In this article I am going to value and analyze a company I have been researching, L.B. Foster (FSTR). I will give a brief description of the overall business and then detail the major sections of the business.
L.B. Foster operates individual business units that specialize in rail, construction and tubular products. These groups manage manufacturing, distribution, and sales facilities worldwide. The company also functions as a distributor and service provider in strategic alliances with industry leading manufacturing and engineering firms. The company three distinct business segments:
- Tubular Products: L.B. Foster Coated Products operates and applies FBE corrosion protection, ARO overcoating, and internal linings in an advanced technology environment. L.B. Foster Threaded Products has the experience required to deliver quality water well products in today's rapidly changing environment. The L.B. Foster team of professionals provide timely delivery, superior reliability, consistent quality, and an ongoing commitment to customer satisfaction.
- Construction Products: L.B. Foster Piling has supplied flat, pipe, H beams, and Z sheet pile to the construction industry for more than 80 years. L.B. Foster's long experience in the production and application of sheet piling extends to today's current line of quality sheet piling sections. L.B. Foster Piling maintains a strategic relationship with Gerdau Long Steel North America and PND Engineers, Inc. CXT Concrete Buildings is the leading U.S. manufacturer of precast concrete restroom, shower, and concession buildings. These durable structures are in use at federal, state, county, city, and private recreational sites. L.B. Foster Fabricated Bridge Products provides steel grid bridge flooring, bridge drainage systems, bridge railing, custom pedestrian railing and complete bridge solutions.
- Rail Products: The Rail Products group is a leading, one-source supplier and manufacturer of quality railroad products for mainline, transit, mining, port, and industrial markets worldwide. Our full line of railroad products includes new rail, used rail, trackwork materials, rapid response/emergency track panels, crane rail, crane conductor systems, insulated rail joints, concrete ties, rail lubrication systems, transit rail systems, railway securement systems, and locomotive and car repair equipment.
As of the 2011 10-K, the rail segment contributed 55% of revenues, the construction segment 40%, and the tubular segment 5%. (The descriptions of the business segments above were taken from the 2011 10-K.)
The following valuations were done by me, using my estimates, and are not a recommendation to buy stock in the company. You should always do your own homework. Valuations were done using first-quarter 2012 10-Q and 2011 10-K. All numbers are in millions of U.S. dollars, except per share info, unless otherwise noted.
|Assets:||Book Value:||Reproduction Value:|
|Accounts Receivable (Net)||62||49.6|
|Prepaid Income Tax||1||0|
|Other Current Assets||3||0|
|Total Current Assets||230||175.1|
|Intangible Assets Net||42.4||20|
Total number of shares are 10.1.
- With Intangible assets: 239.1/10.1=$23.67 per share
- Without Intangible assets: 219.1/10.1=$21.69 per share
Current share price is $28.94 per share.
- Cash and cash equivalents of 67.8
- Total number of shares are 10.1
- Total current liabilities are 72
Short-term investments+cash and cash equivalents-total current liabilities=
- -4.2/10.1=-$0.42 in net cash per share
L.B. Foster has an EBIT of 5.1-1+35=39.1. I am using the trailing 12 months EBIT number.
- 5X, 8X, 11X, and 14X EBIT+ cash and cash equivalents are:
- 263.3/10.1=$26.07 per share
- 380.6/10.1=$37.68 per share
- 497.9/10.1=$49.30 per share
- 615.2/10.1=$60.91 per share
Current share price is $28.94 per share.
- Market cap is 286.7 million
- Enterprise value is 221.5 million
- EV/EBIT= 221.5/39.1=5.67
Since I am a very conservative investor, I usually use the lowest estimate of value as my base case. Since the company has good but slowly declining margins, which I will get to shortly, I am going to be using the 8 times EBIT estimate of value, which is $37.68 per share, as my base estimate of value.
With the current share price at $28.94 per share that gets us about a 25% margin of safety. Good, but not good enough, as I always want at the very least a 30% margin of safety. This company also has some other concerns, which I will get to shortly. But for now, on to the positives.
The company has had a current ratio of over 2 since 2006. A quick ratio of over 1.5 since 2007. Insiders own 5% of the company -- I would like it to be a bit higher, but good enough. It has been creating free cash flow since 2008. Return on equity since 2005 has been at least 7%. Return on invested capital has been at least 5% since 2005. The company has no current debt. It has available credit facilities of $123 million. Gross margins have been over 15% since 2007. Operating margin, or EBIT margin, has been over 5% since 2007. The company has recently started paying a dividend and the payout ratio is only 4%, which leaves room for growth. Book value per share has been steadily increasing over the years and the company is currently selling for about book value. The company is selling at a very low 5.67 EV/EBIT. The Tubular and Rail segments have the best gross margins of the company at 29% and 22%, respectively. The construction gross margin is 14%, which is still very good.
With all of the above, FSTR sounds like a screaming buy when it gets to my 30% margin of safety, right? Not so fast.
The company has some risks: pricing competition, poor economy, and the construction segment of the business has been losing revenue due to the Federal Stimulus having run out. The company's backlog of orders has also decreased recently -- the backlog of orders is used to gauge possible future revenue. Its margins, although very good, have been declining slowly over the years. With those concerns I would still probably be a buyer, but it just needs a bit more margin of safety.
FSTR does have one possibly gigantic concern that I have not talked about yet. It has an outstanding warranty claim against it that could be devastating to the company if it is found that it sold some defective concrete ties.
