Despite its size, CMI is interesting since it's so rare to find a fantastic business that has anything to do with mining. Management is smart and
shareholder-friendly. And yes, it's really cheap: the EV/FCF multiple
is 3.7X on the year ended June 30, 2008. FY09 will be a tougher year,
so perhaps the forward multiple rises to 6 or so. Plus you get a
couple of ancillary businesses which together are at breakeven today,
but probably have real value.
apologies for the erratic liquidity in this name. On a good day it's
250K shares, on a bad day it's zero. The biggest buyer in the market
is the new Chairman of the Board, who recently bought a third of the
equity around $1.20/share and is adding more all the time.
CMI was founded in
1991 by Max Hofmeister as a rather unremarkable Australian auto parts
company. When that industry fell into secular decline, Hofmeister
tried to acquire his way out of the problem. Along the way, he regularly overpaid both himself and his buddies on the Board.
Unlike the rest of his shopping spree, the electrical component makers
he bought have actually worked out quite well. These are
Peaston (1997), Heartland (1998), Minto (1999), Aflex (Oct 2004) and
XLPE (July 2006) - collectively, the "Electrical Division." For the
most part, the products are cables and connectors designed for
specializedindustrial use under harsh conditions.
Minto - the cash cow
Minto makes couplers for the mining industry. Modern mines use lots of
electricity and have miles of electric cable running all over the
place. Couplers are specialized devices that connect one cable to
another, or to the machine that's using the electricity. This rather
prosaic bit of equipment turns out to be a very lucrative niche for a
- Couplers take a lot of abuse, and when one
breaks, the true cost to its owner is not so much the money spent on
fixing/replacing the coupler as it is the lost productivity of all the
miners and equipment who are sitting idle while repairs are under way.
The latter is many times the former. As a result, mines tend to use
only one brand so that they're more likely to have the necessary spare
parts on hand, and so that their guys are totally familiar with the
equipment. Some really big mining operations dual-source, but some
don't. Since couplers are only a tiny part of total costs, buyers are
not price sensitive.
- There's also a safety issue:
the air in a mine often contains potentially explosive gasses like
methane - particularly in coal mines (hence the proverbial
"canary-in-the-coal mine"). If an electric spark were to ignite this
gas, you'd get a big explosion that can kill up to dozens of miners.
Thanks to product improvements and very strict government regulation,
Australia has not had a major incident of this sort since the
mid-1980s. The desire to keep it that way makes buyers even less price
sensitive - nobody's going to risk people's lives and their own career
on some untested brand just to save a little money.
factors combined lead to yet another positive: a near total absence of
foreign competition. Because miners want to always have spare parts on
hand, the lead times on overseas orders become a real problem for
them. Further, Australian electrical standards are unique and
government approval is hard to get. Hence, Australia just isn't an
attractive market to anyone overseas. For a North American supplier,
you'd be looking at re-tooling your production lines and slogging
through the approval process just to enter a market that's only one
tenth the size of your own. And you'd still have the issue with long
lead times. The same would apply to anyone in China, even if they
overcame buyer concerns about product quality.
the business isn't capital-intensive. Capex/depreciation is about 1.5%
of sales, vs 20-30% pretax margins. This business throws off
honest-to-goodness free cash flow, even in bad times.
one of the North American players in this little niche is owned by
Berkshire Hathaway. It's called PLM and it's part of Scott Fetzer,
which Berkshire bought some 30 years ago. The only other
publicly-owned name is Macey, which is a tiny part of Cooper Industries
(NYSE:CBE) and happens to be Minto's main competitor in Australia.
Everyone else is private.
Management is fairly guarded about
details on Minto, so I've resorted to scuttlebutt to fill in the
blanks. Having spoken with lots of buyers and distributors I'm
reasonably confident of the following: Minto leads the market with
something like 60-70% share, while Macey has perhaps 20-25%. The
remainder belongs to Ausproof and New Macey (run by the guys who
founded the original Macey). Sales to coal vs metal mines are split
While replacement parts are constantly in demand,
the big driver for sales is expansion of mining activity. I began the
table below in FY04 as the industry veterans I spoke with tell me that
year was the worst of the preceeding three decades for electric
equipment sales to mining (the number of coal mines in Australia
bottomed that year at 99). Also, CMI finished a cost-cutting program
that year. Thus FY04 probably represents the low-end of expected
profitability. As for the high-end, we don't really know if last
year's result will eventually be exceeded, but at this share price it
probably doesn't matter.
| FYE June 30
| Pretax profit
| Tangible equity
Notes: assumes 30% tax rate. Tangible equity = equity less acquisition goodwill. June '08 equity excludes $15M note due from sale of old auto parts business (since it's an unrelated asset).
Mining accounts for 45% of Electrical sales and probably a much larger percentage of profits. I'd
guesstimate that Minto is doing about 50% pretax margins.
