A Letter To Gencor Industries' Board Of Directors

May.23.14 | About: Gencor Industries (GENC)


Gencor is a deeply undervalued company selling near the value of its cash and marketable securities.

The company has been generating profits and growing book value over many years, and has no debt.

Management has been operating well in a challenging environment, but allocating capital poorly.

I first wrote about Gencor (NASDAQ:GENC) in December 2013. Since then there has been a modest rise in the stock price and the company remains deeply undervalued. Gencor is a profitable company in the road building industry whose market capitalization is approximately equal to its cash and marketable securities. While the management team has been conservative financially and operating well in a challenging environment, it has not allocated its capital optimally. I have explained my reasoning in the letter below, which I sent to the company's Board of Directors. If you are a shareholder and agree with my letter's premise, call or write the company at the address below. Small shareholders can make a difference.

Gencor Industries

5201 N. Orange Blossom Trail

Orlando, Florida 32810

(407) 290-6000

The company's stock is divided into two classes. Holders of class B stock are entitled to elect approximately 75% of the Company's Board of Directors. The CEO, Mr. E.J. Elliott and President, Mr. Marc Elliott (the CEO's son) control approximately 96% of class B shares. Hence outside shareholders have little room in changing the company's direction. The management team has been excellent at managing Gencor's operations and may be swayed into improving its capital allocation with a little nudging from outside shareholders.

There has been some downward pressure on the stock price lately due to partisan gridlock over a bill that funds highways and a comparative decline in second quarter earnings. In July of 2012, President Obama signed a $105 billion transportation bill. The nation's Highway Trust fund is expected to run out of money by August of 2014. Gencor's revenues are tied to highway construction. There is bipartisan support in funding the country's infrastructure but disagreement on how to accomplish it. Failure to reach an agreement will put thousands of highway projects across the country at risk. The gridlock and uncertainty have led to about a 10% drop in the stock price in the last month.

Gencor has had positive EPS eight of the past nine years. Many companies are able to achieve positive EPS under GAAP through loose accounting principles. Gencor, however, has been able to turn those profits into shareholder equity/book value. The increase in their BV is not in the form of intangible assets such as goodwill or long lasting assets (i.e., PPE) that are hard to sell. Gencor's majority of assets are in the form of cash and marketable securities. Management must be applauded for their prudent operations. Now it is time to return some of the cash to its owners.

May 19, 2014

Dear Mr. E. J. Elliott, Mr. Marc Elliott, Mr. Mellen, and other Members of Gencor Board,

We are individual investors and owners of Gencor Industries shares. We believe Gencor is an overlooked stock with outstanding manufacturing and customer service. At its current share price, Gencor trades at slightly above the value of its cash and marketable securities. The market is valuing Gencor's business and other assets at essentially zero. Thanks to exceptional management of operations, Gencor has been profitable for the past four years despite the challenging economic environment. The company's profitability along with an unusually strong balance sheet make Gencor one of the most undervalued companies. While we commend management's long-term operational performance in manufacturing, we believe shareholders will be better served with improved capital allocation through distribution of dividends and/or share buybacks.

Gencor's management team's performance has been impressive given the challenges of the road building industry. With the exception of 2009, Gencor has delivered positive earnings for the past nine years. Since 2005 management has more than doubled shareholder equity from about $51 million to over $110 million all while reducing total share count. Overall, we believe management's operating execution has been exceptional.

With regard to Gencor's capital allocation plan, we believe there is room for improvement. Gencor maintains an overcapitalized balance sheet. It is unclear why the company maintains over $91 million of cash and marketable securities. The cash balance has earned the company around 2% annually despite the S&P 500's rise of over 32% in 2013. The rising cash and securities balance along with low returns has been a huge drag on Gencor's return on equity. For example in 2007, the company's return on shareholder equity was about 23% compared to only 6% in 2013.

Management has suggested that the large cash reserves may be utilized for acquisitions as part of its growth strategy. Acquisitions may make sense in the future for Gencor, but such acquisitions do not justify the company's large cash balance. If Gencor were to pursue an acquisition target, the company could adequately raise the cash through debt financing or equity offering. With improved capital allocation, the stock price would increase, thus allowing the company to raise cash, if needed, through the equity markets at a much more favorable valuation than the current valuation. The company's experienced management team will enable the company to incur debt financing at attractive rates.

A small dividend rate of only 50 cents annually would cost the company less than $5 million per year. That would represent a conservative payout ratio of about 70%. Even if the company ceased to be profitable, the small dividend would deplete the company's cash reserves by only about 5% a year. The balance sheet would maintain its strength and the company would remain cash flow positive. Besides benefiting shareholders, it would lead to a rise in ROE and a higher stock price, thus increasing the company's flexibility in raising cash through the equity markets.

If management is reluctant to distribute cash in the form of dividends, alternatively it could invest Gencor's cash in one of the best investments available today: its own stock. Gencor has bought back its own shares from time to time in the past, as evidenced by the modest decline in its share count. It could now more aggressively pursue share buybacks which would also lead to improving its ROE and stock price. Given Gencor's low daily trading volumes, open market purchases may not be plausible for the company. However, Gencor could make significant purchases of its shares through a tender offer or a Dutch auction.

Given management's talent, motivation, and integrity, we are proud to be invested in Gencor. We believe the suggestions set forth in this letter will serve to further enhance the company and its value to shareholders.


Houman Tamaddon

Sheri Tamaddon

Disclosure: I am long GENC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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