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Company Background

Gencore Industries (7.99) is a manufacturer of heavy machinery used in the production of highway construction materials, synthetic fuels, and environmental control equipment. The company designs, manufactures and sells machinery and related equipment used primarily for the production of asphalt and highway construction materials. The company’s principal core products include asphalt plants, combustion systems and fluid heat transfer systems. GENC believes it has the largest installed base of asphalt production plants in the United States.

Value

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The value is in the balance sheet. I decided to use two valuations: The NCAV calculation and the total asset adjustment calculation. In the NCAV calculation, I am excluding the $7.7 million in the book value of property and equipment as too conservative and because they are harder to value. Note: There is value in P&E that’s not on the books because, as of 9/30/10, the company had $10.6 million in fully depreciated assets that were in service.

I am also excluding $0.36 million in other assets for similar reasons. I am adjusting inventory higher because of the fact that the company uses the LIFO accounting system. The company estimated that the current cost of inventories exceeded its LIFO basis by $4.1 million as of 9/30. The company does not disclose this information in its quarterly filings, so I decided to use the last possible estimate Gencore gave. I increased the liabilities by $0.1 million because of leases. In the total asset calculation, I adjusted all of the asset values as listed in the Security Analysis. Note: Marketable securities are invested in equities, corporate bonds, and municipal bonds and all are valued at Level 1 quotes, which means that they are on the book at last quoted prices and not imputed values

As you can see, there is significant upside to both estimates. In the most pessimistic scenario, the company’s non-cash assets would be completely worthless. Taking out the total liabilities, that leaves the company at a value of $7.07 per share.

Asphalt Industry

The company and the industry as a whole have been in a rut since the financial crisis and the expiration of the highway bill. There was hope at the depths of the recession for the infrastructure stimulus to provide traction for the company, but that did not materialize as the company hoped. More recently, the industry has been hit by another government action, as the standard Federal Highway Bill has not been given a long-term extension but has only been granted short-term extensions. Funding is expected to fall as the stimulus money is expected to run out unless Congress passes the new bill.

Astec Industries (ASTE), which also has an asphalt business, said on its quarterly call in February that there are new efforts to reduce deficit spending, and that any new highway bill would probably be less than the existing bill. The company added that the asphalt contractors are better off under this situation with extensions than a new, smaller bill, because that would allow states to engineer larger bridges and interchanges. This would then leave less money for asphalt. A new highway bill, however, regardless of the size, would give more visibility into the outlook for the asphalt industry.

Although Gencore doesn’t have quarterly conference calls and I wasn’t able to reach management for comment, management has provided some commentary in quarterly press releases on the bill. In its last quarterly release, Gencore seemed to have attributed its lackluster operating results to the lack of a new highway bill. The Chairman, E. J. Elliot, said that “the current absence of the traditional multi-year highway bill, coupled with the depressed economy, have reduced sales opportunities.”

It seems like the only way the company’s results will receive a boost from the highway bill is if the bill has enough funding to leave the states with money for bridges and asphalt. In this type of environment, with government budgets on watch, it doesn’t seem likely.

Company

The bottom line is that this is a below-average company. The company had its best operating performance back in FY00, when it recorded operating income of $7.5 million. Since then, the company has been extremely inefficient and has had a 10-year cumulative operating income of $10.9 million on an average asset base of $80 million.

However, the company’s net income has benefited from interest on the company’s cash balance and its investment in Carbontronics. The company built four synthetic fuel production plants for Carbontronics and received royalties from the production of synthetic fuel. The company received significant income from this arrangement because in exchange for the synthetic fuel, Carbontronics received payment and tax credits, which it sold. Unfortunately, the tax credit legislation expired at the end of 2007 and this has been winding down. The income from Carbontronics totaled $109 million in the 10-year period.

Conclusion

I don’t think Gencore is a good company and, furthermore, I don’t think that a new highway bill is going to make a big difference in the company’s results. At best, I think the company’s operations will become slightly profitable.

Management is intent on keeping this a low-return family business, but at the same time, it is not destroying the business or using it to fill the family’s pockets. The passage of a new highway bill, regardless of the size, should provide a catalyst or at least bring the spotlight back to companies in the asphalt space.

To conclude, despite the pessimistic tone throughout most of this report, the valuation stands out and is what makes this stock a compelling investment. My fair value of the company is what it would be worth in liquidation or $10 a share. With $7.07 being the downside in the most pessimistic of scenarios, GENC is a safe investment. I advise to wait until the stock drops closer to $7.50 before buying, because the stock has spent a lot of time around that area over the past 18 months and it seems likely it will get there again.

Source: Gencore Industries: Deep Value Stock