|Shares Out. (in M):||0||P/E|
|Market Cap (in M):||87||P/FCF|
|Net Debt (in M):||0||EBIT||0||0|
Hidden in a non-operating asset rich balance sheet is a gem of a high ROIC niche chemical business. The real story is South Hampton Refining Company, a historically sleepy assemblage of assets, that is generating profits in its core business as well as capturing material growth opportunities. On top of that there is both downside protection and significant upside potential through the ownership of a non-operating asset owned by the parent Company - Arabian American. ARSD is the ticker for Arabian American Development Co. ARSD has two sets of assets – chemical operations (SHR) and a base metal mine.
To be blunt – I have not come across many opportunities like this over the past 5 years where you have an opportunity to own a good company at a cheap price and have multiple catalysts:
- multiple expansion to peer level,
- expansion / growth of underlying business at incredibly high returns on invested capital (evidenced by recent announcement of BofA financing),
- exploitation / monetization of base metal mine. (third party validation evidenced by $30 million funding of JV last year)
This is a rerun of an idea posted in June of last year. Ran112 laid out a compelling case and has served up a double+ from his price. Even after this run I believe the current business is trading at a 40% or greater discount from current intrinsic value and is capable of delivering returns of 30%-50% per year over the next 4 years.
South Hampton Refining Company (SHR) owns and operates a 97 acre petrochemical facility located in
The Company produces high purity petrochemical solvents and other petroleum based products – it produces a very nominal amount of motor fuel products and other commodity type products commonly sold directly to retail consumers or outlets. 85% of revenue relates to products sold as intermediate components to manufacturers in various markets such as expandable polystyrene (Styrofoam), polyethylene, adhesives, building foams, synthetic rubber and food processing. 10% of revenue is oil related and consists of gasoline blends sold to the majors or other miscellaneous products such as degreasers / flow enhancers, etc. 5% of revenue is for toll processing to customer specific needs.
The facility consists of equipment commonly found in most petroleum facilities such as fractionation towers and hydrogen treatment equipment except the facility is adapted to produce highly specialized products. The aggregate capacity of the facility’s processes is approximately 7,000 to 7,500 barrels per day, via eight different product streams.
The Company is known for consistency in terms of product quality and superior levels of service (being primarily chemical efficacy and delivery). On the production side the Company has approximately 60% of the available North American market share (based on delivery range for their primary products) for C5 solvents (expanding agents). These products replaced CFC related products for expandable polystyrene products (Styrofoam), which are used to make various containers. The Company is also a leader in the production of C6 solvents, which are typically used in adhesives and rubber applications. By products include “flow” enhancers (think “anti glue”) that keeps oil and other “sludgy” chemical products from getting mucked up in manufacturing processes and specialty gasoline blends. A nominal amount of revenue is derived from byproducts sold to other feedstock processors.
On the processing side, the Company is a fee-based processor of customer’s unique feedstock requirements to their specifications – basically SHR is an outsourced chemical processor. SHR contracts with customers to produce customer specific solvents / mixtures (5% of revenue) on a fee basis. Contracts for this business run for 3 - 5 years. SHR receives a toll processing fee in addition to a capital expenditure reimbursement over the first contractual period to cover the capital expenditures made by SHR necessary to produce the specified solvent.
The Company’s prime competitor is a plant owned by Conoco.
Nick Carter is the President and Mr. Do It All. He is a CPA and has worked for the Company since 1977. He has been President since 1987, prior to which time he served as Treasurer and Controller.
Cutomers include Dow, Shell, ExxonMobil, Dupont, BASF, Union Carbide, 3M, Goodyear, Firestone, Lyondell, Penreco, Advanced Aromatics.
The primary cost / material input to processing is natural gas. Thus the Company is very sensitive to natural gas prices. SHR uses what some would call “derivative investing” (swaps and future contracts) to attempt to lock in prices and avoid massive fluctuations – though that would be more of an “accounting perspective” than operational perspective. Essentially, the Company manages feedstock on a rolling basis and prices its products accordingly – thus the overall strategy is designed to protect the company from price spikes, not generate trading profits or take advantage of speculative price changes. Product pricing is based on the “hedged cost”. While this leads to quarterly fluctuations the Company does not expect to be burned or realize any windfalls on a persistent basis from swing in gas prices. The Company reports inventory for fin reporting purposes using LIFO.
