After seeing several stocks on my watchlist get killed as of late, 1x book value has come in play for construction materials supplier Builders FirstSource (BLDR) as well as credit default swap seller Primus Guaranty (PRS). I set up a quick screen to see if there were any more interesting stocks trading at or under 1x book, and I also added a few qualifiers (positive cash flow, ROA, ROE) to weed out companies that are burning through money rather than making it.
The last time I wrote about Primus we were at the start of credit crisis fears, part I. The stock was at $9. It bottomed about a week later at $8 and subsequently ran above $11. Now that we're back at $8.60 - where to from here? In short, I believe the market is undervaluing Primus' earning abilities; more likely than not we will see PRS go down significantly from this point because of the linkage to credit derivatives, but:
- Primus seems unusual to me in that they hold CDS swaps to maturity. Of the approximately 12% of CDS swaps Primus has terminated before maturity, 10% are attributable to portfolio rebalancing and just 2% were attributed to deteriorating credit quality that made executives concerned about potentially greater future losses.
- In the last six months, three Board Members (Lusardi, Esposito, and Hartlage) have bought shares of PRS, in addition to CEO Thomas Jasper and Charles McLendon, President of Primus Asset Management. This doesn't seem to be a Moziloesque-harbinger of liquidity issues.
- And speaking of which, Primus is an Aaa/AAA rated counterparty, per the celebrated folks at Moody's and Standard & Poor's. I realize that many people have criticized the ratings agencies for handing out AAA-equivalent ratings on structured debt offerings like dentists hand out candy on Halloween, but I'd say the ratings agencies do a better job with actual companies.
- Finally, keep in mind that the ultimate decision to sell CDS protection on a company is the decision of Primus and based on its own analysis. So far, they have not experienced a "credit event" - i.e. a default or restructuring that they needed to pay out on.
I think the goods outweigh the bads here. The insider ownership and buying is a positive, and the spreads on credit default swaps have finally widened - something that has crimped Primus' ability to write new protection in the last few quarters… as management seems to favor an odd trait called "discipline." I think Primus' transparency on the kinds of protection they write is good -check out an SEC filing - and they break down notional values by Moody's/S&P rating, sector exposure, and the like. If weakness persists in the stock, I'll look into scheduling an interview with management in the hopes of casting light into the dark corners of structured finance - it would be interesting, and if I show my professor I can hold my own talking about CLO/CDO valuation, maybe I'll get a pass on my Finance final.
Switching gears (and fears) to an equally scary industry - something related to homebuilding - Builders FirstSource has come down to 1x book value. I note this somewhat hesitantly because:
- $173M of the $270M in equity is "goodwill"
- I've been really, really wrong just suggesting you should look at this company positively in the past
The only thing I've been right about here is that free cash flow will remain strong. Woo. Through a combination of stretching accounts payable and drawing down inventories a bit, management has managed to wring about $50M in FCF out of operations in the last two otherwise-anemic quarters. Right now I'm talking with IR in hopes of scheduling a management interview to get some perspective on the direction of the company and what they see regarding demand for building products in the next year or two. When that happens, I'll have more to add…
As I mentioned, a majority of Builders FirstSource's book value is intangible assets. This isn't what I had in mind when looking for "1x book" opportunities - too often, goodwill proves to be worthless a la AOL/Time Warner (TWX). My screen ended with 150 stocks to look at, and only one of the first thirteen fit the "net tangible assets" criteria. I ended up crossing out stocks like Headwaters (HW) (Dereck has some good commentary on HW), King Pharma (KG), and MKS Instruments (MKSI) that seem worth more of a look at a later time, such as after the Patriots-Colts game, leaving only Avatar Homes (AVTR) as the only actual "1x tangible book" stock.
As reader Ryan McP asked when I mentioned AVTR as one of the unloved small-caps in mid-October:
I'm not sure what you see in the housing market. AVTR's latest report (August sometime) stated that sales are pretty much mediocre at best. I checked their numbers ran them against the state of Florida's forecast and its not promising. Unless the housing market in AZ is taking off(didnt bother to check), I just dont see much hope for much growth. So unless you think that they have hit rock bottom and have no where to go but up i'm very skeptical out it.
Do I think AVTR has hit rock bottom? Price-wise, I have no idea. But every time I think of Avatar, I think of Marty Whitman's interview on CNBC, when Bill Griffith kept pressing him to answer all those pressing questions about "today's market" - what does Marty see happening with LBO/Private Equity deal-making? What does Marty think about subprime mortgages? I'm hardly qualified to say this, but I give Marty Whitman all the credit in the world for basically laughing and saying that he doesn't care. For once, something worth watching on CNBC…
Why Avatar? Try $197M in liquid current assets [LCA], which excludes inventories, and $197M in total liabilities - just $36M of it current. CLA and total liabilities nets out to zero. You get the other $525M in assets for 68 cents on the dollar. If you consider this article urging you not to bottom-fish in homebuilders because of their generally poor liquidity, you'll see why this is so important.
- Beazer (BZH): $290.6M in liquid current assets, $608M in current liabilities
- KB Home (KBH): $890M in LCA, $1.76B in current liabilities
- Toll (TOL): $771.7M in LCA, $1.5B in current liabilities
Then we have Avatar, which actually has a strong balance sheet. I know this isn't the most brilliant or exciting proposition ever, but book value plays aren't meant to be. I'd be interested to hear thoughts regarding Avatar vs. the rest of the homebuilders…