|Shares Out. (in M):||8||P/E||0.0x||0.0x|
|Market Cap (in $M):||925||P/FCF||0.0x||0.0x|
|Net Debt (in $M):||5||EBIT||0||0|
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Nacco Industries (NYSE: NC) is a compelling value investment opportunity, which combined with a (very) near term catalyst in the form of an upcoming spin-off, will hopefully be realized sooner rather than later. We apologize for the brevity of this writeup, but given the time sensitive nature of the event we figured it was worth outlining the opportunity. NACCO is a an extremely underfollowed (literally no analyst coverage) $900mm enterprise value mini conglomerate operating a disparate collection of businesses which are insider controlled by the Rankin and Taplin families, who collectively hold voting control. Since announcing their plans to spin off one of their business segments (Hyster-Yale), on June 28, after a brief spike to ~$125 / share, NC has traded back down to pre-announcement prices around $110. We believe that under very conservative assumptions, an investment in NC hosts at least 25% upside potential in short order. Downside risk is muted by the strength of the Company’s balance sheet (no leverage, trades near tangible book value), an upcoming promotional roadshow that kicks off Monday, the event of the spin, and for the first time, the likely initiation of analyst coverage.
Prior to the spin, the Company was made up of 4 segments, described below:
NC will be spinning off Hyster-Yale (ticker to be: HY) effective September 25, 2012 (to receive spin-off shares, purchases must be made by September 20). The spin-off will occur in the form of a stock dividend, in which each holder of any share class will receive one Class A (1 vote) and one Class B (10 votes) share in HY. The spin-off is expected to begin trading on a when issued basis shortly (date has not yet been determined). NC insiders currently have voting control through their ownership of the B shares, as well as 20% of the Class A shares. The spin mechanics will initially remove insider control, although insiders will still own ~35% of shares outstanding. However, insider control will likely eventually be restored, because the B shares need to be converted to A shares before any sale.
The spin-off will allow the Hyster-Yale to pursue strategic growth opportunities in the form of acquisitions and JVs, as well as provide direct access to the capital markets. Additionally, it will align management of each company with their direct performance. While insiders will likely retain voting control as described above, we believe the spin-off will result in substantial appreciation for pre-spin holders, as the more cyclical Hyster-Yale will no longer obscure the relatively stable cash flows of the remaining businesses, and will allow investors the opportunity to decide for themselves which businesses, if any, they would like to invest in.
We value the Company first by looking at the spin-off (Hyster-Yale). HY generated TTM EBIT of $107 MM (TTM EBIT margin of 4.2%). Management is targeting mid-cycle EBIT margins of 7%, which would be ~$175 MM of operating income. Therefore, we believe a 6X multiple of trailing operating income (net of additional standalone company expenses of ~$3 MM) is quite conservative. This results in a value for HY of ~$620 MM, or $75 / share on a pre-spin basis. The Company has approximately zero net debt, so in the interest of simplicity we exclude it from this analysis. HY’s adjusted EBIT has averaged approximately $50 MM over the last decade, but management believes that the massive restructuring that HY initiated in ’07, in which they closed two underutilized and high cost manufacturing facilities in Italy, fired 15% of their workforce, and introduced more standardized lift truck models, which are significantly higher margin, has permanently altered the margin profile of this Company for the better. Once volumes started to come back strongly post crisis, the substantial earnings power of this segment became evident. The Company’s market share in the America’s is estimated to be 25%, globally 12%. Toyota is their biggest competitor, followed by Kion (owned by KKR) and Jungheinrich AG.
Next we value the stub, made up of North American Coal, Hamilton Beach, and Kitchen Collection. The North American Coal business supplies lignite coal to power plants. This business has been remarkably consistent, never generating less than $24 MM of EBIT, while averaging ~$40 MM over the last decade. Additionally, through long-term contracts, they have very limited exposure to coal price fluctuations. The contracts with their utility customers allow for reimbursement at a price based on actual costs to mine/extract the coal plus an agreed pre-tax profit per ton of coal. Moreover, the customer (utilities) agreed to fund the development of the mine. The utilities they sell to are base load power plants. They handle your everyday electricity, not shoulder season plants. Their contract expirations range from 2025 – 2037 with three major utilities. The mines are located in the backyard of the utilities, and the utilities are built to only handle coal, largely mitigating any switching risk to natural gas. We apply an 8X EV / EBIT multiple, which we believe is very conservative given the history and stability of this cash flow stream, resulting in a value of ~$330 MM. Hamilton Beach, a manufacturer of small consumer appliances, is also relatively stable, with average EBIT of $37 MM, with a low of $20 MM. We apply a 7X EV / EBIT multiple to this business, and value it at ~$240 MM. Kitchen Collection has shown negligible profitability, generating $0-$7 MM of EBIT on ~$225 MM of annual revenue. We value this business at $20 MM, giving some value to the potential upside if it can become consistently profitable. After deducting corporate overhead, we arrive at a combined value for the stub of $65 / share.
Summing it all up, we arrive at a total value of ~$140 / share, or 25% upside from current prices. Using less conservative assumptions, we could easily see 40+% upside from current levels. Adjusted for what we believe to be a very low likelihood of near term capital impairment given the strength of the Company’s balance sheet, stable cash flow profile (ex-HY), upcoming promotional road show, spin-off event itself, and possible analyst coverage, we believe the risk/reward is very attractive.
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