Looking back over the past 7 years EBITDA margins have a normalized range between 8% and 16%. Maintenance cap ex is nominal - $1 million per year at the max. Factoring in hedges on raw material management seems somewhat comfortable targeting a normalized gross profit of 20%. G&A costs have recently been around $6 mil – however, that includes one time payments related to past performance and other non-operating expenses that are eliminated going forward. G&A going forward is likely to be between $4 and $5 million on the current asset base.
So…what’s the story here? Well for SHR the story revolves around two factors. The first is a fairly straightforward growth story – nothing sexy. Production capacity for chemical products was increased by about 30% in 2005 at a cost of about $1.5M. This added capacity has been running at 100% capacity. The tolling facilities were expanded in Oct. 2005 to accommodate a major customer and have been running at between 80% and 90% capacity. A second expansion was undertaken in Aug. 2006 for a separate customer, and this expansion is expected to further enhance tolling revenues going into 2007.
The second factor is completely UNRELATED to anything SHR did, but rather what their competitor did. Prior to 2003 SHR faced stiff pricing competition from a division of Phillips Petroleum. Based on discussions with management, the Phillips plant had no reasonable profit metrics to hold to being essentially an orphan plant producing derivative products that had no material impact to Phillips overall results. They simply were an afterthought. It appears that for sheer survival purposes and to justify their existence the Phillips plant demonstrated “volumes” - price be damned. And to make matters more convoluted it appears that there was incomplete internal reporting about the price the Phillips plant paid for raw material (feedstock came from a “sister” plant in the Phillips family). It was a cluster …… and unfortunately SHR had to compete against this “irrational” business.
To make a long story short - apparently, after the Conoco Phillips merger – some Conoco mgmt figured this out and lo and behold a rationale competitor was created by 2004. Due to Phillips prior stupid pricing – SHR was basically the only survivor. So, what once was a somewhat fractured industry with an irrational participant turned into a “semi” competitive duopoly. Enter the new world of “profitable chemical operations.”
OK, that fixes the existing operations. The result – a business that will this year generate over $100 million in revenue and ebitda in the $13-$14 million range.
Now the story gets better. The Company is running at capacity and management has indicated they have essentially turned away an additional 20% of revenue. Thus, yesterdays announcement. Here are the key excerpts:
“Board of Directors has approved a $12 million expansion of the Company's Penhex Unit, currently operated by the South Hampton Resources, Inc. subsidiary. The expansion is part of the Company's plans to capture additional market share and respond to increased demand for the Company's petrochemical processing services.”
“We are confident that 20 percent of the increased capacity will be immediately utilized," commented Nick Carter, the Company's President.”
"We expect to fill the remaining capacity within three to four years. The expansion will add an estimated $65 million to $80 million of revenue potential that the incremental 3000 barrels per day represents. We believe our current staffing levels and operating infrastructure will meet the near-term processing needs and as we approach full capacity approximately $1 million in additional operating expenses may be required for increases in contract or outsourced labor.”
So to walk through the impact – the Company will spend $12 (I think it will be slightly lower) and in year one following they will generate an additional $20 million in revenue yielding a gross profit of $4 million. No additional operating expenses will be incurred for this phase – dropping the $4 million straight to ebitda. That’s an incremental ebitda margin of 25% and a year one pretax return on investment of 33%.
But the exciting part is over the next 3-4 years. The impact is large. Using the bottom end of their range of $65 million in additional revenue yields $13 million in gross profit and then with $1 million in operating expenses yields $12 million in incremental ebitda. This expansion has the potential to nearly double ebitda at long terms returns on incremental invested capital in excess of 100%.
And the best part is that this is demand driven in the current environment. Based on the timeline – the capital will be put in place this year with operations to begin first quarter of ’08.
As a side note – this growth just relates to their “production” business. The tolling operations (currently at $5 mil) can be grown fairly easily to a $10 million dollar business and management states that this is 50% gross margin business. (Further – cap ex in this business is reimbursed by the customer further enhancing ROIC).
Base Metal Mine
Based on a 2005 feasibility study by SNC Lavalin, ARSD owns a 50% interest in a 700,000 tonne per year mine in
You can refer to Ran112’s writeup and Q&A for ranges of value. Here are some highlights:
- On a bare bones, eyes closed basis its worth $30 million based on the fact that a third party contributed $30 million in cash last year for a 50% interest.
- Using current metals prices and assumptions in the SNC study regarding cash costs, etc. and a 10% discount rate the NAV for their 50% interest is in excess of $180 million!
