow.

HIBB - A sporting goods store business that has managed to grow revenues in recession. Margins have increased and at all time highs. Conservative inventory growth and receivables. Looks like the company manages its working capital extremely well. No intangibles, debt is close to 0. 5yr ROE, ROIC, CROIC is 23% for a sports retailer. Amazing.

Download the 200 Best Small Companies List

Forbes 200-2009_20111121 – Excel (XLS) version

Forbes 200-2009_20111121 – PDF version

Free Spreadsheet Downloads

Want to use some of the financial models for yourself? Sign up with your email at the bottom of the page and you will receive free valuation spreadsheets to download.

What are you waiting for? Get cracking. No spam or inbox overloading I promise.

P.S. Happy Thanksgiving

If you are in USA, then have a safe and thankful thanksgiving. For the international crowd, look forward to the weekend. You guys are the best. Rock on.

Written by

Jae Jun

As you read the comments, keep in mind that every company can be a great opportunity at one price and a horrible investment at another.

My comments are based on current prices.

Hard to Find Good Investments

60 stocks have now been completed and it’s clear that finding quality companies is a difficult task. The market is still loaded with mediocre opportunities at mediocre prices. All I can do is keep turning over as many stones as possible. The more rocks you flip over, the more opportunities you are bound to come across.

Meridian Bioscience (VIVO): Solid and stable margins. Does not pay taxes? If they have NOL’s how long will it last? Very healthy, no debt and ROE is averaging 22% in past 5 years. Growth looks to be coming down to the 13% range. FCF positive for past 10 years. Worth looking further into but expectations are too high and looks to be fairly priced now. However, based on absolute PE method, 13% growth + 4.79% dividend produces a fair PE of 20 to 22.

Steven Madden (SHOO): Increasing sales, margins, FCF since 2003. Excellent growth but it involves acquisitions. Receivables and inventory growth looks to be getting out of hand. In MRQ, inventory jumped 100%. No debt. ROE and CROIC is getting into the 20% range. Inventory turnover being managed well. However this is a retail and shoe business. No moat. I can easily buy another designer shoe.

American Science & Engineering (ASEI): Government contracts lead to high revenue and margins. Based on earnings power it looks like company has a big moat. New xray machine technologies being used in airports for security. Security is continually an issue so demand will likely remain. 10 years of shareholders equity growth. Bought back a lot of stock in 2008 when prices were low. Lots of “sale of assets” in investing activities. Paid dividend since 2008. 5 yr ROE is 14.6% and CROIC is 13.6%. Very healthy. Just doesn’t look cheap enough.

National Instruments (NATI): Use their products at work. No moat engineering software. Easily replaceable. EPV suggests the same thing. Dependent on corporate spending. Efficiency increasing leading to highest margins achieved in its history. Growth is slow. Looks mediocre.

Ampco-Pittsburgh (AP): Erratic cash flow with slowing sales. Low ROE and CROIC. Nothing impressive.

L.B. Foster Company  (FSTR): Made an acquisition within the year. Has paid off most of the debt. Cyclical but making money. However looks like a value trap as the growth and ROE, CROIC is not high enough to earn more than the cost of capital. No moat biz.

Lufkin Industries (LUFK): Cash flow is erratic. and CROIC is 0-1% since 2009. They can’t perform in a recession margins have been squeezed considerably. No moat. Pass.

Natural Gas Services Group (NGS): High capital intensive. Margins are good, but it doesn’t convert to bottom line. Wild FCF. Not a fan of such companies.

Stratasys (SSYS): Looks like a no moat business with limited growth. Nothing outstanding that catches my eye.

AngioDynamics (ANGO): Medical device with 10 years of history but only the last two years have been good. Lots of share dilution 5 years ago, with high intangible assets. ROE ROA and CROIC all in the low single digits. Management isn’t effective.

Diodes Incorporated (DIOD): Made money during recession and latest year has been huge. Operating at the upper range of margins. Share count increases slightly each year. Revenue, receivables and inventory growth are aligned so the big increase isn’t a warning. Short term debt is high but has been reduced over the past 2 years. Capex has increased from $50m in 2008 to $90m in TTM which is causing intrinsic value to remain flat.

Anika Therapeutics (ANIK): mediocre company. Nothing special. No consistency, no proven management, no moat.

Allegiant Travel Company (ALGT): Travel company that provides chartered air services as well as operating a small fleet of planes. P/FCF of 14 is very high and all businesses related to airplanes is going to have high capex. Evident in FCF. Pass.

ICF International (ICFI): Short history with uptrend. Barely lost money in recession. Increased margins. Extremely high receivables and intangibles. Lots of acquisitions. Low CROIC and ROE of around 10% median over 5 years.

Comtech Telecomm (CMTL): Made money in recession and revenue growth is still impressive at 30% last year. Most likely due to an acquisition in 2009-2010. Increase in growth has led to inefficiency showing margin decrease. Net margin has taken a big drop. If company can get back up to upper range of margins, intrinsic value will be much higher. Share count has increased. Warning is that revenue grew 30% but receivables grew 70% in 2010. Even with 15% discount rate and 10% growth off conservative FCF, valuation is compelling. 5year CROIC is 12% and 5 year FCF/Sales is 13%. Cash converting cow. NCAV of $16.7 and NNWC of $14.5. Meaning business is being priced for about $10.

JDA Software Group (JDAS): Decreasing SG&A is always a good sign but so has R&D. R&D expenditure of 20% from 2006 down to 11% in 2010. Interest income is about 4% of revenue. For a software company, net margin is extremely low. Big increase in intangibles and long term debt. Not well management.

