5 (More) Profitable Smallcaps Trading at a Fraction of Tangible Book Value

Last November, my first Seeking Alpha contribution featured five profitable small capitalization stocks priced at significant discounts to tangible book value. Since that time, the Russell 2000 (^RUT) has fallen about 13%. However, all five of those stocks have outperformed the index and two, Chinese dietary supplement manufacturer Tiens Biotech Group (TBV) and zinc producer Horsehead Holdings (ZINC), have seen very high returns over the past five months. I once heard a director of equity research at a large buy side firm say that an analyst doesn’t necessarily have to be right on stock calls more than 50% of the time, but when he/she makes a right call, it better be very right. TBV no longer fits the criteria of trading at a fraction of tangible book value. However, since ZINC is still trading at a slight discount and is a reasonably good dollar weakness play, I’m still holding on to it for now but am examining other opportunities that may represent better present values.

There are still a number of these values out there. This time, my screener is set for public companies with market capitalization less than $250 million, a price to tangible book ratio of less than half market value, normalized trailing twelve month P/E of less than 25 (this premium multiple is, in my opinion, acceptable given the low P/TBV ceiling used) and a LTM interest coverage ratio no lower than 15 (or zero debt). The resulting list of profitable, discounted, yet balance sheet healthy, companies is much shorter than it was late last year. Five names on this list, nearly all of which have posted solid returns through the first quarter of 2009, caught my attention.

Avalon Holdings (AWX)

This nanocap sports a market cap of less than six million but also has one of the most unique combinations of business lines that one can find. They provide waste management services in addition to owning and operating several golf courses including those at the Avalon Golf and Country Club in Ohio. In 2008, 80.4% of Avalon’s revenues came from waste management services. 48% of the company’s market cap is net cash and management sees their stable cash flow and access to credit as an opportunity to acquire new golf facilities in order to expand that side of the business. Liquidity, however, is definitely an issue with AWX shares – its heaviest trading day in 2009 was a whopping 10,200 shares. That liquidity risk may be worth some price impact considering if the stock traded at just half of tangible book value, it would represent a 246% return from its current price per share of $1.53.

Benihana (BNHNA)

Since the opening of its first New York restaurant in 1964, Benihana has grown to become one of the best known teppanyaki restaurants in the United States. From Anchorage to Caracas, BNHNA’s core “entertainment cuisine” is complemented by its newer northeast-based Haru and southwest RA Sushi. Of the five stocks in this list, BNHNA has been the best performer year to date and is up nearly 150% since hitting its 52-week low in November. I wouldn’t let that nor the stock’s relatively high P/E deter me from giving it a look. Taking into account $4.2M of restructuring charges and a $9.6M non-cash asset impairment charge in fiscal Q3 (which is calendar Q4 for the company), normalized EPS implies a price-to-earnings ratio of 5.83. That charge resulted in the first loss for Benihana in any quarter over the past fifteen years - quite a track record. Shares got a nice boost last week when the company announced a 5.4% sales increase from calendar Q1 of 2008. To help provide capital for expansion and continued revenue growth, Benihana secured a relatively inexpensive (2.2%) $75M credit line in March of 2007, of which it has borrowed a little over a third, and has access to that credit for another three years.

GSI Group (GSIG)

GSI Group, a maker of lasers, laser systems and precision motion equipment is likely the most speculative of these five stocks. First and foremost, the company has some unresolved accounting issues from as far back as 2006. The company has stated that it “does not expect its cash position will be materially impacted by the correction of these accounting errors.” Since GSIG shares trade at $0.10 on the dollar of tangible equity and roughly 19% of its last reported net cash position (June 2008 balance sheet), the market, however, isn’t as confident. There are others who believe that GSI Group will get through these accounting problems and see a major recovery in share price. One such believer is Stephen Bershad, the CEO of precision motion rival Axsys Technologies (AXYS). According to this SEC filing, Mr. Bershad personally purchased 3.3 million shares of GSIG in February and did so perhaps based on interest in purchasing Axsys that he’s received from large defense contractors. AXYS, by comparison, trades at 5.16 times tangible book value. Another Seeking Alpha contributor noted these same potential catalysts in mid-March. Unless an utterly catastrophic accounting correction takes place in the next few months and annihilates management credibility, it seems as though much of the bad news is currently priced into GSIG shares.

SORL Auto Parts (SORL)

The one Chinese stock on this list is also from an industry that’s under tremendous pressure these days. SORL Auto Parts is China’s largest manufacturer of air brake systems for commercial vehicles. 2008 was a great year for the company as revenues rose 13% and net income improved 15% from 2007. There was, as expected, significant weakness in Q4 2008 as sales fell and net income dropped to $0.10/share. Even if quarterly net income dropped another 20%, SORL shares would be trading at an annualized P/E of 6.25. That’s hardly rich for a company that’s poised to benefit from growing transportation needs in China and access to markets across the globe.

