January 24, 2010 - 12:17am EST by
2010 2011
Price: 4.08 EPS $0.74 $0.74
Shares Out. (in M): 12 P/E 5.5x 5.5x
Market Cap (in $M): 49 P/FCF 5.5x 5.5x
Net Debt (in $M): 46 EBIT 21 21
TEV ($): 96 TEV/EBIT 4.6x 4.6x

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Keystone Consolidated was written up two years ago at a far higher price -- $18 per share. I refer you to that original writeup to get some sense of what the company is all about. Essentially, it operates a legacy steel wire business. Much of the company is owned by Harold Simmons, a well-known value investor. At the time of the last writeup, Simmons owned a controlling interest of around 51%. However, in the intervening years, he has raised his ownership to 62 percent of the company.

The previous writeup focused on the company's incredibly over-funded pension plan. Essentially, Keystone owed something like $40M worth of accrued pension expenses, but its pension plan had ballooned to nearly half a billion dollars. So, the value thesis was that it was a company with an enormous hidden asset that could be monetized.

Incredibly, the company lost $358M of its $546M pension plan in the market collapse of Q4, 2008. The plan's value has dwindled down to $52M, which remains plenty to cover the accrued liability, but is obviously no longer enough to really qualify as a hidden asset.

In addition, in early 2008 the company raised $25M in a subscription rights offering to reduce indebtedness under its revolving credit facility. Essentially, economic woes were hitting the company's core steel wire business. This sale took place at a $10 per share price, and it diluted existing shareholders significantly.

Currently, the company is still working through operational difficulties, but investors appear to pretty much have given up on it. It's clear that those who purchased the stock in hopes of making money off of the pension asset have fled, as have those put off by the rights offering. So, the stock now languishes at around $4 per share.

I believe that this price significantly understates the intrinsic value of the company's core business. In spite of the recession, the company has consistently turned a profit, with the exception of the first quarter of 2009, when the company saw its gross profit turn negative for the first time in the current economic situation. Management quickly righted the ship, however, turning in surprisingly good results for the full-year of 2009.

One potential source of risk for the company was the expected expiration of a utility tax break provided by the state government. The exemption applies to companies with more than a certain number of employees -- and since Keystone has obviously been downsizing to compete in the current environment, they've had to reduce headcount below this level. On Jan 14, however, the state legislature agreed to extend this break to Keystone, saving the company around $2M per year. Part of Keystone's debt -- around $6M -- is also owed to the government as part of this tax legislation.

Another factor key to the company's ability to withstand the economic climate is decreasing raw material prices. In fact, during the commodities boom previous to this recession, the company experienced difficulties because of the higher prices.

The company's business is very simple and fairly stable. The simplicity owes to the fact that most of their production processes work with just-in-time delivery. So, across the past five years, gross margin on an annual basis has ranged from about 18 percent to 20 percent. Most recently (Q3 2009), gross margin stood at 15 percent, in spite of a revenue decline of about 45 percent from the same quarter of 2008. SG&A has scaled similarly, dropping by around 35 percent across that period. This is partly responsible for the company earning $0.48 per share in Q3 -- a pretty impressive performance considering that's more that 10 percent of the stock value in a single quarter.

In spite of the pension-plan debacle, the company's balance sheet remains strong. The company is sitting on some debt, but if you take all the company's current assets, they are more than sufficient to pay off all liabilities -- suggesting that in the worst case scenario management should be able to pay off debt with freed-up working capital as the business downsizes. In addition to this, the company owns an enormous set of fixed assets. The depreciated value is $86M -- nearly the enterprise value of the firm -- but this almost surely understates the true value. As one example, the company's land holdings are on the books at a historical value of $1.5M, in spite of the fact that this includes 2.3M square feet of manufacturing facilities -- all of which are owned outright by the company.

The bottom line is that Keystone is a company whose investors have been shocked by the implosion of a special situation involving the pension plan. As things currently stand, the company is having no difficulty paying interest on its loans, and it is turning a significant profit. Even so, the stock sits at a lowly P/E of 5.5.

I believe that even without significant economic improvement, the company's P/E should be somewhat higher than current levels. In addition, with any improvement in the economy, I would expect a significant turnaround in net income, which should lift the stock significantly.


* Better investor knowledge about recent government action to protect the company from higher taxation

* Improved results from any sort of economic recovery

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