Rimage Corporation (RIMG): Burning CD’s is a dying industry. I remember reading somewhere that management is not shareholder friendly. Selling below tangible book value but very healthy balance sheet. SG&A has increased 8 out of 9 years. Net income decreasing. FCF is also volatile. Not a stable business. ROE,ROA,ROIC,CROIC all in mid single digits now. Has declined a lot. Won’t be able to pay back the opportunity cost.

ESCO Technologies (ESE): Company with a steady income statement. Nothing shouts out. Balance sheet does shout a few things. Doubling of intangible assets in 2008 which has increased vs depreciated. Debt to equity is on the high side.

Chase Corporation (CCF): Highly subject to cycles. Boring business but no moat. COGS has been decreasing since 2008 leading to higher margins. Seems to acquire businesses as growth is limited. ROE, ROA and CROIC was low during 2009 but has climbed back up. CROIC of 14% is very good.

National HealthCare Corporation (NHC): Healthcare center operating company. Always dependent on government. Unsystematic risk is too high. ROIC and CROIC too low with inconsistent FCF making it a diffcult one to judge immediately. Better healthcare operators out there.

Disclosure: None

Written by

Jae Jun

Well it seems like most of you like the quick short stock analysis style. Although I don’t get into deep details, you should be able to see a pattern of the  specific things I look for in a company at first glance.

Here is the next round of 20. When I’ve completed going through the entire 200 list, I’ll put up a nice and neat spreadsheet so that you can track it yourself. For now, let’s just get rolling.

20 Stocks Round 2

INSU: another industrial company in the list. When economy is good, these companies do good business. Cyclical. Requires high capital expenditure and long term debt is increasing. Share count has increased consistently as well.

SHEN : telecomm network company. High fixed capex. big increases in debt. big drop in margins. large acquisition leading to high intangibles or is it from spectrum holdings?

LL: lumber liquidators. specialty store. FCF losses. Owner earnings would be the better way to analyze. Cash flow from other is quite high. inventory turnover and age of inventory keeps increasing.

RENT: latest fiscal year shows increase in revenue and drop in COGS, but ended the year at a loss. Low moat business. Pass.

ATNI: makes a lot of money but doesnt looks like company will find it hard to earn more than the cost of capital. High fixed capex. EPV < Repr meaning the company does not utilize its assets. Issued a lot of debt recently.

AIRT: Very cheap based on numbers. P/tangBV = 0.7 but no opportunity for growth. Largest company is fedex. Trading below NCAV. Value trap imo.

UEIC: Interesting potential. No moat OEM business. Large increase in net receivables and inventory but looks like sales picked up. Need to look at detailed inventory. New short term debt with no LT debt could mean that they had a big order and needed financing to make the order. Gross margin of 31.5%, EBIT of 5.5%

HCSG: EPV > 2x Repr means there is a possibility of a moat, but the current price seems too high. F score of 7 shows that company is healthy. FCF past 5 yr averages drastically lower than past 10 yr avg but other ratios have increased by 1% or so. P/FCF is very high. Intrinsic value looks much lower. Pass

AACC: classified as financial company. Outside of circle of competence.

DDE: Don’t want to help gambling companies.

NCI: Margins declined for 3 years. Due to recession, consulting business not good. Big drop on cash. Only $0.4m left compared to $49m in 2009. For consulting, liabilities make up 47% of balance sheet. Days Payable Outstanding is 8. Very likely leading to liquidity issue.

MED: Good margins for a distributor. Lots of SG&A involved with business. Verify they are viable. Margin trend has been increasing 2009 and up. Increasing share count. Big increases in cash. Very healthy. Shareholders equity increased 10 yrs. FCF +ve from 2008-2009. Looks like a great turnaround. Increase in DPO and inventory turnover. However, there is no moat.

PRFT: Ignoring 2009, margins have dropped nearly every year. Along with tight margins, this is a difficult business to run. Acquisitions every year. Pass.

SUPX: No long term debt. Good margins for semiconductor equipment manufacturer. Constantly needs to update products to keep up to date with new processes. FCF matches owner earnings well which means the financial is very clean and easy to understand. 5yr metrics are worse than 10yr. Mostly likely due to rapid changes in industry. Difficult industry.

AAON: Serves commercial market for air cons and replacement parts. Did well in recession but going down for 2 years. Looks like down cycle where cycle lasts for ~3years. Looks well managed. Repays debt, no LT debt, buys back shares. Not too sure about buying shares at high prices though.

LDR: ROE, ROA, ROIC, CROIC in constant decline. Company has a liquidity issue. Cash conversion cycle is bad for the balance sheet it has.

EXAC: top line growth but doesnt convert to bottom line. FCF very inconsistent. Large increase in long term debt. 1% CROIC.

DRIV: Went from average of 12% Operating margin to 3.6%. Huge increase in LT debt. From $8.8m to $354m. Not much growth in shareholders equity since 2007. New acquisitions every year. Lots of intangibles.

NPK: Accounting is very straight. Easy to understand. Business has greatly improved since 2006-2007. Getting towards high operating efficiency. Did well even in recession and current year. Good margins. Large increase in receivables and inventory from 2006-2007 looks to have been solved now. Solvent with no short term or long term debt. Retained earnings and shareholders equity has increased for 10 straight years. Annual dividend of 8%??? Valuation looks excellent.

QLGC: Cyclical business but profitable. Growth is limited but it looks like the business is solid. Good balance sheet, 5yr ROE 15.3% and 10yr ROE is 16.7%. EPV is > 2.5x Net repro value which suggests that a moat does exist. Hard to predict earnings or fcf because it is erractic but worth another look.

KNX: Truck logitics company. Very erratic. Hard to value. Dependent on gas prices and economy. Pass.

The two that caught my eye is MED and NPK. I especially like NPK but wish it would go down more.

Disclosure: None.