- Using current metals prices and worse assumptions regarding cash costs, G&A expenses, taxes, etc and a 15 discount rate the NAV for their 50% interest is just under $100 million!
Well, both of those numbers exceed the current market cap of the Company.
If I reduce current metal prices across the board by 35% NAV drops to $50 million. To get to the $30 million value based on the recent transaction metal prices would need to drop by 50%.
Development is expected to occur in ’07 and ’08 with production beginning in ’09.
I’m not going to spend a lot of time here as not much has changed from Ran’s writeup. Well, except for two things – the wick is getting shorter and metal prices remain high. Are those points that relative? I would say very much given that the Chairman of the Board and the President of the mine segment are both in excess of 70 years old! I get the sense that they would like to see their work over many years “play out.”
Well, I believe a large disconnect exists. Current market cap is $87 million. Interest bearing debt net of cash and some land in
At a summary level here are the two pieces:
Value = $110 - $120 (based on transactions / comps at 8x ebitda, just over 1x sales)
(with EBITDA growing to $19 million in ’08, and $27 - $28 million by 2010/11)
Value = $30 - $180 (discussed above).
Total Value = $140 - $300.
Implied returns from current price are 60% to . . . . well lets just say large.
I’ve run the numbers a zillion ways – DCF, LBO, equity FCF, etc. and can get to no other conclusion than this is cheap. I’ve asked management what the business would look like in a worst case scenario (this was based on the assets in place without the expansion). Based on a discussion we arrived at a nightmare 12 month scenario where the business shrunk to $70 million in revenue. At that level management indicated that even at that level they should generate $7 million in EBIT. If you allow $30 million for the mine that is 8x trough ebit currently.
For this not to work would require a scenario of total collapse in the chemical business and the mine is scrapped. Neither seems likely to happen and both happening at the same time seems inconceivable.
The way I see it
1) You own a growing chemical business generating current returns on invested capital of greater than 50% (adjusted for mine assets) at a 25% discount to intrinsic value and you own a monstrous base metal mine opportunity for nothing.
2) You own the chemical business for a ridiculously low multiple and a significant discount to intrinsic value after adjusting enterprise value for the base metal mine (even at the low value of $30 million).
Lastly, I believe when ARSD announces results next week that EPS will be in the 30 cent plus area. This is going to look cheap on a P/E basis excluding the mine as well.
|Entry||03/25/2007 11:27 PM|
|Quick reply -|
Will ask about the listing question and get back to you.
On natural gas prices....I've really worn out my welcome with management drilling them on variations/scenarios on natural gas / oil prices, etc. Their "hedging" or "swap" or whatever you want to call it program is designed to smooth things out over a 6 - 12 month time period. However over a longer term this business is really a cost plus type business. They essentially earn their gross margin based on the processing they do which is the value add to the customer. So in a rising price environment I think that is somewhat of a tail wind for them. Falling prices have the opposite effect (In a cost plus scenario think less "gross profit dollars" since the cost piece is lower). However, it is important to note that mgmt doesn't necessarily feel this way as the past is not the future. I think they feel that even in a falling price environment they do OK. (This was the basis for my worst case scenario and they still seem to think they can do 10% ebit). Little ups and downs in gas prices however just don't have much of an impact over the long term.
Saudi Arabia has plenty of risk in my mind. The JV partner is Saudi. I guess I gain some comfort in that being the case - the "home country" investor put money in. I'm sure they are looking for a return - and they serve the strategic role of assisting with obtaining the rest of the financing. Also, I think valuing the mine at the implied value of the JV transaction essentially compensates for the risk. A point to consider is that Saudi investors own a big chunk of ARSD. Thus Saudi investors own ARSD and Saudi investors own 50% of the mine - and these parties are mixed. Thus in my mind it stands to reason that all parties want the mine to move forward. Further, there is a fair amount in the press recently about how SA wants to develop other parts of their economy - mining included. I guess there are enough data points for people to make up their own mind. Clearly it has huge option value if prices stay within 30% of current prices. I'm only assuming its essentially worth the "cost" of establishing the JV.
