Goodfellow Inc. (TSE: GDL)

Goodfellow Inc. (TSE: GDL) is a remanufacturer and wholesaler of lumber products and hardwood flooring. They have over 7000 customers, mainly in Eastern Canada and the United States. I found them by conducting a screen querying profitable companies trading below book value per share with a trailing P/E under 10. Running some quick numbers got me very interested in this little company as not only is it trading below book value but it is trading below current assets after subtracting all liabilities. I jumped on the chance to value this company as on the surface I thought it was a definite buy at this price.

I arrived at a net asset value (NAV) for GDL of $19.67 per share assuming a replacement value of the balance sheet. This took into account my estimation of the value of customer relationships as they seem to be very important in GDL's industry and these were not previously accounted for as any sort of intangible on the balance sheet.

An earnings power value (EPV) for the company of $8.69 per share was found by extrapolating forward normalized earnings from the last 12 months. Normalized zero growth cash flows were found for the trailing 12 months and were then divided by the estimated cost of capital of 7.5% in order to obtain the value of a perpetuity with no growth.

The EPV well below NAV makes sense as GDL is currently returning approximately 5% on invested capital (replacement value of balance sheet). By comparing this to the cost of capital of 7.5% it is apparent that the company is underutilizing its assets. I like how management is focused on keeping costs down and on how management makes clear that capital expenditures are kept to the value of depreciation (essentially replenishment but not growth expenditures) - they are not trying to grow the company as this would only destroy value with the return on capital being less than its cost.

The current trading price of $7.90 per share seems to be based on the company's earnings power minus perhaps the market's own margin of safety due to the unknown prospects for GDL's industry moving out of this recession. GDL mainly serves the housing market which has been decimated over the past 12 months and it is anyone's guess what the prospects are for the industry.

The fact that GDL can be bought for less than its current assets, after satisfying all liabilities, has no implications for an investor. The company has a stable balance sheet, is profitable and operates in a viable industry - it is not going to be liquidated anytime soon. The only benefits an investor will see from this company are in the form of earnings to equity. As the shares are trading in line with EPV, buying shares in this company would essentially be speculating as to the prospects for the industry as a whole. If the industry picks up GDL will surely prosper. However if the industry prospects get even worse then you can bet that the company's shares will move in lockstep.

As a value investor I refuse to speculate on the industry and would rather know that I am buying a company for below its true worth. I see no catalyst that may bring EPV closer to NAV as management seems content with the operations (except perhaps for the suffering top-line due to current market conditions). As such my intrinsic value for the company is $8.69 per share as found for EPV. Applying a satisfactory margin of safety implies an entry price of around $5.80 per share. As shares are currently trading around $7.90 I will be staying away from this company for now.

Disclosure: None