TJM and Capitalcorp
On July 1, 1999 Hofmeister bought
TJM, a maker of 4WD automotive accessories (e.g. bull bars,
differential locks, roof racks, etc.) While CMI's traditional auto
parts were fairly generic and sold to OEMs, TJM's are made for offroad
enthusiasts and mostly sold in the aftermarket. Unfortunately, TJM has
not been a huge success thus far - sales have grown modestly from $36M
in FY99 to $45M in FY08 and margins have been fairly thin.
July 1, 2003 Hofmeister bought Capitalcorp, a loan broker specializing
in financing for used cars. This was an act of blatant
diworsification, with predictable results. Like the U.S., Australia
also went through a bubble in consumer finance. When it popped, so did
the profits at Capitalcorp.
Enter Ray Catelan
is a self-made entrepreneur with a thing for deep value and activist
investing. Between 2006 and early 2008 he bought about 1/3 of the
shares, cleaned house at the top, cut overhead, and sold the lousy auto
parts company back to Hofmeister, using some of the proceeds to pay
down debt. Catelan also tried to spinoff or sell both TJM and
Capitalcorp, but was basically thwarted when the credit crisis hit.
CMI sold a 51% stake in Capitalcorp in an MBO. The business is losing
money, but an aggressive restructuring should limit CMI's share of
future losses to $2M max. I value this between -$2M and zero, to be
The company is keeping TJM for now, and there's a decent
chance it could have significant value. Australia is home to the
world's best 4WD technology. The leader in this market is a company
called ARB (ARP AU on Bloomberg), which does a mid-20s ROE year after
year with essentially no debt. TJM is a distant second with less than
25% of ARB's sales volume and a roughly 5% ROE, while a private company
called Opposite Lock is third. The remaining half of the 4WD accessory
market is highly fragmented. If TJM could close even part of the
performance gap with ARB it would really boost earnings at CMI.
4WD enthusiasts love talking about their trucks, and from what I can
tell, TJM's products are well received by the marketplace. So I think
ARB's advantage is probably an operational one. Scale obviously helps,
but note that when its sales were similar in size (FY99), ARB had
pretax margins in excess of 11% vs 3% for TJM today. Getting to 11%
would mean an extra $0.07 in EPS for CMI, which is a big deal for a
$0.55 stock. Under Ray Catelan, TJM has focused on improvements in
design and manufacturing. Time will tell how well they succeed.
In FY08, profits at TJM roughly offset losses at Capitalcorp. So the
valuation multiples I mentioned earlier are essentially based on just
the results at Electrical. It's like you get these other two for free.
Capital structure & valuation
Ex-Capitalcorp, CMI did about $0.31/share in FCF for FY08. That's
against an EV of $0.55 less $0.23 net cash plus whatever the Class A
Shares are worth. Briefly, the Class A Shares were issued years ago
and are entitled to the first $0.14/share per year of any dividends
paid, plus there's a liquidation preference of about $1.20. The catch
is that the Board has full discretion as to whether or not any
dividends get paid, and it's non-cumulative. The company discontinued
the usual quarterly payment back in February and the Class A's sold
off. Then in September, CMI offered to buy all 28M Class A shares for
$1 each. The offer was to be put to a vote in November, but the
company recinded the offer in late October, saying it didn't feel too
comfortable taking on $28M of bank debt while the world's economy was
going into tailspin.
At $1 per Class A Share and 33.8M ordinary shares, that brings the
total EV to $1.15/share, or 3.7X FY08 FCF. Again, this ignores TJM and
Capitalcorp, which taken together are roughly breakeven.
I suspect that Catelan's game plan is to eventually take out the Class
A's and start paying dividends to the ordinary shareholders. In any
case, I don't worry about dumb capex or acquisitions since Catelan has
no sentimental attachment to this industry (he made his fortune in real
estate/IT). He's in this to make money. By the way, the boardroom
upheaval has not left this company short of expertise, as each of these
businesses still has the same management teams in place.
The second largest shareholder, Greg Nunn (aka Farallon Capital), is an
entrepreneur who made his fortune in electrical equipment. One of his
main product lines was electrical substations for coal mines (a
substation takes power off the grid and converts it for use). Trust
me, it's a small world when it comes to electric equipment for
Australian mining. Nunn bought in around the same time/price as
Catelan and I'll bet you he knows this business pretty well.
Metaliferous (zinc, copper, etc.) mines are hurting in this recession,
but demand from coal mines (~70% of coupler sales) has been holding up
so far. I'm not in the business of grand predictions, but let's just
say that Australian mining booms historically don't end in just four
years. Compare that to what Japan and S. Korea did for Australia back
in the '60s and '70s. Also, China is somewhat larger than those
countries. In any case, we might not need a rebound to make money at
this share price.
Purchase of Class A Shares, followed by big fat dividends
Operational improvement at TJM
|Subject||closing position due to price appreciation|
|Entry||02/05/2011 04:18 PM|
fairly valued, thus I'm out