PS - the stock popped at the end of the week. Obviously the financing PR had an impact. I guess you can try to be patient and wait for a bit of a pullback (its happened before). At the same time, I think even at Fridays price that there is 25% - 30% ups just to get to a realistic current value, and operating earnings growth will get you to similar returns compounded annually over the next 3 - 4.
|Entry||03/29/2007 11:18 AM|
|What did you think?|
|Entry||03/29/2007 05:00 PM|
|Why do you think management only owns 2.5% of the stock?|
|Entry||04/18/2007 05:13 PM|
I want to clarify something. In your write-up you say EBITDA is $13-$14MM run rate but in your update you say EBIT is currently $13-$14MM.
|Subject||Re: Nice run|
|Entry||04/18/2007 09:32 PM|
|The Company's first ever conference call is very instructive. Based on that I said I thought it was worth $6 all day long, meaning - no brainer worth that much. I see no reason why this shouldn't be worth mid $7's right now using comparable take out multiples and assigning the nominal value to the mine. |
The kicker here is that operating income is set to nearly double after the expansion. I think that only takes 3 - 4 years. With no multiple expansion along the way that means the underlying business offers near 20% returns from this point forward.
What is crazy is that metal prices have remained very strong. The 50% interest in the mine is worth multiples of the $30 million I am using in my analysis. That implies returns well above 20% per year going forward.
While there is the sense the train has left the station - we are continuing to hold. Our objective is 20% net annually - I think we meet our hurdle rate and then some from this price level.
Hope that helps. I would really encourage you to listen to the call if you haven't already.
|Entry||04/18/2007 09:39 PM|
$13 - $14 is a range essentially for both I guess was my point. Depreciation is less than $1 million from an accounting sense but economic depreciation is less. I wouldn't focus too much on whether it was $13 or $14 with precision. I guess better to be roughly right that precisely wrong.
Keep in mind there are other expenses in the financials associated with the mine / one time costs associated with debt repayments, etc. So adjusted ebitda could be $14/$15 and ebit would just be $1 million less (on an accounting basis). The key to the thesis is that the expansion will drive significant growth at high returns on the capital employed. A relatively clear path to ebit doubling in 3-4 years is pretty rare.
Hope that helps.
|Subject||Great results / story intact|
|Entry||08/09/2007 06:37 PM|
|Quick review of the quarter. |
- Company is on pace to do $18 - $21 mil in ebitda this year. I was low on my estimate.
- Capacity expansion is on track and is planning to be operational Q1 '08. Based on how things are going currently they expect to be able to immediately add 20% - 30% of growth based on current customer demand. I estimate this will add between $3.5 to $5.5 in ebitda for '08.
- Mine permitting still in process - "no clouds" on the horizon - strategic additions to Saudi team to help move things along. They are in the "any day" stage now for getting approval.
- - - - - -- -- - -- - - -
Update on valuation:
Using midpoint current business ebitda of $18 and specialty chem multiple of 8x (maybe a tad low given strategic buyers) that gets you $144 million.
That is the current price.
What are you NOT paying for???
For free you get:
Growth: Year one growth of 20% to 30% in ebitda (with no multiple expansion that adds around $40 million - $1.75/sh) and in 3 - 5 years a near double in ebitda when utilizing all the expansion (say another $120 million - $5/sh.)
The Mine: $30 million on cost basis. And really silly, silly number once the approval hits. The mine is will produce cash flow of $90 - $100 million of which ARSD owns 50%. Kiss534 suggests in his recent writeup that a mine would be valued at 4 - 10 times cash flow. Lets use a 5x multiple. That would correspond to a about $220 - $240 million for ARSD or another $10/share.
This isn't a boring chemical company (ok, it is!) but a simple growing business with multiple kickers to make returns outstanding from this level.
Easy value right now = $8.00 - $9.25.
Easy value when growth becomes apparent = $11 - $12.50
Value upon mine announcement = $14 - $20.
This is still an outstanding opportunity.
|Subject||Saudi Mine approval|
|Entry||10/24/2007 11:49 PM|
|Not sure if the info on the Saudis putting in $60 million is right or if it is a typo - previously it was $30. I'm guessing its a typo but I'll be calling tomorrow to find out. Obviously very good news. With operating income growth strong going forward based on the expansion this has the potential to keep running. If speculators jump in this could get silly.|
Arabian American Development Co. Gains Approval for Joint Stock
Wednesday October 24, 5:38 pm ET
DALLAS, Oct. 24 /PRNewswire-FirstCall/ -- Arabian American
Development Co. (OTC Bulletin Board: ARSD - News) today announced
that it has received official notification that the Ministry of
Commerce and Industry for the Kingdom of Saudi Arabia has approved
the formation of the Al-Masane Al-Kobra Mining Company (ALAK). The
approval is to be published in the Official Gazette (the Saudi
version of the Federal Register) at the Company's expense. The next
step in the process will be for the joint stock company to hold an
organizational meeting to form its Board of Directors. Upon
completion of the publication of the approval and of the
organizational meeting, the Ministry will issue the license allowing
ALAK to do business in the Kingdom. The Board of Directors of
Arabian American has approved Hatem El-Khalidi, Ghazi Sultan, Dr.