The following are quotes from the most recent 10Q.
Product Liability Claims
On July 12, 2011 the Union Pacific Railroad (UPRR) notified the Company and the Company's subsidiary, CXT Incorporated (CXT), of a warranty claim under CXT's 2005 supply contract relating to the sale of prestressed concrete railroad ties for the UPRR. The UPRR has asserted that a significant percentage of concrete ties manufactured in 2006 through 2010 at CXT's Grand Island, NE facility fail to meet contract specifications, have workmanship defects and are cracking and failing prematurely. Approximately 1.6 million ties were sold from Grand Island to the UPRR during the period the UPRR has claimed nonconformance. The 2005 contract calls for each concrete tie which fails to conform to the specifications or has a material defect in workmanship to be replaced with 1.5 new concrete ties, provided, that UPRR within five years of a concrete tie's production, notifies CXT of such failure to conform or such defect in workmanship.
The UPRR's notice does not specify how many ties manufactured during this period are defective nor which specifications it claims were not met or the nature of the alleged workmanship defects. CXT believes it uses sound workmanship processes in the manufacture of concrete ties and has not agreed with the assertions in the UPRR's warranty claim notice. The UPRR has also notified CXT that ties have failed a certain test that is specified in the 2005 contract. Since late July 2011, the Company and CXT have been working with material scientists and prestressed concrete experts, who have been testing a representative sample of Grand Island concrete ties. While this testing is not complete, the Company has not identified any appreciable defects in workmanship. Additionally, a customer of the UPRR has claimed that a representative sample of ties manufactured by the Company's Grand Island facility have failed a test contained in its product specification. As a result of this specific allegation, the UPRR has informed the Company that they currently intend to remove approximately 115,000 ties from track, which are a subset of ties subject to the July 12, 2011 claim.
The Company is reviewing this claim and, while its review is not complete, the Company continues to believe that these ties do not have a material deviation from its contractual specifications. The Company expects that the testing required to address this product specification issue will be completed sometime during the latter part of the second quarter of 2012; however, the Company expects that it will continue to work collaboratively with the UPRR to address their overall product claim for some time to come.
On January 11, 2012, CXT received a subpoena from the United States Department of Transportation Inspector General ("IG") requesting records related to its manufacture of concrete railroad ties in Grand Island, Nebraska. The Company believes that this subpoena relates to the same set of circumstances giving rise to the UPRR product claim. CXT and the Company intend to cooperate fully with the IG. The Company cannot predict what impact, if any, this investigation will have on the UPRR's product claim. Based on the non-specific nature of the UPRR's assertion and the Company's current inability to verify the claims, the Company is unable to determine a range of reasonably possible outcomes regarding this potential exposure matter. As a result, no accruals have been made as a result of this claim, as the impact, if any, cannot be reasonably estimated at this time. No assurances can be given regarding the ultimate outcome of this matter. The ultimate resolution of this matter could have a material, adverse impact on the Company's financial statements, results of operations, liquidity and capital resources.
According to FSTR's warranty, it owes 1.5 times the amount in question, which is 1.6 million.
- 1.6 million x 1.5=2.4 million in potential ties it would have to pay for.
The current price that I found for concrete ties is $42 a piece.
Let's assume for the sake of being cautious that it has to replace the entire 2.4 million ties.
- 2.4 million x $42=$100,800,000 in potential cost.
Even if it is only one-half or one-quarter of the 2.4 million, then it would be:
- 1.2 million x $42=$50.4 million.
- 0.8 million x $42=$33.6 million.
- If it is only the 115,000 ties that need replacing: 115,000 x 1.5=172,500 ties.
- 172,500 x $42=$7.245 million.
The company currently has around $68 million in cash on hand. It has $124 million in a revolving credit line that it could use if needed. So FSTR should be covered even in the absolute worst-case scenario. However, if it is the full $100.8 million amount, that is more than one-third of its current market cap, and almost one-half of its enterprise value. Those are shocking amounts to me.
FSTR has currently only made a reserve of $6.8 million to cover defective ties in this potential situation, which will not even fully cover the absolute minimum case. As of the most recent 10-Q, after analyzing some of the so-called defective concrete ties, the company has not found any defects in its concrete ties, which is of course very good news.
At worst, this could be devastating to FSTR going forward. If it has to draw down the credit facility, FSTR would not be able to fund future growth, make acquisitions, and probably have to stop paying the dividend that it just started. This could also lead to mistrust, loss of faith, and loss of confidence in the company. At best, this could turn out to be a minor blip on the radar screen and amount to only a few million dollars' worth of ties having to be repaid under the warranty.
There is currently too much uncertainty with the potential warranty claim for me to be a buyer in FSTR at this time. In the meantime, I will continue to research FSTR, and I will reassess after there is some conclusion to the warranty claim to determine if I will be a buyer at that time or not.
I did not talk about FSTR's competitors because I cannot to a good degree. Two of its competitors are private companies that do not release financial information. Alstom, the other company listed as a competitor, is not really a true competitor. Alstom conducts most of its business in the thermal power area. It also does most of its business outside of the U.S., where FSTR does almost none of its business.
So all I can really say about FSTR and its competition is what FSTR says in its SEC filings: That it is in a highly competitive businesses, it has to compete on pricing, and it has to place highly competitive bids for jobs.