My investment thesis was based on the following points:
- This Israeli food distribution company has been plagued by complex corporate governance issues for the past year.
- The current controlling shareholder is alleged to have misappropriated WILC's cash and is now forced to sell his stake in the company. A Class action lawsuit was launched against the company.
- I believe that none of these events poses a material threat to WILC's fundamentals as the scope of the lawsuit is limited and new ownership could even be a value catalyst.
- This creates an opportunity in the stock as the shares are still trading 17% below the NCAV, or what is most likely to be the liquidation value of the company.
- On top of that, the operations ran smoothly during the managerial chaos. The company's margins were stable and the operations were able to produce free cash flow.
I believe that all the points hold and the opportunity is still present in the stock.
Share Price Reaction
As you can see, since my initial article in late August the share price has slightly appreciated after the results released on the 22nd of November.
I believe that the price action was reasonable due to the results being positive, but I do think that there is still potential for further upside. Mainly because the results have shown that WILC's business continues to be profitable, which then makes the current valuation unreasonable as the stock is trading 15% below its NCAV value or what likely could be a liquidation value. Moreover, the ownership issues are likely to be resolved soon and end in a scenario that is largely positive for the minority shareholders.
Therefore, the long-term outlook remains stable and in the short term, shareholders will be benefiting from a recently announced dividend of $0.37 per share, which will be paid out in December.
As mentioned in my initial article, the key point about the fundamentals was that the company was able to function efficiently despite the ownership issues. This continues to be true as the company reported a profit and did not showcase many negative trends.
- Revenue Base
The only slightly less positive trend is that of the revenue, which declined by 7.6% QoQ and by roughly 5.2% from the previous quarter in June this year. The company mentioned that the three main reasons for this decline were the following:
- Loss of revenue on account of discontinued sales of private label products with one of our main customers, which had a one-time effect in the third quarter of 2015.
- The impact of shortage of inventories in third quarter 2016 due to, the Israeli Ministry of Health strike in July-August 2016 which significantly delayed the release from customs of our products.
- Overall market decline in food product consumption by the Israeli consumer.
Source: Q3 report filed 22/11/2016
While the first and the third points are negative for the overall business, when one looks at the trailing twelve months' revenue, it does not seem to be in a major downturn due to these two factors and thus if the company is able to post similar numbers in the upcoming quarter these concerns should not be an issue.
Moreover, due to the second point it might be that WILC will be able to post slightly better revenue numbers for the rest of the year, as the strike seems to be now resolved. The origin of the problem was likely the government's plan to privatize driving license testing process, which the biggest Israeli labour union, Histadrut, was against and decided to strike. The strike included customs services, which then likely impacted the ability of WILC to operate normally.
While the situation is now resolved, Histadrut could continue to disrupt the operations in the future. For example only couple of days ago, the government averted a significant strike of Histadrut after extending the current agreements regarding healthcare insurance for many public workers.
On the other hand, one positive macro news is that the Israeli government continues to be open towards releasing bans on importing various types of food. Recently, for example, the Ministry of Finance allowed duty-free imports of fresh meat. Should this sentiment continue distributors like WILC could find themselves with a lowered operational cost and in the long run maybe even new revenue opportunities as the distributors could try to take advantage of the newly 'opened' product offerings. On the other hand, it could also mean greater competition in the long term.
- Profitability and Cash Flow
While the revenue showcased slightly negative results, the margins have partially offset this as the gross margin remained largely stable due to WILC's continuous ability to leverage its exclusive partnerships and the operating margin declined mainly due to new marketing efforts not the revenue change.
The marketing efforts cost the company $0.7 million (14% of gross profit), most of which was for a program aimed at increasing awareness of WILC's products. The management did not mention whether this is going to continue for the foreseeable future. One will possibly be able to judge the effectiveness of the effort in the next quarter or two.
Finally, the cash flow remains to be positive and the company was able to generate free cash flow.
Although the free cash flow generation did drop compared to the levels in 2015, when the company was able to shed significant amounts of inventories and account receivables as seen below.
Although due to the likelihood of continuous profitability and the stable levels of account receivables and inventories, as seen below, the company should not see a sudden decline in the ability to generate cash flow over longer period of time.
To conclude, the operational results were mixed as revenue slightly declined, but profitability remained stable. The fact, though, remains that the company is able to break even and should not face any existential challenges in the foreseeable future. Therefore, I believe that the outlook remains the same, which means that the company should not trade below its NCAV value from the fundamental perspective.
Ownership situation is getting clearer
I believe that the main reason for the stock to trade under the NCAV value is ownership. In my initial article, the main question regarding the future of WILC was who is going to take over the control from Mr. Gurtovoy, a businessman who owned a controlling stake in WILC for a year before he was charged with allegations that he misappropriated money from two companies.
First from BSD, a holding company that owns a significant stake in WILC and which Gurtovoy had control over. The allegation is predominantly connected to $13.1 million of BSD's cash, which Israel 18 (company that Gurtovoy controls as well) apparently used as a collateral for its loan in Azerbaijan. BSD refuted that the board of directors ever authorized this and now sue Mr. Gurtovoy and demand the money back. Meanwhile, the Bank of Azerbaijan is reserving the right for the $13.1 million (deposited into the bank's accounts) because the Israel 18 is currently in default on this loan.
