Rocky Mountain Dealerships (OTCQX:RCKXF) describes itself as a "consolidator of agriculture and construction equipment dealerships, primarily focused around Case IH, Case Construction and New Holland brands." It's a Canadian (figures in Canadian dollars) company that has 40 stores across Western Canada (December 2013). For customers it delivers value by offering a one-stop place with new and used equipment (including trade-ins), financing & insurance, parts and maintenance & repair services. Being able to do this has required the company to make multiple acquisitions of smaller dealerships. Only around early 2012 did the company decide that it needed to rebrand all of these dealerships under one name, Rocky Mountain Dealerships. Today, the company reports its numbers in two segments: Agriculture and Construction. Over 90% of revenues come from agriculture, the rest from construction. (Source: company website)
The company finances its inventory through floor plan payables. In short this means that the company finances up to 75% of eligible inventory through the floor plans and then pays the debt back fully after selling the inventory (or 48 months if that comes first). With the latest June 30 numbers, the floor plan payable was $374 million and inventory stood at $522 million, meaning that a bit over 71% of inventory was financed through floor plans. The past 3 years it has paid about 1% of revenues in floor plan interests. Rising interest rates could pose a threat to company's margins, especially in the short-term. Up to discussion is the fact that the company hedges its interest rate risks. In the 2013 annual report it was estimated that a 0.5% rise in interest rates would decrease net profit by little under $1 million.
Management has said that they intend to keep SGA expenses on an annual basis sub-10% of revenues. The past 3 years this has been fairly stable, between 10 and 11%. Gross margins have been tightly around 15%, although in 2013 they were 13.9%. Revenues have grown from 2008 to 2013 by 16% per year (from $404 million to $1007 million). From 2012 to 2013 the revenue grew $69 million, of which $12.5 million or 18% was organic growth (in agriculture segment).
A somewhat bullish scenario would be one where revenues would increase by 5% per year for the next 5 years. End result would be revenue of $1280 million, and assuming gross margin of 15%, SGA expenses of 10%, interests of 1.5% (1% floor plans and 0.5% others) and taxes of 29% (roughly what they've been in the past) we get net earnings of $32 million. Putting a p/e multiple of 11-13 on top of that, you get a market cap range of $350 to $410 million. From today's $220 million market cap that represents an upside of 60% to 85%, or 10% to 13% annualized. A lot depends on the company's ability to grow in the future, and at the same time to keep the margins and expenses in its hands. When 5% growth should give around 10% returns for investors, this in a sense leaves faster growth a 'free' option.
On a TTM basis, it currently trades at 15 times net earnings, hardly a massive bargain. On the contrary, as the above shows, the current price already assumes that the company is able to keep on growing without losing its margins. Without going deeper into macro forecasting, this could be challenging task but certainly not impossible. In short, a slowdown in the Canadian economy or agriculture sector would be a big negative for Rocky Mountain Dealerships.
In a bear scenario the company might even see negative net earnings. Its debt load (assuming inventory doesn't go terribly bad and leave them in problems with the floor plans) is quite alright, debt to equity being 0.30 (excluding floor plans). It is hard to estimate how far the price might fall in a very bad scenario. If we take the book value and assume a multiple of 0.85 on it, we get $135 million, downside of 38%.
There are risks with this company, no doubt. A big slowdown in Canada is probably among the largest risks. The probability of this is something no one will be able to predict. Economic headwinds are mostly temporary in nature and therefore might open up great buying opportunities, which could be the case with this one as well. Agriculture and the machinery needed in it isn't likely going away, even though the market might decline for some years. In the author's opinion this boils down to the question of whether it's good to buy now or simply look and wait whether the price comes down.
CEO Campbell and President Stimson announced that they will both retire in the end of 2014. This may or may not be significant for the company's future. It is worth noting that these people built the company basically from scratch to what it is now. The successors have large boots to fill and it is to be seen whether they'll manage to do that or not.
Capital allocation often times seems to be a matter that doesn't get enough of the attention. RMD allocates its investments in the business mainly via acquisitions. From 2008 to 2013 the company used a total of $49 million in acquisitions (net of cash). In 2013 the amount was $5.3 million, whereas earlier it has been between $7.5 and $9.8 million. As was discussed previously, the company's sales growth has come in large part due to acquired dealerships. For +5% growth rates to materialize in the future, the company most likely needs to keep finding dealerships to purchase at an annual rate of +$5 million (assuming management doesn't loosen their criteria).
Whether RMD is able to find suitable dealerships to acquire or not is a key factor to follow. Naturally if the company shows signs of being able to grow by 5% organically, then great, but until that happens the acquisitions need to continue.
RMD's business is cyclical and quarterly figures may not show much if looked at individually. One should pay closer attention to year-over-year changes instead. For the positive thesis to play out, gross margins need to stay close to or above 15%, SGA expenses sub-10% and interest expenses sub-1.5%. Increases and decreases year-over-year are the meaningful numbers.
Roadmap for investors
For investors looking for exposure in the agriculture sector, RMD is a decent opportunity at current prices and an even better if the price drops below $200 million. It's not difficult to see how this could give returns of around 10% at the current prices, although one should expect some volatility. The company is well-capitalized (assuming floor plan payables won't cause trouble) and therefore requires very serious headwinds to get into debt issues.
If an investor wants to purchase the stock at a price that should deliver +10% returns even if no material growth occurs, then the current price of $220 million might not cut it. For these investors looking for a bigger margin of safety, it might be better to wait and see if the price drops below the $200 million line.
Disclosure: The author has no positions in any stocks mentioned, but may initiate a long position in RCKXF over the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Please do your own due diligence. There’s always a risk of losing one’s principal.
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