Given the amazing drop in the market price of this company, we are again writing this up as a long position. ARSD, like so many other relatively illiquid names, is incredibly cheap by any measure. One measure would be an EV/EBITDA multiple of 2.7.
This has been written up a few times in the past and we won’t go into many details of the story as the previous write-ups and threads have provided a good background to the company story. Apologies to those who don’t like multiple write-ups on the same company. What is different today is that they have completed a few more chapters of the story and the stock price has been taken out back to the wood shed and beaten severely.
South Hampton Refining. As discussed previously, South Hampton has undertaken an expansion of their petrochemical processing capacity. This expansion is now complete and is fully operational. The increase in capacity will likely be closer to 115% from what it was before the expansion. Currently, we estimate that South Hampton is utilizing between 15-20% of this extra capacity within the first month and we believe that figure will slowly grow as the year progresses. Barring a complete collapse of the economic environment both nationally and internationally, we feel the majority of this capacity will be utilized during the next 30 months.
Feedstock pricing has been all over the board this year and there is no doubt that will have an impact on the next quarter or two of headline profits. In early February, in the year, while feedstock pricing went through the roof, South Hampton hedged out approximately 30% of their feedstock costs essentially for the balance of the year. Further, they were able to pass along the price increases throughout the year to their customers. As feedstock prices continued up in an unprecedented manner those hedges became significantly in the money. That has now reversed of course…but the Company has been slow to lower prices. In the short run, this activity has an impact to profits but as we look over the long term their hedging activity typically washes out. If oil prices continue to collapse ARSD’s hedging loss will be a meaningful number, but likely offset by the strong profitability from being slow to reduce prices. With this type of program, obviously margins are impacted on a quarter to quarter basis, we feel that in properly valuing a company like South Hampton, there are normalized margins available. Quarterly earnings may be lumpy, but going forward there shouldn’t be any significant additional costs dealing with the expansion as part of the expenses and that in ’09 the plant operates in a much more normal environment. We'd also expect the current quarter to be negatively impacted by Hurricane Ike.
We will focus on normalized earnings, if there is such a thing in today’s panic environment. Eight months ago, we provided an estimate of a normalized annual EBITDA of $18M. We’ll maintain that figure and add 15% for the new expansion that is operating today, providing an EBITDA of $20.7M. We would expect this figure to grow by approximately 15-25% annually over the few three years as the expansion becomes fully utilized through a focus on more international customers. Although they are currently using the extra 15% of the added capacity, one could certainly argue that in our current economic environment, profits could be down substantially over the next couple of years. While we don’t feel this will be the case, we will account for it and will address this below in our valuation.
To this figure we could add the new transloading business, which although being a low margin business, it purely an add-on to cash flow from resources that were virtually 100% in place before this business began earlier this year. EBITDA for this business is estimated to be in excess of $2M. This provides us with a normalized headline EBITDA of $22.7M. But for simplicity sake lets assume the transloading opportunity is a one time event. Over the next three years or so, we could see EBITDA approach $30 - $35M when the plant capacity is fully utilized. Cash flow from operation should be significant in the upcoming year and we would be excited to see the debt fully repaid over the next 18 months.
24M shares outstanding @ $2.60/share = $63M + $17M debt = $80M EV
As discussed in all previous write-ups, ARSD has a 50% interest in ALAK – the Saudi mining venture. The JV is well underway (you can see recent pictures on the website) and mining should commence in 2010. We conservatively estimated the value of the mine in our previous write-up at $3 per share. Given the collapse in metal prices since then, we’ll further discount that figure at today’s metal prices and arrive at a conservative figure of $1 per share for ARSD’s ownership interest, or $24M (note this is a 20% discount to the cost to develop and a 50% discount to the implied value of the creation of the JV). This does not provide any value to the possibility that the mining area significantly increases in size from its present 44 sq km size. Although not providing any value to this, we have come to believe it is a very real possibility of being significantly expanded and that will have true value.
EV $80M less $23M mine = $57M EV for South Hampton.
EV/EBITDA = 2.7 for South Hampton.
You feel that earnings will be hit hard over the next year or so and figure a trough figure of 30% less profits:
Trough EV/EBITDA = 3.93 for South Hampton
Don’t feel the mine is worth anything at all?
EV/EBITDA = 3.8X
Plus earnings will decrease 30%
Trough EV/EBITDA = 5.5X
Even in today’s environment of cheap stocks – that’s cheap. It isn’t arrived at through any wild assumptions. It is quite evident that the stock is more than sold off at this point as anyone attempting to liquidate a sizeable position over the past few months has been forced to drive the price lower and lower. This has lead to today’s ridiculously low price.
What’s it worth in a few years? In recent discussions with management, margins are anticipated to be normal through ’09 and at this time, the demand for the new capacity continues to exist. We’ll let you put a multiple on the $30-$35M EBITDA and add in something for the mine. We’ll just say that it is worth significantly more than today’s price.
Normal operating performance
Perhaps some small growth in the next few years
Continued transloading business
Profitability of the mine
A significant buyer of illiquid micro-cap company thrown out for dead (seemingly nothing but sellers the past few months)
|Entry||10/29/2008 11:40 AM|
|With the current stock price down 23% since our writeup last week, the value proposition here is insane. Sort of Volkswagen in reverse.|
|Entry||11/06/2008 05:42 PM|
|grant, what is your take on earnings, the cost of the hedges and liquidity? Thanks|
|Entry||11/07/2008 09:46 AM|
|I'll caveat my answer as preliminary as we are visiting the Company today. |
"Core" earnings were obviously good. The Company produces a product that is better than their competitors along with better service. The Company was pretty much on target in that 15% - 20% of the capacity expansion would be used immediately. So these are all good things from a running the business perspective and the value of the operating assets.
The hedging obviously was a disaster. Frankly, I was relying on this sleepy company to just plod along for the rest of this year with the only risk being that their hedges didn't protect them enough and they lost some margin along the way. Well, that is what played out through six months, but Q3?!? I'm not sure there's any other way to say it other than mgmt appeared to panic, freeze up, and then try to save the day.....and essentially everything went against them. The key to me is what did they learn? What is the plan going forward? The big hit to the positions is plain for all to see...the immediate cash flow hit is plain to see and the first 3 months of '09 will require cash payments totalling approx $4 mil. The P&L impact going forward is just an accounting shift from unrealized to realized.
Cash flow from regular operations is good, so while things will be tight in Q1 I don't see an immediate liquidity concerns (they have half the amount due in cash right now).
At $2 per share my view is that the stock essentially represents a slight discount to replacement value of the chemical assets with the mine being assigned zero value.
At this point management has some credibility to earn back, however, nothing in the hedge disaster has changed the fact that they have a good position in their market niche, demand has been good, and international opportunities are still becoming available.
I'm sure a lot of loose hands will get shaken out today, but tough to sell below replacement cost.
Will update if anything else comes to light today.
|Subject||Thanks for the update|
|Entry||11/07/2008 10:30 AM|
|And look forward to any insights from mgmt|