Secondly, Mr. Gurtovoy could have used a similar scheme with $2.75 million of WILC's cash position. This, though, seems not to be the case as the money is likely to be a bond that pays a regular interest, which WILC has indeed received as mentioned in my initial article. Therefore, it is unlikely that Mr. Gurtovoy would face similar allegations or a lawsuit regarding WILC. The only question that remains, in this case, is that the issuer of the bond is alleging that WILC has pledged to buy additional $2.25 million of the bonds. The company has refuted this. The issuer is yet to deliver a response. Even if WILC has to buy the rest of the bonds, this is not going to materially impact its cash position, which stands at $58 million.
During these allegations Mr. Gurtovoy was also facing additional liability as he still owed approximately $10 million to Mr. Shani for his stake in Israel 18, which Mr. Gurtovoy agreed to buy in order to consolidate his control over WILC in 2015. Thus, it was likely that an auction of Israel 18 holdings is at hand as Mr. Gurtovoy was unlikely to repay the $10 million. They were four seriously interested parties as shown in my previous article.
From the beginning the single best outcome for shareholders of WILC would be if the ownership is gained by Mr. Shalom Hayim, an owner of Ta'aman, another Israeli food distributor. The main reason for this is the likely incentives of Mr. Hayim, who might want to control WILC in order to realize synergies and expand his distribution operations, and therefore manage the business as efficiently as possible.
This scenario now seems to be realizing as Mr. Hayim was able to negotiate a deal with Mr. Gurtovoy. Ta'aman lent Israel 18 $10 million so that Mr. Gurtovoy was able to repay Mr. Shani for his stake in Israel 18 in time. This then prevented an 'open auction' for the stake in WILC and the other parties were unable to bid for the control. The two companies then drafted a memorandum of understanding (MoU) which would set up a 50%/50% control over WILC.
This new setup then can be represented in the following diagram.
While this does not simplify the complex structure, nor it removes Gurtovoy completely out of the picture, I believe that it prevents past issues from resurfacing as Mr. Hayim and Ta'aman will have half the voting power. As it is likely that he is interested in WILC because of the underlying operations, he will be able to stop any dubious transactions. The MoU also states that once in effect WILC will get a new management, which could be the first step to enhance shareholder value from this new ownership.
That being said the MoU is not yet in effect as it awaits a decision from the Israeli Anti-Trust authority as Ta'aman is also a food distributor. Should the MoU fail to come in effect, the situation could complicate and the uncertainty regarding the ownership could pressure the share price. Though, I believe that Mr. Hayim would not have done the deal before being highly certain of the outcome. When contemplating the offer, he mentioned that he is mainly analyzing the legal situation so that he would not ' enter bag of snakes,' therefore the MoU is likely to come in effect rather than not.
Another liability that should now be behind WILC is the class-action lawsuit connected to the February halt of trading in the shares. The company mentioned that the class-action lawsuit was dropped at no cost to WILC.
Therefore, the only legal liability that is left is connected to Mr. Gurtovoy himself and BSD. BSD shares continue to be halted on the LSE and should Mr. Gurtovoy be found guilty of the misappropriation of $13.1 million he, through Israel 18, might be forced to reimburse BSD shareholders. It is unlikely that Mr. Gurtovoy would be able to afford this and thus Israel 18 might again face liquidation.
Now though this would not be a huge issue as Israel 18 agreed in the drafted MoU that should this occur, Ta'aman would be able to pay the reimbursement and any additional legal penalties for Israel 18, but in effect take over Israel 18's share in the NewCo for 'free' (likely cost would be the loan of $10 million and the legal penalties). Thus, Ta'aman would become the sole owner of the control over WILC, which would likely be in the end even better scenario than the currently proposed structure.
This takeover would be possible because Israel 18 pledged its shares as a collateral when accepting the loan from Ta'aman (as specified in the MoU), which can then in the case of non-payment be seized by Ta'aman. This not only prevents WILC to be embroiled in uncertainty should Gurotovy be forced to pay for the BSD case, but in most other legal liability scenarios as well.
To conclude, WILC's ownership is likely to be resolved soon. Once the MoU is effective, there are not many challenges that could stop Mr. Hayim and Ta'aman from being able to control WILC. I believe that this is positive for shareholders as Ta'aman is likely to be incentivized to manage the operations efficiently, maintaining profitability and generating free cash flow. Thus, again making the current valuation of the shares unreasonable.
Valuation & Dividend Announcement
As mentioned, the shares remain to trade roughly 15% below the NCAV, most of which is in cash, as can be seen below.
Note: I adjusted the NCAV value for the upcoming dividend of $4.9 million.
Therefore, I believe that the current valuation still presents an upside potential as the company is slowly emerging from the ownership chaos and remains to be profitable. The downside is also limited to the potentially unforeseen legal liabilities due to the constitution of the NCAV value.
Additionally, the management of WILC has signaled that it is likely to be open to distributing a portion of its cash value as it announced a dividend policy, which will start this December as mentioned with a dividend payout valued at $0.37 per share. This policy is based on annual 'after-tax revenues' (likely net income) and the management said that it pledges to distribute at least 25% of these.
While a step in the right direction, we will see if this is going to be material going forward as the 25% level would not have been that significant in the past.
That being said the management could clearly afford to distribute more due to its cash position of $58 million. Although it is likely that after the ownership is settled the management might want to invest into the business as well.
I believe that the share price continues to present an opportunity. The company's worst legal liabilities are now behind it and should the ownership be resolved (MoU comes in effect), WILC's share price is likely to see significant upside as Ta'aman is likely to offer the company significant synergies and professional management.
That being said I would not buy a substantial portion of desired position now and would add only incremental number of shares. I would wait for a more significant purchase after the MoU is in effect.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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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