After completing the acquisition of JEVCO, Westaim is a leading Canadian provider of P&C insurance products, specializing in non-standard auto and motorcycle, recreational vehicles, commercial auto, as well as property and liability. Historically Westaim was a holding company of a slew of unprofitable businesses, including Nucryst Pharmaceuticals and iFire Technologies. Needless to say neither of these businesses made any money. In 2009 alternative asset manager Goodwood Inc. acquired 20% of Westaim with the intention of using it as a shell company by disposing of the two unprofitable holdings, leaving effectively a small sum of cash and tax loss carryforwards.
JEVCO was locked within insurance holding company Kingsway Financial. Kingsway's Canadian CEO Serge Lavoie removed JEVCO from unprofitable lines of business like cross border trucking and focused on efficiency gains in its core non-standard auto business, for instance by introducing a web based portal from brokers. In early 2010 Westaim, JEVCO, and Kingsway hammered out a deal whereby Westaim would buy JEVCO for $261mm, or 95% of book value. The deal was financed by Alberta Investment management Corp ($148mm), insiders of Jevco and Westaim ($17.5mm), and a brokered placement for the balance. The deal worked out to $0.50 per share.
What I like about the story, as in any asset conversion story, is that management becomes directly responsible for the firm's results. This gives them autonomy over their roles and provides justification for higher compensation down the road. It is also a vote of confidence that management bought the deal and now have skin in the game.
Financials for JEVCO are broken out in some company filings, but these only offer a glimpse of what the consolidated Westaim results can look like. JEVCO was under the influence of Kingsway (hence engaged in less profitable or riskier underwriting). Now that the company is leaner and can use its dominant market position to improve its combined ratio. The company also just pushed through a 10% rate hike and is benefiting from Ontario's new claims rules that limit the damages a customer can claim in the event of an accident.
WED's valuation is compelling. At 0.495/share, the market cap is $328mm. Book value is $353mm which consists of $1B in investment grade corporate and government securities earning 3% or so. Historically JEVCO has been very conservative with their loss reserves and have adjusted them higher, so realized claims may well be lower. So basically you are buying a levered investment grade bond fund at a discount to NAV. Their tax loss carry forwards give them a near zero tax rate over the next year and a half, so $1b yielding 3% is $30mm per year. Historically they have operated at a combined ratio in the 95% range, but even if underwriting breaks even over a prolonged period you are getting a 9% cash flow yield on high quality debt instruments.
The fact that management bought a big slug of stock makes me think prolonged periods of operating loss are not too likely. WED could also get more aggressive and throw equity into its $1B portfolio to increase yield.
Tuesday, November 2, 2010
Monday, July 12, 2010
Sun Gro Horticulture ($4.35 last)
Sun Gro Horticulture is a vertically integrated producer, processor and distributor of peat moss and bark based growing media to the professional growing market. The investment thesis in Sun Gro is compelling due to its low valuation on a price to book, price to earnings, and DCF basis, combined with its dominant "price setter" market position as well as shareholder base with a history of takeovers.
Sun Gro leases peat bogs from provincial governments in Canada and mines peat moss. The raw peat moss is shipped to its wholly owned network of processing facilities that creates custom mixes that tailor to a professional growers market, namely nurseries and greenhouses. While Sun Gro is the largest company of its kind in North America, there are two main competitors to Sun Gro: Premier Tech and Conrad Fafard. Premier Tech is an industrial, agricultural and environmental company that has amassed a 24% equity position in Sun Gro and continues to actively buy stock on the open market. Also, in 2007 Premier Tech itself was the target of a hostile takeover by Oakwest Capital before inevitably going private through a management led buyout. Oakwest now owns 7.8% of Sun Gro. Conrad Fafard was bought by European agricultural powerhouse Syngenta in 2006. Worth noting is that Sun Gro's management has also recently been purchasing stock in the open market.
Sun Gro hit a number of stumbling blocks over the past few years. Management used debt to consolidate the professional growers distribution chain through a slew of acquisitions instead of using its internal free cash flow. Instead, due to its income trust structure it passed the majority of its cash flows to shareholders. During late 2008 the company announced the permanent suspension of this distribution and intended conversion to a corporation. Also at this time the company realized a 10%-15% decline in organic sale volumes (overall volume and revenue stayed roughly flat due to higher ASPs and acquisitions) and a large increase in the US dollar. As a Canadian firm selling into the US (85%+ of sales) a strong USD is normally good, but it had a large currency hedge in place that resulted in a $25mm marked to market loss. At the present time the firm has a $75mm short USDCAD hedge in place at 1.12, evenly spit over 2010 and 2011.
