Would you be interested in a small capitalization hard-asset company with a long reserve life, high barriers to entry, substantial free cash flow, and track record of terrific operational performance over time? The company I am talking about is U.S. Lime & Minerals (NASDAQ:USLM). Since 2000, U.S. Lime & Minerals has been in the capable hands of CEO Timothy Byrne, who has been with the company in various positions for over 20 years.
The company has two business segments: Lime and Limestone operations (90-95% of revenues) and Natural Gas Interests (5-10% of revenues).
The Company, through its Lime and Limestone Operations, is a manufacturer of lime and limestone products, supplying primarily the construction, steel, municipal sanitation and water treatment, oil and gas services, aluminum, paper, glass, roof shingle and agriculture industries and utilities and other industries requiring scrubbing of emissions for environmental purposes
The Company, through its wholly owned subsidiary, U.S. Lime Company - O & G, LLC ("U.S. Lime O & G"), has royalty interests ranging from 15.4% to 20% and a 20% non-operating working interest with respect to oil and gas rights on the Company's approximately 3,800 acres of land located in Johnson County, Texas, in the Barnett Shale Formation.
The lime industry is characterized by high barriers to entry, including:
- The scarcity of high-quality limestone deposits on which the permits for extraction can be difficult to obtain
- The need for lime plants and facilities to be located close to markets, paved roads and railroad networks to enable cost-effective production and distribution
- Clean air and anti-pollution regulations, including those related to greenhouse gas emissions, which make it more difficult to obtain permitting for new sources of emissions, such as lime kilns; and the high capital cost of the plants and facilities
- These considerations reinforce the premium value of operations having permitted, long-term, high-quality limestone reserves and good locations and transportation relative to markets.
- Lime is a low priced commodity relative to its weight. This means that regional producers tend to have pricing power, as the cost of shipping a relatively cheap and heavy commodity large distances prevents competition from other regions. This same price/value dynamic also tends to protect the domestic limestone industry from foreign competition. In effect, regional producers (As a group) have a semi-monopoly supply situation in their local markets.
Here is a (very conservative) summary of USLM's current limestone reserves:
U.S. Lime & Minerals owns royalty interests ranging from 15.4% to 20%. It also has a 20% non-operating working interest in oil and gas rights on the company's 3,800 acres of land located in Johnson County, Texas, in the Barnett Shale Formation. The company's overall average revenue interest is 34.7% in the wells drilled under the O & G Lease.
The company also has a royalty agreement with XTO Energy Inc. This agreement covers oil and gas revenues deriving from approximately 538 acres of land next to the company's Johnson County, Texas, property. U.S. Lime & Minerals receives a 3% royalty interest and a 12.5% working interest, resulting in a 12.4% revenue interest, in the six XTO wells.
The great thing about the Natural Gas revenue streams is that there are no fixed costs associated with it. U.S. Lime & Minerals receives its top line royalty payments (between 3% and 20%) and then can choose whether it wants to participate as a non-operating owner by paying its fraction of the drilling and operating costs (12.5% to 20%). The company has zero employees devoted to the natural gas business.
Note in the above table that future estimated net revenues from the company's Natural Gas interests currently stand at approximately 34 million.
Let's examine U.S. Lime & Minerals book value growth from 2003 to 2013:
Please note this is only a very rough estimate of shareholder value creation. Balance sheet book value does not reflect the stock's intrinsic value for a number of reasons. In the case of USLM, the company is such a strong cash-flow producer that balance sheet trends are largely a product of cash piling up on the balance sheet.
USLM has over 225+ million tons (highly conservative estimate) of proven or probable reserves that it owns, and additional reserves that it controls through long-term leases. At current limestone prices, these tangible assets are worth many billion dollars - in other words U.S. Lime & Minerals' real assets are worth a massive multiple of the current enterprise value. However, because the value of this enormous asset base can only be realized over a very long period of time, the impact on current intrinsic value must be discounted. Regardless, the balance sheet book value significantly underestimates the company's hard asset intrinsic value.
Book value declined in 2012 because the company purchased over 700,000 of its own shares. While the purchase was at a price above book value (At $58/share, which is why book value declined), it is far below my conservative estimate of intrinsic value, which I believe is closer to $70 per share.
Let's look at price trends in Lime hydrate and quicklime to gain a better understanding of how the current value of USLM's limestone reserves have changed since 2003:
Price trends have more than kept up with the inflation rate, in spite of the recession and financial crisis. Note, this is national data and does not reflect the prices that USLM is able to sell its product at. However, I expect that over a long period of time, lime prices will continue to rise with or above the inflation rate, which should benefit the company.
EPS and share price growth from 2002 to 2012:
I think the above numbers speak for themselves. U.S. Lime & Minerals has a long history of rewarding shareholders with growing earnings per share, which over time has been reflected by a climbing share price. To paraphrase Warren Buffett: over the short term the stock market is a voting machine, but over the long term, it is a weighing machine. This has certainly been true for the U.S. Lime & Minerals share price.
The majority of U.S. Lime & Minerals' common stock is owned by Inberdon Enterprises, Ltd. as can be seen in the recent Proxy statement here:
Consider this: U.S. Lime & Minerals could easily support a two dollars per share annual dividend, which at the current price would equal a 4% yield. This would provide Inberdon Enterprises Ltd. with almost seven million in annual income. Inberdon is solely owned by one individual. The fact that this is not occurring suggests that Inberdon Enterprises Ltd. is oriented towards long-term value creation and potentially increasing its percentage ownership via the company's share repurchase program. I believe this long-term orientation will end up creating value for all shareholders.
U.S. Lime & Minerals bought back 700,000 shares in March 2012, which were purchased from NSB advisory LLC, at $58 a share. This transaction suggests to me that institutional buyers should look to NSB Advisory LLC as a potential source for a large block of USLM stock. As of 3/31/2013, NSB still owned over 220,000 shares. Otherwise, the stock is very difficult to trade efficiently on the open market.
I believe this company is presently worth around $70 per share. This value could be realized very quickly if the company ends up being acquired, or over time as the business continues to compound value for shareholders. In this later case, intrinsic value can be expected to grow, so the "value" created would end up being more than $70 per share.
In the spring of 2012, one of North America's largest lime producers (Graymont) purchased Western Lime in the private market. Could USLM be next? It is possible. However, I am not completely thrilled with the idea, even at a premium price. I think there is a potentially much better way for U.S. Lime & Minerals to unlock value and create wealth for shareholders. Click here to find out what I think it is.
Also, make sure to check out Mr. Leonard's excellent article "United States Lime & Minerals Should Benefit from Growing Infrastructure Spending," which is what inspired me to complete this article and get it published.