By Randy Durig
Adams Resources & Energy Inc. (NYSEMKT:AE)
Per share values on 9-3-2010:
Market value $16.85
Cash $ 9.05
Equity value $ 7.82
Dividend rate 2.90%
With the success of our High Cash Stock Review and This Weeks Best Bond Report, we wanted to offer an hybrid that offers income with growth potential.
Adams Resources & Energy, Inc., along with its subsidiaries, is engaged in the business of marketing crude oil, natural gas and petroleum products. The main profit centers are tank truck transportation of liquid chemicals and oil exploration and production. Its subsidiaries include Gulfmark Energy, Inc. (Gulfmark), Adams Resources Marketing, Ltd. (ARM), Ada Resources, Inc. (Ada), Service Transport Company (STC) and Adams Resources Exploration Corporation (AREC).
To better understand Adams business model, think of the business model for a garbage truck route. The driver goes out and provides pick-up services for a fee to remote locations then pays to unloads at a centralized location making a margin or spread. Adam core services are fundamentally the same however financially backwards. Adams pays the owner/operators at the site of pick-up, the wellhead, and delivers the hydrocarbons to the pipeline where they receive payment. The core operations is a repeatable and profitable services business that is becoming less competitive due to companies like Adams achieving economies of scale. In addition to the reduction of competition, wellheads are continually being drilled thus increasing margins. In my opinion, this is a solid business.
Richard Abshire, CFO of Adams Resources explained that, "the core business provides such strong cash flow that they take the excess funds and invest in partnership oil and gas exploration.” While the gas exploration is currently a small business unit, it should over time, develop into a major profit center. During the first half of 2010 alone, they invested $6 million in oil and gas properties or $1.42 per share.
Insiders control 50.42% with very limited internal buying and selling. Having over half of the company owned by insiders illustrates to the outside investor that the very people operating the company think it is a strong investment for their personal wealth.
Great Balance Sheet
Adams has $9.05 of cash per share with no debt, that equates to the remaining enterprise having only a $7.82 value per share. They earned $.39 a share in their second quarter ending June 2010 and $.82 for the last six months. The cash flow from operation for the last six month was over $29 million dollars or $6.87 per share. That works out to be 84% return on the enterprise cash flow in only 6 months. The trailing annualized cash flow from operations was over $40 million. The annualized cash flow works out to be $9.47 per share. It appears that the high levels of cash are camouflaging the true earning power of the company.
The current peer groups trade about 8.15 times cash flow. Applying this metric would value Adams at about $74 per share plus $9 cash thus creating a market value of $83.
|Price to enterprise Cash Flow||.86||8.33||8.15||12.18|
The $.82 per share earned during the last 6 months gives them and enterprise PE of 10 and if you annualized that performance it is a PE of 5. The last four quarters of operational cash flow generated over a 100% return on the current equity value. That is an amazing high especially when you consider the 10 year treasury is yielding 2.645 %.
Price to Sales
Price to enterprise sales
The price to sales ratio is $.03 per share and their price to enterprise sales ratio is $.015 per share. Because of their model of buying and selling hydrocarbons(derivatives) instead of a mark up or mark down, typically used in trading commodities, we don’t believe the revenue model for valuation represents underpinning conditions.
|% Gross Margin||1.14||67.58||38.48||44.70|
Great Cash flow
Adam’s generated over $40 million in free cash flow from operations in their trailing fiscal year. That works out $9.47 per share. Realizing the value of the entire enterprise is only $7.82, again subtracting out the cash, the return on enterprise (ROE) works out to be over 120%. With the dividend rate of $.50 per share, Adams is paying out only 6% of the operational cash flow to it’s shareholders.
Since, in my opinion, the high level of cash is hiding the outstanding free cash flow generation from operations coupled with the initial outlay and poor performance of the new oil production/exploration venture, I believe they are in a position for a substantial dividend increase. Backing this theory up is the fact that the dividend payout ratio is only 6% of free cash flow.
Since the insiders own 50% of the outstanding shares they also have personal motives to significantly increase the payout ratio knowing this would greatly increase managements(their) personal cash flow, possibly before low personal tax rates expire.
Adams started issuing a dividend in 1994 and has paid one annually in November/December since then. The growth in dividends, see below, demonstrates their commitment to return excess earnings and pay shareholders.
Percentage Dividend Rate Increase from the prior year.
Adams historically has paid one dividend per year and the rate has been announced concurrently with the Q3 operating results.
Assuming they maintain the $.50 per payout per share, the yield would be 2.94% based on a share price of $17. Since they have over $9 of cash per share and the cash is concealing their real earnings power, for illustrative purposes only, let say they increase their payout to $.75 or only 11% of their 6 months operation cash flow showing how little a 50% dividend increase would affect cash flow. The stock is currently trading with at 2.9% yield or a 14% premium to the 10 year US treasury. It my option that with or without a dividends increase, just based on Adams history of growth, the current yield should be below the 10-year treasury, and if you look at the enclosed graph the dividends yield tops out around 3%.
Even though Mr. Kenneth S. Adams, Jr. is the Chairman of the Board and Chief Executive Officer of Adams Resources and a legend in the industry, he is 87 years old and his stewardship of the company appears limited. Many of his companies and services are commingled with his private operations including secretaries, office space, telephones service, and retirement/pension plans. The commingled services will make the separation of the enterprises much more difficult, once Adams leadership is no longer possible.
The oil industry in general has been tarnished by the mishaps of British Petroleum (NYSE:BP) in the Gulf of Mexico. This unfortunate, on some accounts unpredictable, incident has reignited the growing environmental concerns of the industry. With the current political leadership, the industry is also facing mounting regulation and with regulation comes cost.
Since the financial crisis, investors of the world shiver with fear when the term “financial derivatives” is used. As it happens, Adams main operations involve trading these hedging instruments. With the general public so scared of derivatives, it gives Adams another black eye. As far as we can tell, Adams has used derivatives how and why they were developed and intended to be used not on out of control speculation. Adams is servicing over 3,800 diverse properties in doing so transporting and selling more than 2.25 million barrels annually. Adam’s hydrocarbon intake volume correlates directly to the end services it sells to, not as speculative leveraged hedges as some firms have done.
Their large cash balance of over half their current equity value is only earning minimal bank investment returns. If they earned only a 3% higher return on their cash it would work out to be an additional $.27 per share of earnings before tax.
Adams core business appears to be gaining strength, even in the last year when the economic, environmental, and derivative markets provided tremendously negative attention in both the media and the investing public and corresponding stock value. It appears that based on cash flow, the enterprise value the company should be significantly higher. In my 30 years of investing, this is an amazing high return on equity. With a dividend above current benchmark bonds and Adams in a position to possibly increase it, knowing what the core operations are and the simple profitable repeatable service provided, the total investment, income, and cash flow appear so compelling we put into a core position in our Investment Growth & Income Portfolio.
Disclosure: Durig Capital and its clients currently do have long positions in Adams Resources