In 2009 the company put these missteps behind them, earning $19mm and generating $17mm in FCF. Management used this cash flow to pay down debt and is committed to delevering the balance sheet. On a trailing basis, including Q1/10 where volumes grew 9% YoY, Sun Gro is trading at a PE of 4.5x, 0.8x book value (1.3x tangible book), and has a 20% free cash flow yield. Going forward, assuming a very conservative flat volume and ASP profile plus a higher corporate tax rate, the company can generate $15mm in FCF. Investment broker dealer Cormark has FY2011 EBITDA of $28.5mm and notes that Premier Tech went private at 7x trailing EBITDA and Conrad Fafard was bought by Syngenta AG at nearly 12x trailing EBITDA. Sun Gro currently trades at 3.4x FY2011 EBITDA, and should have a greatly reduced debt load by that point. Cormark also notes that much of Sun Gro's idle off season capacity could be utilized by retail, private label brands to add upwards of $100mm in additional sales with limited CapEx. To be conservative of course I have left this out.
What I like about Sun Gro is that it is a relatively straightforward story to understand. They are already generating loads of cash and have an irreplaceable asset base with high barriers to entry and limited competition. Management are great at disclosure, are develering the balance sheet, and have bought stock in the open market recently. The company has a shareholder base with a history of unlocking value through takeovers. In absolute value terms, the company is trading at a discount to book value of $5.09/share, and if you value the business as an annuity with a very conservative $15mm in FCF @ 10% it is worth well over $6/share. On a risk reward basis, Premier Tech buys stock between $4 and $4.10, so the current $4.35gives you a $0.35 downside to a $0.65 to $1.65 upside.
Sun Gro leases peat bogs from provincial governments in Canada and mines peat moss. The raw peat moss is shipped to its wholly owned network of processing facilities that creates custom mixes that tailor to a professional growers market, namely nurseries and greenhouses. While Sun Gro is the largest company of its kind in North America, there are two main competitors to Sun Gro: Premier Tech and Conrad Fafard. Premier Tech is an industrial, agricultural and environmental company that has amassed a 24% equity position in Sun Gro and continues to actively buy stock on the open market. Also, in 2007 Premier Tech itself was the target of a hostile takeover by Oakwest Capital before inevitably going private through a management led buyout. Oakwest now owns 7.8% of Sun Gro. Conrad Fafard was bought by European agricultural powerhouse Syngenta in 2006. Worth noting is that Sun Gro's management has also recently been purchasing stock in the open market.
Sun Gro hit a number of stumbling blocks over the past few years. Management used debt to consolidate the professional growers distribution chain through a slew of acquisitions instead of using its internal free cash flow. Instead, due to its income trust structure it passed the majority of its cash flows to shareholders. During late 2008 the company announced the permanent suspension of this distribution and intended conversion to a corporation. Also at this time the company realized a 10%-15% decline in organic sale volumes (overall volume and revenue stayed roughly flat due to higher ASPs and acquisitions) and a large increase in the US dollar. As a Canadian firm selling into the US (85%+ of sales) a strong USD is normally good, but it had a large currency hedge in place that resulted in a $25mm marked to market loss. At the present time the firm has a $75mm short USDCAD hedge in place at 1.12, evenly spit over 2010 and 2011.
In 2009 the company put these missteps behind them, earning $19mm and generating $17mm in FCF. Management used this cash flow to pay down debt and is committed to delevering the balance sheet. On a trailing basis, including Q1/10 where volumes grew 9% YoY, Sun Gro is trading at a PE of 4.5x, 0.8x book value (1.3x tangible book), and has a 20% free cash flow yield. Going forward, assuming a very conservative flat volume and ASP profile plus a higher corporate tax rate, the company can generate $15mm in FCF. Investment broker dealer Cormark has FY2011 EBITDA of $28.5mm and notes that Premier Tech went private at 7x trailing EBITDA and Conrad Fafard was bought by Syngenta AG at nearly 12x trailing EBITDA. Sun Gro currently trades at 3.4x FY2011 EBITDA, and should have a greatly reduced debt load by that point. Cormark also notes that much of Sun Gro's idle off season capacity could be utilized by retail, private label brands to add upwards of $100mm in additional sales with limited CapEx. To be conservative of course I have left this out.
What I like about Sun Gro is that it is a relatively straightforward story to understand. They are already generating loads of cash and have an irreplaceable asset base with high barriers to entry and limited competition. Management are great at disclosure, are develering the balance sheet, and have bought stock in the open market recently. The company has a shareholder base with a history of unlocking value through takeovers. In absolute value terms, the company is trading at a discount to book value of $5.09/share, and if you value the business as an annuity with a very conservative $15mm in FCF @ 10% it is worth well over $6/share. On a risk reward basis, Premier Tech buys stock between $4 and $4.10, so the current $4.35gives you a $0.35 downside to a $0.65 to $1.65 upside.
Sunday, June 20, 2010
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