I initially read about Avalon Holdings (AWX) here and here. Although the company has a history of low returns on investment/equity/assets, it seems to be undervalued as its shares trade at a market prices more than 1/3 of its book value.
Is the low price to book ratio caused by negative industry outlook?
This waste management industry screening gives us the following facts:
- AWX is by far the smallest (publicly traded) company in this category. Its market capitalization is 7 times smaller than that of the second smallest in the screening.
- AWX has the lowest Price-to-Sales (0.31) and Price-to-Book (0.29) ratios and the second lowest Price-to-Free Cash Flow ratio (4.08)
- The average Price-to-Book ratio is 2.71
- Only one other company reported operating losses in the screening.
Conclusion: A negative industry outlook is not the reason for the low market value compared to book value per share of AWX.
- Slow growth rate (5Y annual avg. sales growth is 4.24% compared to 12.5% industry average)
- Low profitability (note: the main source of losses comes from the golf operations)
- The stock is very small and illiquid
- Chairman and former CEO Ron Klingle has total voting power and therefore control over the company
- Gross margin is very low (18.4%) compared to industry average (60.7%)
The company has $5.5M in cash and carries hardly any debt. Are investment opportunities likely to improve its profitability?
In the latest SEC 10-Q form, the management reports that:
The waste industry has been consolidating and continues to consolidate as a result of a number of factors, including the increasing costs and complexity associated with waste management operations, lower volumes, and regulatory compliance. Many small independent operators and municipalities lack the capital resources, management, operating skills and technical expertise necessary to operate effectively in such an environment. Avalon believes that this pressure will continue to fuel the consolidation within the waste industry and has positioned itself well to capitalize on these opportunities in the future, either through acquisitions or strategic partnerships.
I find this interesting, as a consolidating market also means fewer competitors which could improve margins. The low barrier of entry seems to have caught the interest of Warren Buffett as he has invested in the second largest company in the industry, Republic Services (RSG).
Although the capital intensity of the industry is a negative factor, it could work in the company’s favor in future acquisitions because of a limited number of exit strategies for owners of privately held companies.
We will look to acquire businesses that complement our existing business platform. Our acquisition growth strategy will focus primarily on privately held companies and the waste operations of municipal and other local governmental authorities. We believe that our ability to acquire privately held companies is enhanced by increasing competition in the waste industry, increasing capital requirements as a result of changes in waste regulatory requirements, and the limited number of exit strategies for these privately held companies’ owners.
In regards to the Golf segment, the company reports:
In addition, several private country clubs in the northeast Ohio area are experiencing economic difficulties. Avalon believes some of these clubs may represent an attractive investment opportunity and is giving consideration to the possibility of acquiring one or more additional golf courses.
Conclusion: The consolidation of the waste management industry and the economic difficulties of Ohio based country clubs, offers opportunities of acquiring assets at fair value that are likely to offer economics of scale to the company’s current operations.
Disclosure: Long AWX