Ibrahim Al-Moneef and Mohammed Al-Omair to represent its interests
on the Board of ALAK.
In announcing this development, Hatem El-Khalidi, President and CEO
of Arabian American stated, "The Company is grateful to the Ministry
for the approval of our venture and appreciates the careful
examination they gave our application. Their decision to approve the
formation of the joint stock company reinforces our belief that the
project will be good for the growth and diversification of the Saudi
economy and good for the shareholders of Arabian American
The approval is an important step in the development of the mining
venture which Arabian American has been working on for many years.
The joint stock company will be owned 50% by Arabian American and
50% by Saudi investors. The Saudi investors are contributing $60
million in cash, and Arabian American is contributing its 30 year
mining lease in the Al-Masane area of southwest Saudi Arabia. The
lease was granted by Royal Decree in 1993 when the Company
discovered and proved reserves of 7.1 million tons of ore containing
zinc, copper, gold, and silver. The lease contains a provision for a
20 year extension beyond the original term. The construction of the
mill, which will process the ore, will commence when the formalities
of the formation of ALAK are completed, the lease is transferred to
the name of ALAK, and the construction contract is finalized with
the prime contractor. Negotiations with the prime contractor and the
sub contractors have been ongoing and can be finalized when ALAK is
licensed to conduct business. Arabian American estimates the mill
will require approximately 22 months to complete and will cost
approximately $120 million, which will be financed partly with cash
contributed by the Saudi investors, and the remainder being financed
within the Kingdom.
About Arabian American Development Co.
Arabian American owns and operates a petrochemical facility located
in southeast Texas just north of Beaumont, Texas, specializing in
high purity petrochemical solvents and other solvent type
manufacturing. Arabian American also has a mining project, as
mentioned above, in Saudi Arabia which is under development and is
expected to produce economic quantities of zinc, copper, gold, and
silver when it is put into production. There are currently about 20
employees at the mine site.
|Subject||$30MM or $60MM|
|Entry||10/26/2007 04:55 PM|
|Did you find out if it was a typo?|
|Subject||Re: $30 or $60|
|Entry||10/27/2007 12:23 AM|
|This is a little cryptic as it is from quick back and forth emails/voicemails - no one on one live conversation yet. But here is what I have interpreted and surmised so far. |
The $60 million is correct. But little twist. $30 million is truly for the 50% interest in the JV. The other $30 is ..... not sure how to describe it in super technical financial terms yet.....an "advance" to 1) fund working capital which ultimately relates to 2) help in raising
the the $120 million to build out the mine.
So it is not "true equity". From the message that I received and as I understood it essentially it appears the financial institutions who have been looking to provide the $120 million said basically hey - $30 million is great, but that's really just a contribution for the equity to set up the JV. It would be helpful to have someone put more skin in (20% - 25%) to make the loan approval process go smoother. Well, the same dudes who
put in the $30 just doubled up to make it $60 to help the loan get approved more easily (ie now only need to borrow $90). Now the terms of the additional $30 (once the loan gets funded) are going to basically mirror the $90 million loan terms. So while it "sounded" like equity, (and maybe it "looks" like equity to the bank - subordinated to their
loan), it appears economically to be debt.
Speculating here, but I think this explains the delays. ARSD didn't want the additional $30 to be true additional equity (didn't want to own less than 50% upon contributing the mine assets) and then the JV partners had to come up with more money, all the while working with the banks while also dealing with all this as it relates to Ministry approval (who wanted to know about ownership structure). Think that explains a lot on why this took a bit longer than anticipated. But again - that is me speculating. With the additional $30 going in I would expect to see a PR on financing commitment shortly.
If I get further clarification I'll pass it along.
|Subject||Ran, Part 2|
|Entry||05/14/2008 10:29 AM|
|(continued from ARSD write-up #1)|
...sometimes difficult to know where to post an update. You raised some points, Grant responded. But your tone in response to Grant that said...(continued in ARSD write-up #3)