Almost all of Rex Stores’ $370 million revenue and $11 million profit is generated from the aforementioned consumer electronics stores. Unfortunately, this is a low margin business (3% net). The interesting part of the RSC story relates to its “hidden” assets. The good news is that management has demonstrated an understanding of the retail shortfall, closing less profitable locations at a rapid rate. The Company closed 14, 16, 25, and thus far 29 stores in 2004, 2005, 2006 and YTD 2007, respectively. For the purposes of the forthcoming valuation, we will assume that the business associated with their remaining 164 stores and accompanying inventory (carried at cost of $70.1 million) are WORTHLESS. In our sum-of-parts/assets analysis it will be valued at $0.
My valuation of this company is based on three components: their strong cash position, understated real estate holdings and the value of their ethanol production investments.
The Company recently closed the sale of 86 existing and former store properties to Coventry Real Estate Investments for $74.5 million. After closing costs, taxes and paying down of $16 million in debt, the company nets over $50 million in cash. This brings their net cash position to nearly $80 million. Finally, $13.2 million needs to be removed from this total because of the combination with the Levelland/Hockley ethanol investment. This leaves roughly $65 million in unencumbered cash. $65 million.
Even after the recent sale, the Company still owns 40 stores and 3 distribution warehouses. The stores are carried on the books (after adjustment for the Conventry sale) at $60 million. (All real estate on the Company’s book is related to the consumer electronics business, not ethanol). The stores in the recent transaction were carried at about 80% of fair market value. Furthermore, the Company stated on their March call that the carrying value of the 3 warehouses is “significantly understated” on the balance sheet. To be reasonable we will assume that all RSC real estate is carried at 80% of fair value. This means current values need to be marked up by a factor of 1.25 to equal fair value. 1.25 times $60mm equals $75 million. $75 million.
Finally, we get to the ethanol business. Over the past couple years the company has made investments and contingent commitments in five ethanol production facilities. The plants are at various production stages (including one that is operational). Based on my calculations, the plants should have a collective capacity of 342mm gallons by mid/end 2008 (Company financials suggest 420mm gallons). Of this, I calculate an annual accrual to RSC of around 50 mm gallons (again, the Company has quoted figures closer to 100mm after consideration of contingent investments and existing ownership option exercise). For our purposes, we will assume 50mm gallon production capacity for RSC. In order to estimate the value of the business, we will use a measure of Enterprise Value to Production Capacity. Comparables include Pacific Ethanol (NASDAQ:PEIX) (5.3x), VeraSun Energy (VSE) (3.6x) and Aventine Renewable (AVR) (3.0x). To be conservative, we will use 3x. 3 times the annual accrual of 50mm gallons equals $150 million enterprise value. $150 million.
Adding cash ($65mm), real estate ($75mm) and ethanol business enterprise value ($150mm), the total value equals $290 million. Split amongst the 12.7 million (diluted) RSC shares, share price would be $22.83.
Alternative measure: An alternative method for valuing the ethanol business is to use an earnings multiple. Comparables include Pacific Ethanol (18.3x), VeraSun (18.7x) and Aventine Renewable (16.7x). To be conservative, we will use 15x.
Based on a recent call, the Company indirectly confirmed that operating profit per gallon of ethanol is $0.40-$0.50. Multiplying $0.40 times the above production of 50 million gallons equals $20 million in earnings. $20 million earnings times 15 P/E equals a market cap of $300 million. $300 million divided amongst the 12.7 million diluted shares equals $23.62 per share. Add the $65 million net cash and $75 of unrelated real estate (i.e. electronics stores) and you’re left with $34.65 per share.
Valuation 1 = $22.83
Valuation 2 = $34.65
Current share price = $15.86
• Ethanol goes out of favor
• Ethanol comps are overvalued
• RSC Management is slow to close unprofitable electronics stores
• Ethanol projects are slow to develop
• The leap from TVs to ethanol is just too much
The icing on the cake for investing in Rex Stores is the strong insider ownership. Stuart Rose, the CEO, owns 9.39% of the company.
Disclosure: Author holds a long position in RSC
RSC 1-yr chart