TII Network Technologies (TIII)

Founded in 1964 and currently based out of Edgewood, New York, Tii Network Technologies is the second nanocap on this list. The company develops a number of connectivity products for in triple play or strictly VoIP services. Considering that TIII had $8.28M of net cash on its balance sheet at the end of 2008 and now trades at a market cap just below that level, the market is clearly pricing in weakness for telco spending in 2009 having a serious impact on the company. There are some deteriorating product lines and that has shown up in near 25% top line decrease from 2007 to 2008 and a quarterly loss to close out an otherwise profitable year. Current CEO Ken Paladino helped see the Tii through difficult times as CFO in 2003. After dropping by more than half since the beginning of the decade, company revenue troughed that year and began a steady recovery. TIII shares saw a low of $0.13/share in 2003, but bounced back sharply to see prices greater than $2 by the end of that year. On a positive note, insiders have been acquiring stock over the past six months. If the company can manage costs through an economic slowdown and kick start growth in certain product lines, profitability could be maintained and shares would then likely see a very sharp rise later this year.

While these five stocks have passed the initial screener and my brief, preliminary analysis, I have not fully analyzed these companies. If you find any of them interesting you should perform additional research before investing.

Disclosure: At the time of this writing, the author has long positions in QXM and ZINC.

Comments

[SeekingValue]

Thanks for the post. I like this type of investment and I did own ZINC from the fall until very recently. I liked the looks of GSIG here, but on further reading, they spent about $320 million on an acquisition in August (after their last filing), so their tangible book is much lower now. I don't know what it is, but it seems that GSIG isn't the screaming bargain it appears at first glance.

2009 Apr 13 11:09 AM

[Tom Shohfi]

You are certainly correct - thank you for pointing this out. More at:

biz.yahoo.com/e/080821...

As I had mentioned, this analysis is preliminary and GSIG is a very speculative holding. Assuming GSIG hasn't generated any new cash since June 2008, it would still have $60M in cash after the acquisition and would likely have a reduced tangible book given goodwill. The stock still meets the criteria of the screener.



On Apr 13 11:09 AM seekingvalue wrote:

> Thanks for the post. I like this type of investment and I did own
> ZINC from the fall until very recently. I liked the looks of GSIG
> here, but on further reading, they spent about $320 million on an
> acquisition in August (after their last filing), so their tangible
> book is much lower now. I don't know what it is, but it seems that
> GSIG isn't the screaming bargain it appears at first glance.

2009 Apr 13 11:32 AM

[Tom Shohfi]

Actually, considering the interest payments on the debt issuance, GSIG would likely no longer meet the final criteria of the screener "LTM interest coverage ratio no lower than 15 (or zero debt)."


On Apr 13 11:32 AM Tom Shohfi wrote:

> You are certainly correct - thank you for pointing this out. More
> at:
>
> biz.yahoo.com/e/080821...
>
> As I had mentioned, this analysis is preliminary and GSIG is a very
> speculative holding. Assuming GSIG hasn't generated any new cash
> since June 2008, it would still have $60M in cash after the acquisition
> and would likely have a reduced tangible book given goodwill. The
> stock still meets the criteria of the screener.
>

2009 Apr 13 11:42 AM

[ArtfulDodger]

Thank you very much for pointing out these small companies which are obviously flying far under the conventional radar.

They're finds worth looking into.

2009 Apr 13 01:56 PM

[Arnbjorn Ingimundarson]

Thanks for a helpful article. What a great year this is to pick up some true bargains, although it is likely to come with some anxiety.

I noticed in AWX's annual report that management is considering a delisting, which along with the liquidity issue is keeping me away from this extremely cheap looking stock. Picked up some BNHNA shares, however, and I am tempted to get some SORL too.

2009 Apr 13 02:07 PM

[JR Ewing]

Benihana (BNHNA) - I have been going there for years, not sure how they are faring other places but in Cincinnati they seem to be going down hill - even though they are always packed. It is the experience that is become less - Mexicans as the chefs - you know the little things.

2009 Apr 13 10:35 PM

[Spartacus the Great]

Here's another for you to look at.

CGDI.OB (China Growth Development Inc.)

Never heard of it?
You're not alone.

But here are the FACTS.
They are a commercial mall developer and operator of 6 malls (with 2 under major expansion) in the capital city of Taiyuan, Shanxi Province.
ttm eps .11/share (for a PE about 1.5 on today's close)
Real estate/commercial mall property holdings valued at $66M, or $1.89/share (fully diluted on 35m shares)
Book value = .79/share
Insiders restricted from any sales until May 2010.
Trading float about 3M
annual report due out by Wednesday...loking for eps of .10-.12 for the year.
PICS of their properties:
www.chinagrowthdevelop...


Filings:
yahoo.brand.edgar-onli...

They have no IR firm yet, their web site is a little underwhelming still.


BUT HERE'S THE REAL BEAUTY OF THIS COMPANY

Since CGDI gets it's rent paid in advance in many cases for their longer term leases, they don't have an accounts recievable issue. In fact, they have the exact opposite- they have non-current deferred revenue of $25,724,975 for the last reported quarter.

