Buhler Industries (BUI) is a manufacturer of high-quality tractors and other related equipment for use in the agricultural industry. They are the only manufacturer of such tractors in Canada and one of four in the world.
The following screen brought this company to my attention:
- Return on Invested Capital (ROIC) greater than 10%
- Price to Book value less than 2
- 5-year earnings growth greater than 5%
- Debt to Capital less than 50%
What I was expecting to find was a company perhaps having a competitive advantage and that should be trading well above its book value but for some reason was able to be bought relatively cheap. BUI definitely wasn’t what I was screening for but I’m happy to have found it. The only reason it showed up on this screen was due to its turnaround performance in FY2008. After 5 straight years of declining sales and abysmal returns on capital, this company suddenly showed an ROIC of almost 17% in 2008 and reported its largest sales number since revenues started to decline in FY2003. This definitely warranted looking into further.
BUI is currently trading at a price/earnings (P/E) of 6.25, a price/book of 1.13 and a price/book (tangible) of 1.29. The company traded at an approximate average P/E of 18 over the previous 5 fiscal years. This definitely looks cheap but the question remains, is it unusually cheap or is the low price warranted? With a market cap of $136 million and no analysts covering the stock to my knowledge, there is definitely a possibility that this company is flying under the market’s radar only to be noticed at a future date.
Coming to BUI’s rescue in FY2007, the company’s worst reporting year since FY2000, was a Russian company by the name of Novoe Sodruzhestvo. This company’s reputation in Russia is, fittingly enough, that they acquire and transform factories. As is apparent from their track record, Novoe Sodruzhestvo lives up to their reputation. Even more fitting is that one of their previous acquisitions is the largest producer of combines in Russia. If you don’t know what a combine is, all that matters is that they are fixed onto tractors and used in agriculture. The Russians have already begun diligently working on their plans for BUI, which include introducing new products to the North American market as well as taking advantage of the Russian company’s distribution network in Eastern Europe. Over 160 official representatives of the combine manufacturer in Russia, Eastern Europe and Central Asia will support the distribution into new markets.
The results of the new ownership have so far been promising. The new owners restructured sales and production activity to be more efficient and reinvigorated the work force with some changes at the management levels. In addition, the Russian’s network overseas enabled the company to ship double the amount of tractors as in the previous year. There is room for improvement, which we can expect to see, as suppliers couldn’t keep up with the production level. The company has already begun improving their supply chain and efforts have been successful to date. Next year’s plans are to further develop the product to cater to client tastes, develop the dealer network through an aggressive marketing budget and more finance options, and to further improve the supply chain by finding replacements for weak suppliers.
Before even attempting to arrive at a value for a company it is important to understand the company and its assets as well as the strategic positioning and the current environment in which the company is situated. Only then can an estimate of fair value be arrived at with conviction. Prior to arriving at or relying on the following numbers it is helpful to read the company’s annual reports, most recent quarterly report and to visit the company’s website as well as those of its competitors. Obviously the more time and effort spent understanding the company and its industry, the better. The largest risk I see going forward is the strengthening Canadian dollar and the impact this may have on the amount of international sales and/or the conversion of those earnings into Canadian dollars. I believe this to be mitigated however by the company's continuing operational improvements as well as by the margin of safety employed in arriving at an entry price.
Based on the current capital structure of 30.2% debt-to-capital and 69.8% equity-to-capital I found a weighted average cost of capital of 8.41%, using proprietary measures. With a ROIC (replacement value of balance sheet) of 4.02% in the last 12 months, earnings power value (EPV) would be expected to be below net asset value (NAV). EPV was found to be $5.65 per share with the major driver being normalized zero-growth free cash flows of $12 million. NAV was found to be $8.75 per share with the major drivers being hidden balance sheet assets (product portfolio and customer relationships) of $33.71 million.
If you would like to understand these numbers in greater detail please see my explanatory articles.
Remember, as value investors we do not want to project future growth unless a company has a sustainable competitive advantage and as such I do not project growth for BUI in my valuation. Rather I see the new management as knowledgeable, capable and as motivated to bring the company’s EPV in line with the competitive state of NAV. It is for this reason that I give an 80% chance to this being accomplished, which implies an intrinsic value of $8.13 per share for the equity.
Utilizing a 33% margin of safety, an entry price of $5.44 is recommended. At its current price of $5.44 this stock should be a valuable one to purchase and to hold onto for the long-term.
Disclosure: Long BUI
Hi Jon, have been reading your blog and think it's quite good. There's a general dearth of value blogs in general, and your analyses seem to be more thorough and methodical than most.
ReplyDeleteIf you're looking for content ideas, here's one. In addition to posting your own "finds" and valuations, it would be interesting for you to "review" or evaluate valuations made by others in newsletters, blogs, etc. So if a certain value newsletter values a company at $10, you would look at their valuation and confirm, critique, modify, etc. For those without your training it can be difficult to judge the valuations made by others, so demonstrating how you would do this could really help a lot of people out. Anyway, just an idea.
Keep up the good work.
Thanks scrilla. That's a great idea. I'll definitely keep this in mind for future posts. What I'll do is I'll put it out there to my readers. If you or any of them have any companies you're considering investing in based on a report you read then please pass the report on to me and I'll do my best to critique it. Hopefully there will be a lot of direct value add this way.
ReplyDeleteThank you for following. I look forward to your future comments.
Reports can be emailed to critique at jonathangoldberg dot com.
Great blog, Jonathan - well done and thank you!
ReplyDeleteBUI looks somewhat interesting from a valuation standpoint, but how do you get comfortable with the risk of a private Russian co owning 80% of the company? You can potentially have all sorts of internal pricing issues, disguised margin transfer, etc. I would personally be highly suspicious of this arrangement. How come BUI has zero cash, that seems just odd. While the borrowings are not excessive, they are all short term rolling bank debt. Also, how do you value the hidden balance sheet assets, that's a key driver of your valuation? I would like to understand how you get such a high NAV, given that BV/share is only $4.8. Thank you.
Thank you Pov.
ReplyDeleteAll great questions and I'm sure different people will have different opinions and levels of comfort. If I was running a huge portfolio and had access to management I would 100% want to do primary research to ascertain my conclusions. Based on what I've read and on the fact that the Russian company paid close to my intrinsic value I am fairly confident that they are motivated to and see the potential to close the value gap. All of your concerns are warranted however and the individual investor needs to consider them. My write-ups are only investment briefs; I definitely encourage people to do their own homework.
Regarding zero cash, while I did notice this I just assumed they had run down their cash and were using the rolling bank debt. I didn't think much into this beyond that. Would be grateful for your thoughts as I am always looking to expand my knowledge.
Hidden balance sheet assets were all done with proprietary calculations, based on percentage of SG&A as well as R&D to sales multiplied by an appropriate factor that has ben shown to work in the past.
Thank you for your insightful questions.