If you're unsure of how much of a beautiful thing that is, then Google "non-current deferred revenue" and read what it is, and how it is accounted for in future quarters.

Apple has it on their I-phones....and it's a huge positive for them, or ANY company that has a business model where they can bank non current deferred revenues.

Non-Current Deferred Revenue of over $25M in a penny stock with only 35M shares (or about .70/share of GUARANTEED future revenues) is something I've NEVER seen before.

CGDI is a .80-1.00 stock- EASILY based on the deferred revenue they're raking in, the $66M value of their properties, ($1.89/share) their history of revenue growth, and future property expansion.

2009 Apr 14 07:57 AM

[Edward Dostillio]

Aloha,

AWX is a great risk/reward play but it requires patience. I first bought a big chunk in early 2000 and within 2 years I was down 60%. I was not panicked however because of the underlying value of the assets. I actually stepped up to the plate and bought more. Over the next 5 years the stock rewarded me quite well for patience as it went up 500% from that low. I sold 65% of my holdings at various intervals as the stock reached that multi year high back in 2007. I started buying again at $4 in July of 08 and was amazed at how low the stock price got. I got more aggressive with the purchases as the stock got lower and was thrilled I was able to buy 10K shares at $1. The amazing thing about this story is the company itself is actually performing better in 2008 then at any other time and looks to be profitable in 2009. My guess is the cause of the breakdown in stock price was not based on the fundamentals of the company, but the liquidity of the stock and the need for someone to sell because of margin calls. This is a perfect stock for my Roth IRA account as I expect after 3-5 years it wil have traded at $10 or higher at least 1 time during that period. Many people are afraid of the two tiered class A and B stock structure, but I took the time to meet the CEO who owns all of the class B stock and runs the company and I have been rewarded by my faith in him and His company

In Christ
Edword

2009 Apr 15 05:43 PM

[PeteK]

GSIG is interesting due to the nature of its business.
Not many business in this field and GSIG should come back strong.
Sure worth my consideration. Thanks.

2009 May 28 07:00 AM

[Ellito]

GSIG, no doubt about it.
best potential.

2009 Jun 04 08:15 PM

[Value Scouter]

GSIG also sold its General Optics for 21MM, "The Company also stated that its cash position, including the sale proceeds, but excluding approximately $25M of auction rate securities at fair value, totals approximately $70 million.". this news can be found on company website: www.gsig.com/investors/
How is the debt issurance component plays into it?..

2009 Aug 09 09:12 AM

[Tom Shohfi]

GSIG has not filed formal financial statements since that announcement in October 2008. Their last statement says that the company's cash position has not been impacted by the revenue recognition issues - finance.yahoo.com/news... - but it's likely that cash pile has been impacted by the company's results since it's last report and is now significantly lower. We will see when they finally file formal financial statements. Revenue declines and high interest payments on their debt from the Excel acquisition ( www.gsig.com/investors... ) likely exacerbated losses. Recently, much of that debt was converted into equity - finance.yahoo.com/news... - at extremely high dilution to shareholders. The stock is still very speculative. Best.

2009 Aug 10 06:51 PM

[Value Scouter]

Tom, thanks for your reply and I agree with you this is a speculative play. Good news is that they are getting out it and the company seems to be unique in what it is doing. Bad news are as what the news read. I wonder whether one can dissect the valuation from most recent 13D filing in June 09, can be found on company IR/sec filing... it looks complex to me.

2009 Aug 10 10:36 PM

[Tom Shohfi]

13-D fillings ( www.sec.gov/answers/sc... ) just showbeneficial ownership of the company's shares. Since these filings were made shortly after the debt announcement, it is unclear whether or not these are new holders on the open market or the beginning of senior debt owners converting into new shares. Either is possible. I tend to believe the latter because the filings include huge blocks of shares and there were only 4M shares traded on July 1st following the announcement. Here is a summary:

Company Shares

Goldman Sachs Asset Management 1,534,369
Hale Capital Partners 149,488
Highbridge Capital Management 1,325,136
Tennenbaum Capital Partners 1,325,135

2009 Aug 11 10:03 AM

[Value Scouter]

Tom, I believe it is the latter, as decribed in 13D under SEC filing: www.gsig.com/investors/
can one figure sth out from this:
"The Reporting Person may be deemed to beneficially own 149,488 shares of Common Stock, representing approximately 0.03% of the shares of Common Stock outstanding " and
"The shares that were purchased, Original Notes and Original Warrants were acquired with the Reporting Person’s investment funds in accounts under management. A total of $5,000,000 was paid to acquire the Original Notes and the Original Warrants. A total of $18,210 was paid to acquire the 10,000 shares that were purchased." this is senior notes i believe...
so we know how much Hale paid for the oringinal senior notes, and their current stake of equity, we may be able to get the valuation? then we need the dilution factor after the restructure. not sure whether this way of rationalizing is on the right track...?

2009 Aug 11 10:37 PM